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COVID-19 Legal Resource Guide
Oct. 09, 2020

SEC Issues Report on Credit Market Interconnectedness and the Effects of the COVID-19 Economic Shock

On Oct. 5, 2020, the Securities and Exchange Commission (SEC) published a staff report titled U.S. Credit Markets: Interconnectedness and the Effects of the COVID-19 Economic Shock (the Report). The Report contained a number of observations relevant to the leveraged loan and high-yield bond markets, including the following:

  • Leveraged loan risks have grown in recent years as a result of an increase in covenant-lite loans.

  • Downgrades from Investment Grade (IG) to High Yield (HY) may be procyclical, resulting in bond sell-offs that further lower prices in an already depressed market.

  • Based on widely accepted indicators of debt capacity, e.g., interest coverage ratios and leverage ratios, the ability of U.S. corporations to service their debt has not decreased during the last decade despite the lower average credit ratings and the concentration of corporate debt, reflecting the effects of lower interest expense.

  • During COVID-19 market stress in March 2020, the trading of corporate bonds peaked, resulting in a 48% increase of daily trading volumes and high transaction costs. In March, the bid-ask spreads and credit spreads for HY spiked by as much as 125 and 1,087 basis points, respectively. Although spreads have declined since March, they still remain high compared to the pre-COVID-19 period, indicating that default risk and market uncertainty are still a concern.

  • Although HY bond trading generally has stabilized, the impact of COVID-19 on issuers’ financial health might deteriorate and result in increased HY bond defaults and corporate restructurings.

  • The credit default outlook in 2021 for HY bonds is between 112 and 289 defaults and a default rate between 6% and 15%.

  • Leveraged loans in the LSTA 100 Index that traded at 98% in February, traded below 80% in March and now trade at 94%, indicating that default expectations are higher relative to pre-COVID-19 levels but significantly lower than the March levels.

The report is available here.

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