Maybe history wouldn’t have to repeat itself if we listened once in a while. – Wynne McLaughlin
Maybe history wouldn’t have to repeat itself if we listened once in a while.
Despite the absence of a recession or systemic crisis, the U.S. leveraged loan market just matched the Global Financial Crisis (GFC) in one dimension: the duration of elevated defaults. The trailing 12-month loan default rate slipped to 3.7% in November, ending a 22-month stretch above 4% that tied the GFC as the longest on record and exceeded the COVID-19 cycle. We are experiencing a broad and persistent default cycle in the leveraged loan market without a traditional macroeconomic downturn.
Multiyear default measures highlight the breadth of this cycle. The five-year cumulative default rate for loans peaked just above 16% earlier this year, nearly matching the 17% reached in 2012 following the GFC.
The comparison to the GFC also highlights an important distinction in the shape of the two cycles. The trailing 12-month default rate climbed above 8% in 2009, compared with a peak below 5% in the recent cycle. The GFC remains the deeper downturn, yet the breadth and persistence of the current cycle are notable.
The breadth of the current cycle reflects a loan market that expanded during a period of exuberant growth that weakened underwriting standards. The market has tripled in size to roughly $1.5 trillion since 2012, and the surge in capital has been accompanied by looser documentation and a sharp rise in distressed exchanges. These out-of-court restructurings, which now represent nearly three-quarters of defaults, allow troubled borrowers to negotiate directly with creditors and impose losses on lenders.
With the Federal Reserve cutting the federal funds rate and the loan default rate slipping below 4%, there are early signs that borrower pressure might be easing. Further monetary relief could help stabilize interest burdens, but the underlying credit backdrop has not materially improved. Loose documentation and continued reliance on distressed exchanges appear to be structural features of today’s loan market rather than temporary byproducts of the current cycle. These dynamics suggest that even as conditions improve at the margin, the loan market will remain vulnerable to persistent credit stress.
Loan investors have suffered significant losses over the past few years, yet the market never experienced the cleansing reset that followed 2008 or the COVID-19 downturn when lenders regained the ability to demand wider spreads and better structures. Loan spreads now sit near post-GFC tights despite elevated defaults, which reinforces the lack of a meaningful turn in the credit cycle. In assessing the signals coming from the loan market, the breadth of this cycle, rather than its peak severity, has been the defining feature of modern credit stress and serves as a reminder that having peak defaults as the sole focus risks missing the contours of the market.
Between the Lines is a weekly blog by DoubleLine Portfolio Managers Sam Garza, Joseph Mezyk and Quant Analysts Fei He, CFA and Sunyu Wang that breaks down topical macro and market issues. For questions or suggestions please e-mail us at betweenthelines@doubleline.com. The views and opinions expressed herein are those of the authors and do not necessarily reflect the views of DoubleLine Capital LP, its affiliates or employees.
