February 20, 2020 - Loan defaults climbed (slightly) this month and leveraged M&A structures have been more conservative in the last three months. These two facts likely are unrelated.

First, on the default side, S&P/LCD reported four loan defaults in January, bringing the LTM default rate to 1.95% by count and 1.8% by volume. To be fair, this is a 22-month high, but the default rate remains well below historical averages. (Fitch notes that the HY default rate is 3.2%, even with no January defaults.)

Likely totally unrelated, deal structure on new loans is a bit tighter. Covenant Review discussed metrics of the deals it has seen in the last three months through mid-February. As their charts indicate, unadjusted leverage on M&A transactions fell from 4.7x first lien/5.5x total in fourth quarter to 4.3x/5.0x in the last three months. In addition, EBITDA adjustments shrank a bit, so adjusted leverage declined even further. Covenant Review flags three major drivers behind this trend: First, LBO volume is down in early 2020, so there has been a shift in the sample. Second, purchase price multiples are lower. (However, PPMs fell less than leverage multiples; the gap was bridged by equity contributions climbing to 57% in deals emerging in first quarter.) Third, early 2020 deals were underwritten in late 2019 when choppy conditions and recession concerns reduced arrangers’ appetite for underwriting risk. So are conditions suddenly tough for BSL borrowers? Not exactly. Repricings have come fast and furious in January, pulling down spreads. And, as an added benefit, 3M LIBOR has dropped from 1.9% at year-end to 1.69% recently. As a result, Refinitiv LPC notes that, even as middle market institutional loan yields remain relatively stable, yields on new BSL loan have dropped 84 bps since 4Q19 and 270 bps year over year.