US junk debt investors cautious of leveraged loans as economy slows

By Matt Tracy

(Reuters) – Leveraged loan deals are expected to pick back up after a stabilization in markets over the past week, although some investors say they are cautious about junk-rated loans if the economy weakens.

Borrowers pulled back on leveraged loan deals last week, following disappointing jobs data on Aug. 1 and Aug. 2 that raised forecasts for aggressive interest rate cuts and spurred concerns about lower-rated debt.

A total of six leveraged loans worth $3.3 billion sold last week, which falls well short of the $10 billion weekly average this year and is the worst week for issuance outside the holiday-shortened first week of July, according to PitchBook LCD data.

One junk-rated loan deal sold on Monday, airline JetBlue Airways’ five-year term loan, according to PitchBook LCD. JetBlue originally sought a $1.25 billion loan, but downsized it to $750 million and upsized its bond offering to $2 billion from $1.5 billion, according to Informa Global Markets. JetBlue did not immediately respond to a request for comment.

At least two leveraged loan deals hit the market on Tuesday, including a $160 million add-on to virtual dataroom Datasite’s cross-border term loan and a $253 million repricing of for-profit education operator Adtalem Global Education’s term loan, according to PitchBook. Datasite and Adtalem did not immediately respond to a request for comment.

Lower rates can be good news for highly indebted companies.

“There’s no doubt if the Fed ends up cutting more as is priced in currently, that’s going to be a big relief for (those) borrowers,” said Hans Mikkelsen, credit strategist at TD Securities.

“But (investors) can now expect to earn less going forward because of that, (and) there’s going to be less availability of financing in the leveraged loan market (as a result),” he said.

Leveraged loan funds reported $3.1 billion in outflows last week, which is the most since March 2020, according to JPMorgan. That includes a record $2.4 billion outflow from exchange-traded funds.

The Morningstar LSTA US Leveraged Loan Index fell 0.55% on Aug. 5, the worst daily performance for the index since the collapse of Silicon Valley Bank in March 2023. The index has since clawed back these losses.

“For leveraged loans, a wave of volatility did throw a wrench into the works for the loan primary… forcing several opportunistic transactions to the sidelines,” said Marina Lukatsky, global head of credit research at Pitchbook.

These included deals for investment firm Focus Financial Partners, theme park owner SeaWorld Entertainment (owned by United Parks & Resorts Inc.), and wireless provider SBA Communications, according to Lukatsky. The companies did not immediately respond to a request for comment.

“I think we will see a pickup in primary issuance in both markets,” said Jeremy Burton, portfolio manager for U.S. high yield and leveraged loans at PineBridge Investments.

“In the loan market, there were a number of repricings (and) refinancings that were either pulled or just didn’t launch…we could see some of those come back,” he said.

A gap between net loan supply and investor demand since the Fed began hiking rates in 2022 should sustain demand for new loan deals through the end of this year, according to Lukatsky. She estimated that investor demand this year exceeded net loan supply by at least $130 billion as of July 31.

But headed into 2025, further signs of an economic slowdown and aggressive Fed rate cuts could prove detrimental to certain leveraged borrowers’ refinancing or new loan plans.

“Getting away from (last) week, I think investors will be focused on the potential for a slowing in the economy,” said PineBridge’s Burton.

(Reporting by Matt Tracy; editing by Megan Davies, Shankar Ramakrishnan and Chizu Nomiyama)

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