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Modest near-term refinancing needs, resilient credit trends, and growth in private credit are driving our constructive outlook for speculative-grade credit quality. But recovery rates for first-lien debt will likely remain under pressure as debt structures for speculative-grade companies have become more leveraged and top-heavy.

What We're Watching

For U.S. issuers rated in the speculative-grade category ('BB+' or below), 2024 marked another resilient year for credit-measure performance—the fourth in a row with median EBITDA growth (through the third quarter). Along with earnings growth, repricings and rate cuts have helped reported EBITDA interest coverage stabilize at around 2.3x, following a protracted decline from 3.6x in late 2022 through late 2023.

Still, while credit metrics for most issuer rating categories have stabilized, interest coverage for borrowers in the 'CCC/CC' bucket remains strained at less than 1x. Other challenges and uncertainties remain, as well.

Potentially adverse consequences from the Trump administration's policies could reignite (or prolong) inflationary pressures, add to budget deficits, keep interest rates elevated, and weigh on corporate profitability amid heightened market volatility.

High borrowing costs continue to strain lower-rated speculative-grade borrowers' credit profiles, with approximately 20% of public speculative-grade issuers reporting deficits in EBITDA interest coverage (almost exclusively in the 'CCC' and 'B-' categories). The proportion of speculative-grade issuers rated in the 'CCC/CC' category remains elevated at about 12% in January, and these companies exhibit persistent cash flow shortfalls and interest coverage deficits.

Overall, the leveraged credit market continues to have wide issuer and market dispersion but narrowing downside tail risk. For example, speculative-grade bond-only issuers maintain stronger credit profiles, while loan-only issuers are more challenged, with median EBITDA interest coverage in the mid-to-high 1x area—about three turns lower than bond-only issuers. Furthermore, S&P Global Ratings saw more upgrades than downgrades among its higher-rated speculative-grade issuers.

Our credit-estimated middle-market issuers saw an increase in cash-to-payment in kind (PIK) amendments , but slightly higher median cash interest coverage along with an improving downgrade-to-upgrade ratio that nearly reached parity in the fourth quarter of 2024.

What We Think And Why

Modest near-term refinancing needs, fairly favorable credit conditions, robust investor demand, and the expansion of private credit all bode well for U.S. leveraged finance. A manageable 10% of public market speculative-grade issuer debt due in 2025–2026—representing just 1.2% of speculative-grade debt overall—currently trades at distressed levels. Additionally, favorable economic and earnings expectations should support improving ratings momentum and lower defaults and may bolster growth-oriented financings such as those for mergers and leveraged buyouts.

Issuer ratings outlooks have improved, with the proportion of those assigned a negative outlook declining to 19%, from about 23% a year ago. Still, default rates remain elevated after spiking to a new post-COVID high of 5.1% (preliminary estimate) at year end 2024, although we expect this to decline over the course of 2025. A resilient economy, sustained earnings growth, and a more manageable near-term refinancing burden lead us to forecast the U.S. speculative-grade corporate default rate will fall to 3.5% by December 2025.

What Could Change

If shrinking EBITDA growth and margin contraction keep default levels elevated, recovery rates for first-lien debt will likely remain under pressure as debt structures for speculative-grade companies have become more leveraged and top-heavy.

Our recovery ratings (which estimate future recovery rates on rated debt in a default scenario) on first-lien debt have declined to the mid-to-low 60% area in the past six years, compared to long-term average actual recoveries of 75%-80%. Key drivers include a combination of increasing total and first-lien debt leverage, shrinking junior debt cushions, and the predominance of covenant-lite loan structures. These factors generally pressure recovery rates on junior debt but can vary significantly based on the underlying debt structures.

A surge in aggressive out-of-court loan restructurings—often referred to as liability management transactions (LMTs)—that impair some (or all) existing lenders poses another threat to recovery rates for syndicated first-lien debt investors in the U.S., while shareholders retain their equity positions.

Since mid-2017, we've tracked 42 aggressive non-pro rata loan LMTs, with the annual count reaching a record of 15 in 2024 (up from the previous peak of 10 in 2020 during the COVID pandemic). Most of these LMTs haven't solved the capital structure problems that forced these companies to restructure in the first place, with 33% of the companies subsequently filing for bankruptcy, while another 56% have either defaulted again or are rated 'CCC+' or lower (issuer ratings of 'CCC+' or lower connote our expectation that an eventual default is more likely than not).

The effects on disadvantaged lenders (those excluded from participating in a transaction or subordinated relative to others) can be dramatic. These restructurings have impaired first-lien recovery expectations for the most disadvantaged lenders by about two-thirds on average (roughly 35% of par), with these lenders' recovery expectations wiped out entirely in 15 cases.

Given the often-dramatic effect of LMTs on loan recoveries for disadvantaged lenders, it's important to note that a recent court ruling casts doubt on the viability of restructuring tactics that have been a key element of numerous LMTs in recent years. Still, it's unclear if this will meaningfully impede the ability to complete LMTs or lead to a change in restructuring tactics or in the documentation terms requested by companies (both of which already appear to be in play).

On a positive note, the desire to avoid litigation risk appears to have triggered a trend to offer all lenders the opportunity to participate in these restructurings, which has somewhat narrowed the gap between winners and losers in the past year.

Writers: Joe Maguire and Molly Mintz