October 3, 2019 - Headlines notwithstanding, it doesn’t seem like the U.S. leveraged loan market is that hot. Admittedly, S&P/LCD says lending picked up 15% between second and third quarter. But in the year-to-date, leveraged lending is down across the board, according to S&P/LCD and LPC. Consider this: LCD sees total leveraged lending volume at $372 billion in the first three quarters, off 26% year-over-year; LPC’s volumes are down 41% to $563 billion. Institutional? Off 34% (to $237 billion) for LCD; off 57% (to $259 billion) for LPC. What’s up? HY bond issuance – a non-trivial 32%, says LPC.

Part of the decline in lending comes from a fall in opportunistic refinancings – after all, most loan spreads are higher today than they were in first half 2018 – but it also may be due to increased lender conservatism. Lenders’ resulting preference for higher-rated (BB) credits extended to both price flex and covenant flex in third quarter (and particularly September), LevFin Insights and Covenant Review write. On the pricing side, in September, reverse flex led upward flex 10:0 for BB credits; it was 12:10 for lower rated borrowers. In turn, BB clearing yields hit a one-year low, while single-B spreads widened.

On Covenant Review’s Document Score side, 3Q19 borrowers hit market with aggressive documents; proposed document scores averaged 3.79 points – ranging from 1 (most protective) to 5 – in 3Q19 vs. 3.63 in 2Q19. However, investors pushed back, with the final documentation scores tightening 0.32 in 3Q19 (to 3.47). In contrast, 2Q19 deals flexed tighter just 0.17 points to 3.46. Importantly, lenders mostly pushed back on lower rated credits: Those rated B1 or lower saw Documentation Scores improve an average 0.36 points, while borrowers rated Ba3 or higher improved a mere 0.02 points.

Lenders’ increasing caution mirrors “loans of concern” – and leads default statistics. According to Fitch, their “Loans of Concern” have climbed; Top Loans of Concern sit at $47.7 billion and Tier Two Loans of Concern total another $56 billion. Still, Fitch’s year-to-date default volume is down 11% versus last year, the leveraged loan default rate still sits at an achingly low 1.5% and is expected to climb above 2% in 2020.

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