Junk-Loan Rally Cuts Company Borrowing Costs
Investors are scooping up low-rated corporate loans, fueling a rally that is lowering borrowing costs for highly indebted companies.
Investors poured more than $8 billion into funds of so-called leveraged loans in January and February, according to Lipper data from Refinitiv—the most in more than two years and a notable reversal from more than $26 billion in net outflows last year. That has helped boost loan prices to around their highest levels since November 2018, beating returns on corporate bonds and Treasurys.
Companies issuing new loans, including web-hosting firm
GoDaddy Inc.
and racetrack operator
Churchill Downs Inc.,
are taking advantage of the demand, raising a record of $110 billion during the first two months of the year. Other borrowers, such as consulting firm AlixPartners LLP and software firm Kofax Inc., have pursued more opportunistic loan deals intended to pay a dividend to shareholders.
The rally is notable after loans rebounded from the pandemic more slowly than other assets last year. Now, with junk bond yields still hovering around 4.5%—below their pre-pandemic record lows—investors are turning to leveraged loans because their interest payments increase with short-term rates.
The yield on the benchmark-10-year Treasury note recently climbed above 1.6% to its highest levels since the pandemic began, powered by investors’ expectations for vaccine- and stimulus-fueled rebounds in growth and inflation.
Investors, meanwhile, this year have poured more than $8.8 billion into U.S. mutual and exchange-traded funds that buy loans as of March 4, according to Refinitiv Lipper, while pulling $3.7 billion from comparable junk-bond funds during the same period. While junk bonds still pay out a higher average yield, loans are more senior in the capital structure, putting investors closer to the front of the line to get paid in the event of a bankruptcy. Unlike junk bonds, loans also are often backed by a portion of the company’s assets, providing additional collateral.
“If you think inflation is coming or rates are going to rise, you’re going to want to move up in the capital structure,” said Keith Berlin, director of global fixed income and credit at FEG Investment Advisors.
Loans have returned over 1.8% in 2021, counting price changes and interest payments, ahead of the roughly 0.4% return on high-yield bonds and 10-year Treasurys’ minus-5.2%. Loans rated triple-C, one of the lowest credit rungs before default, have led the rally, returning more than 5.7% to investors during the same period.
Many investors look to the loan market as a barometer of credit conditions, since deals tend to involve debt-laden companies with low credit ratings—a combination that tends to deter lending when people get nervous about the future.
One reason the loan market recovered more slowly than bonds was because the biggest buyers, who bundle the loans into so-called collateralized loan obligations, got caught up in last year’s credit crunch. Many large borrowers in the loan market didn’t qualify for support from the Federal Reserve and instead had to work with lenders to renegotiate or amend loan terms.
This year, CLOs are off to a hot start, with issuers selling more than $58 billion during the first two months of the year, according to data compiled by
PLC, the biggest start to any year since at least 2013. Analysts expect CLO creation to grow from last year’s volumes, providing another steady source of loan demand.
Some companies have taken advantage of the recent rally to cut interest costs, which can lead to upgrades and rising loan prices. Some have improved the terms of their loans. That has sparked…
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