Stock markets have been hitting all-time highs and credit spreads remain low, yet higher interest rates and mounting floating-rate debt are straining lower-rated borrowers. This tension is surfacing first in leveraged loans as “quiet defaults” become more common — opening up a dynamic set of opportunities for investors specialized in stressed and distressed assets.

A Decade of Cheap Debt Comes Due

Years of exceptionally low interest rates prompted companies to borrow heavily, with lenders accepting weaker protections in loan agreements. Now, rising rates are colliding with high leverage, especially for companies whose loan costs rise directly with Federal Reserve policy.

Since 2019, the proportion of leveraged loan borrowers with interest coverage ratios below two has increased meaningfully (Exhibit 1). Lower ratios suggest less cushion for borrowers, making them vulnerable if economic conditions worsen.

Why Loans, Not Bonds, Are Breaking First

Two main factors explain why stress has become more centralized in loans rather than high yield bonds:

Market mix: More lower-rated borrowers now rely on the loan market, leaving it exposed to rising rates, while the high-yield bond market holds stronger credits.

Floating-rate exposure: Borrowers with floating-rate loans feel rate hikes immediately, while those with fixed-rate bonds face increased costs at refinancing. In 2024, loan default rates outpaced high-yield bond defaults by the widest margin in decades.

Additionally, collateralized loan obligations (CLOs) — which own about two-thirds of U.S. loans — are forced to sell when holdings of downgraded (CCC-rated) debt exceed certain levels, often leading to “non-economic” selling and opportunities for these opportunistic credit buyers.

Europe as a Leading Indicator

The eurozone experienced this stressed and distressed opportunity before the U.S., with ongoing economic stagnation, persistent budget deficits and global uncertainty fueling distress. By mid-2025, several major restructurings spiked European default volumes, despite tight spreads. CCC-rated loans were hit hard, and capital became scarce for riskier issuers. 

The ‘Quiet Default’: How Debt Restructuring Is Changing the Cycle

While formal defaults may appear low, many stressed borrowers are quietly restructuring debt through liability management exercises (LMEs). LMEs allow companies to renegotiate debt terms and improve liquidity without declaring bankruptcy. In 2025, the combined default rate — including both bankruptcies and distressed LMEs — ended the year at 3.5% by issuer count, with about 46% of defaults coming from LMEs rather than missed payments.

Weaker loan agreements have enabled the rise of LMEs, which can buy troubled companies time but often disadvantage creditors who do not participate. Frequently, LMEs signal deeper issues and may precede in-court restructurings if fundamentals fail to improve.

Compelling Backdrop for Opportunistic Credit Investing

This cycle of stressed and distressed investing is less about waiting for a massive bankruptcy wave and more about actively engaging across different opportunities. Expect a steady stream of LMEs, extend-and-amend deals, and creative capital solutions as companies address upcoming maturities in a higher-rate environment. Forced sales from CLOs and other technical pressures continue to create mispricing, particularly in performing but stressed senior secured debt.

Here are three main types of opportunities for opportunistic credit investors:

Liability Management Exercises (LMEs): Also known as Capital Solutions, these allow troubled companies to adjust debt terms outside of court, with lenders often receiving tighter terms, higher yields, or equity stakes in exchange for support.

Stressed Situations: Investors can purchase deeply discounted debt where borrowers are still meeting obligations, expecting eventual recovery to par value at maturity.

Distressed Restructurings: Creditors can swap debt for equity, helping reduce company debt loads and interest expenses, while retaining potential upside from any recovery.

Specialized and nimble managers — like hedge funds — can exploit these situations across asset classes, jurisdictions, and legal systems, unlike mutual funds or ETFs.

Bottom Line: Don't Wait for the Default Wave

Don’t be misled by headline spreads or strong equity markets; underlying structural issues in the loan market and the surge in LMEs create a prolonged distressed credit opportunity set. Specialists capable of navigating complex legal scenarios, acting quickly during forced sales, and moving across the capital structure are best positioned for strong returns across varying economic environments.

For investors, we believe the best approach is to embrace this evolving landscape with a flexible approach — focusing on undervalued performing assets, bespoke capital solutions, and out-of-court and in-court restructurings — instead of waiting for an unlikely one-off wave of defaults.