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US leveraged loan defaults hit two-year high after $4.5B of August filings

·5 min read

Default activity in the U.S. leveraged loan market roared back to life in August after bankruptcy filings from four issuers in the Morningstar LSTA U.S. Leveraged Loan Index pushed $4.46 billion of institutional loan debt into non-performing status.

Coming off historic lows, the default rate of the index rose to 0.69% by issuer count, and to 0.60% by amount, from a respective 0.43% and 0.28% in July.

There was more defaulted loan volume in August than in the prior 17 months combined.

Leading in size among index defaults, Endo International filed for Chapter 11 protection in New York’s Southern District bankruptcy court to reduce debt and address lawsuit liabilities stemming from its alleged role in the US opioid epidemic.

The drug maker’s term loan B, placed in 2021 to refinance existing debt, had $1.975 billion outstanding at the time of filing, marking the largest issuer default since SeaDrill Partners’ $2.6 billion loan in July 2020.

According to Endo International’s Chapter 11 petition, the company has total assets of $6.33 billion and total debts of $9.54 billion. Shareholders listed on the petition include The Vanguard Group, with a 12.07% stake; BlackRock, with a 7.93% stake; Paulson & Co., with a 7.37% stake; and Renaissance Technologies, with a 7.07% stake.

Endo's India-based entities are not part of the Chapter 11 proceedings, the company said, adding that it expects to file recognition proceedings in Canada, the United Kingdom, and Australia.

The pharmaceutical company is the latest in high profile Chapter 11 filings for addressing opioid claims. Among other loan index issuers, Mallinckrodt recently emerged from bankruptcy after placing $1.9 billion of index loans into bankruptcy in October 2020.

Also under the healthcare umbrella, medical imaging company Carestream Health filed for bankruptcy in the District of Delaware. The recapitalization contemplated by the prepackaged plan will eliminate approximately $470 million of debt. Carestream’s term loan had $507.7 million outstanding, according to court filings.

Citing rising print costs and reduced mail demand, OSG Billing Services filed for Chapter 11 bankruptcy with a plan that would leave all creditors either unimpaired or with a recovery valued at 100%.

According to the company's disclosure statement, the proposed reorganization plan would amend and restate the company's existing first-lien term loan, outstanding in the amount of about $599 million, with a slightly larger facility in the amount of $601.4 million. The restated loan would mature in June 2026, and the new interest rate would be an adjusted Sofr+225 bps (with 75 bps paid in cash and 150 bps paid in-kind), subject to a 1% Sofr floor, according to a term sheet attached to the company's RSA, which was also filed with the bankruptcy court.

Rounding out the busiest month for default activity since July 2020, lights manufacturer Lumileds filed for Chapter 11, citing challenges caused by supply chain constraints, Covid-related issues, and the conflict in Ukraine for the company’s excessive leverage. Lumileds, a developer and manufacturer of lighting products that serve mainly the auto, smartphone, and industrial end markets, had $1.61 billion outstanding on its term loan B due 2024, court filings show.

Situation imminent?
Looking at potential near-term situations, U.K.-based cinema operator Cineworld confirmed that it is considering a Chapter 11 filing in the US and ancillary proceedings in other jurisdictions as part of a potential balance sheet restructuring.

Cineworld last warned about its ability to continue as a going concern in the release of its full-year results for 2021 in March. Among other headwinds — including the pandemic and competition from online movie streaming — the firm is appealing against more than $900 million of damages awarded to former merger partner Cineplex after it walked away from a deal to buy the Canadian group in June 2020.

With $3.49 billion of loans across three facilities in the loan index, a Chapter 11 filing from Cineworld would be the largest default of loans from a single issuer since McDermott International placed $3.52 billion of term loans into bankruptcy in 2018.

Hypothetically, a default from Cineworld would lift the August loan default rate (by amount) to 0.87%.

A potentially less immediate, but still pressing, situation emerged from long-standing loan issuer Avaya. The telecommunications and software vendor — which entered the loan market for LBO financing in 2008 — has walked the path of Chapter 11 before. Once again, the company is warning of its ability to continue as a going concern after it reported a nearly 70% year-over-year decline in adjusted EBITDA in preliminary third-quarter fiscal 2022 results, and at the same time announced this it is working with advisors to assess options relating to its 2.25% convertible notes due June 2023. Avaya has three term loans in the Morningstar LSTA US Leveraged Loan Index totaling $1.89 billion.

More broadly, stress indicators continue to tick higher, but remain well below long-term averages.

Per LCD’s data, the "below 80" cohort of performing index loans has nearly doubled in the past six months, to $45 billion, though for context, during the height of the pandemic market crash in March 2020, this skyrocketed to $672 billion.

The August distressed volume translates to 3.19% of performing loans in the Morningstar LSTA US Leveraged Loan Index. While this is the highest month-end reading since October 2020, it remains well below the 10-year average of 4.23%.

In a final measure of credit risk trends, downgrades outpaced upgrades for a third consecutive month (a 16-month upgrade cycle for the asset class was snapped in June). On a rolling three-month basis, the downgrade count of loan facilities in the Morningstar LSTA US Leveraged Loan Index exceeded upgrades by 1.89x in August, up from 1.74x in July, and 1.32x in June.

This article originally appeared on PitchBook News