Middle-Market Loan Defaults May Jump to 10% Amid Shutdowns

Middle-market loan default rates are likely to soar in the second half of the year as business shutdowns due to the coronavirus pandemic take their toll, according to a survey released Wednesday by Carl Marks Advisors.

Three-quarters of the respondents said default rates among non-investment grade borrowers will hit or exceed 10%. The middle-market advisory firm and investment bank received responses from 110 financial advisers, lawyers and lenders in late April.

“You’re clearly seeing situations unfold as the first, second and third layer of borrowers is impacted and you’re seeing it affecting a much wider swath of the economy in much more deep, unknowable ways,” Brian Williams, a partner at the firm, said in an interview.

Before the virus struck, analysts had predicted that defaults would remain relatively low. Fitch Ratings had projected a 3% and 3.5% default rate for leveraged loans and high-yield bonds this year, respectively.

Some lenders are providing near-term support to companies, including allowing interest to be paid-in-kind rather than cash, or relaxing penalties. Some 63% of respondents in the survey said they expect lenders to be flexible in handling non-accrual loans or covenant grace requests.

“We’re absolutely seeing lenders work with borrowers,” Williams said. “Lenders are in triage mode right now trying to figure out which of their borrowers have real problems that they need to be aggressive about, and which are better served by being patient -- but the vast majority of lenders are being supportive and accommodating.”

Some of the biggest headwinds to a resurgence in financing and deal activity is the inability to project revenue with confidence because of the pandemic, volatility in capital markets and irrational purchase price multiples, the survey found.

Many companies intend to use U.S. government stimulus measures like the Paycheck Protection Program and Federal Reserve’s Main Street Lending Program to boost their financial strength.

“Everyone and their brother is taking advantage of them to the extent they can,” Williams said.

Survey participants expect a rebound in lending later this year, with about 66% stating that they think markets will reopen for well-capitalized mid-size borrowers. Nearly 95% say debt markets will reopen by spring 2021.