COVID presents survival of the fittest for credit issuers

Strong underlying fundamentals and a favourable outlook for 2022 and beyond are apparent across non-investment grade (IG) credit. Within such markets, issuer default rates are an important driver of market and portfolio performance. Our Non-Investment Grade Credit Team recently conducted a bottom-up analysis to project issuer default rates for the U.S. corporate high yield¹ and leveraged loan² markets for 2021 and 2022. 

The analysis resulted in projected 2021 default rates of 0.3% and 0.6% for the US corporate high yield and leveraged loan markets, respectively. The high yield default rate would be an all-time low while the leveraged loan default rate would be well below the historical average. With respect to 2022, our bottom-up analysis is projecting default rates of 0.9% and 1.2%, respectively, which are modestly above 2021 but still well below the historical average for both markets. 

The primary drivers of the low projected default rates are the adaptability of issuer business models and cost structures at the onset of the pandemic, the ability for most issuers including those in COVID impacted sectors to access capital markets during 2020 and year-to-date 2021, and current strong macro tailwinds associated with the global reopening of economies.

We believe 2020 ended the credit cycle that began following the global financial crisis, with 2021 marking the start of a new cycle. Notably, while non-IG default rates were above the historical average in 2020, they were significantly below default rates experienced in each of the prior three credit cycles. In our view, the events of 2020 have proven the ability of most non-IG corporate issuers to navigate a period of extreme volatility, while accelerating the removal of the weakest issuers from the market—the majority of which were already expected to default over the next several years even prior to the onset of the pandemic. 

Additionally, robust capital markets activity during 2020 and YTD 2021 has allowed most issuers to extend maturity profiles and strengthen liquidity positions, providing a long runway prior to any refinancing needs or default catalysts. The duration of the prior credit cycle (2010 – 2019) has shown that these favourable fundamentals can persist for an extended period. 

We expect default activity that does occur to be concentrated in sector-specific or idiosyncratic situations, which highlights the importance of bottom-up credit analysis and deep sector-specific expertise within the current environment.

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Footnotes

1. As defined by the ICE BofA U.S. High Yield Index.
2. As defined by the S&P/LSTA Leveraged Loan Index.