The risky-loan trade is back



Yields of 9% are drawing investors to leveraged loans, whose defaults have remained low.

A corner of Wall Street long shunned by investors is suddenly in demand.

Higher rates over the past two years were expected to slam risky corporate borrowers that rely heavily on floating-rate debt. That hasn’t happened.

Instead, low-rated corporate loans have steadily outperformed investment-grade bonds and are drawing inflows for the first time since 2021. So far this year, everyday investors have poured $12.2 billion into mutual and exchange-traded funds focused on such loans. That is after a combined $27 billion in outflows for 2022 and 2023, according to LSEG data.

The attraction for investors: Yields of about 9%, and defaults that have remained low as the U.S. economy cools with little sign of an impending recession.

“With the Goldilocks economy narrative coming to the forefront, investors are feeling a little bit more safe in the loan market," said John Lloyd, a portfolio manager at Janus Henderson Investors.

That is despite the risky reputation of low-rated corporate loans, which are also known as leveraged loans for their role in funding private-equity firms’ buyouts of companies.

Since the start of this year, the Morningstar LSTA U.S. Leveraged Loan Index, which includes loans to companies including Uber Technologies and American Airlines, has delivered a return of 4.6%, including price changes and interest payments. Meanwhile, investment-grade bonds have edged up 0.4%, while junk-rated bonds gained 3.1%.

Over time, analysts say higher interest rates could hurt the profitability of risky corporate borrowers, leading to falling loan prices and rising default rates. For now, investors’ confidence in leveraged loans is reflected in the shrinking premium they are demanding above the benchmark overnight rate.

The sudden demand for risky corporate debt has helped spark a flurry of loan sales and refinancings by companies including Peloton Interactive and United Natural Foods. Collectively, low-rated businesses issued and refinanced $736 billion of speculative-grade loans through June 30, according to PitchBook LCD. That is up from less than $200 billion for the same period last year.

“The market is wide open," said John Sherman, a portfolio manager at Polen Capital. “If you can’t refinance in this market, that’s saying some pretty negative things about the performance of your individual company."

First Eagle Investments, a New York-based money manager, entered the year with about $1.775 billion in floating-rate debt due in February 2027. Encouraged by a rally in its loan prices, the firm refinanced $1.3 billion of that earlier this year, pushing out the maturity to March 2029.

Then last month, First Eagle refinanced another $300 million—more than it had planned.

“We had a lot of excess demand," said Brian Margulies, First Eagle’s chief financial officer.

In late April, United Natural Foods was able to lower borrowing costs on $500 million of senior secured debt, from an initially indicated range of 5 to 5.25 percentage points to 4.75 percentage points above the benchmark rate. The food wholesaler priced the loan at the top end of the initially indicated price range, reflecting strong demand.

Investors and analysts still have concerns about leveraged loans, which could pay out lower coupons if the Fed cuts rates later this year. The loans are also widely seen as carrying a high risk of default, and the overall quality of the market continues to deteriorate.

The two highest rungs of risky corporate loans now account for 30% of the Citi Leveraged Loan Tracker, down from 33% at the start of the year and from 54% in 2015, according to Michael Anderson, head of U.S. credit strategy at Citigroup.

“The average quality of the market is a big concern," Anderson said. “If we continue to lose our higher-quality companies, it changes the complexion of the market into one that’s of lower quality."

Defaults remain low by historical standards but are creeping up. The share by dollar amount of the Morningstar leveraged-loan index that has defaulted in the past 12 months was 0.92% as of June, up from 0.83% at the start of last year, according to PitchBook LCD data.

Investors have nevertheless been flocking to collateralized loan obligations, which buy up leveraged loans and package them into securities. But much of the activity in the leveraged-loan market has been companies refinancing existing debt, instead of issuing new debt.

About 60% of the loan-issuance activity so far this year is for refinancing, said Marina Lukatsky, global head of credit research at PitchBook LCD.

“There’s a massive imbalance between supply and demand for leveraged loans," Lukatsky said.

Write to Vicky Ge Huang at

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