The leveraged loan market has staged a strong rally as consensus that a recovery is just around the corner becomes more entrenched, prompting investors to look further and further down the ratings spectrum in a bid to boost returns.

Loans rated triple-C recorded an 18.31% gain in May to return 43% so far this quarter, according to the S&P/LSTA Leveraged Loan Index. That’s the best month ever, according to Standard & Poor’s LCD unit and well ahead of loans from borrowers rated single and double B. Single- and double-B rated loans gained 7.4% and 2.93% last month, respectively, with returns of 20% and 9.5% so far this quarter. This is in stark contrast to the first three months of the year when BB-rated loans returned 13.5% and loans from triple-C-rated borrowers returned a negative 7.6%.

“In June 2007, leveraged loans were priced as though no loan would default, but at the end of last year they were priced as though every one would default. Now some normalcy has returned,” said Steven Miller, managing director of S&P’s LCD. With the S&P/LSTA index returning 26.63% year-to-date, leveraged loans have outperformed most other asset classes this year. But they might not have rallied so furiously without the help of the junk bond market, which has
returned with a vengeance.

More and more junk-rated borrowers have been turning to the bond market this year to refinance billions of dollars of leveraged loans maturing through 2014.

Issuance of junk bonds has soared even as the market prepared itself for Monday’s chapter 11 bankruptcy filing from General Motors Corp. This has helped cut the stock of leveraged loans and put money back into the market, giving loan investors a stream of cash to put to work.

Indeed, proceeds from about 60% of high-yield bond sales in 2009 have been used to pay down bank debt and this has already helped reduce the amount of outstanding loans to $575 billion, according to Miller.

“If the high-yield market remains strong, the loan market has further to run and it can get back to business,” Miller said. “We can get to a more normal situation where the loan market is printing $200 billion a year in new issuance…” he said.

The rising prices and the prospect of excellent returns will continue to lure investors and may even encourage managers of collateralized loan obligations, structured product that pool high-risk loans sold by junk-rated companies, to return.

But for that to happen, investors have to keep believing that the banking system will heal and that the economy will improve. “…and these things have to continue to be true for the loan market to continue its rally,” Miller said.

The Central Bank said total foreign debt as a percentage of GDP rose to 22%
in February from 19% a year earlier.

In absolute term foreign debt owed by the government and private companies was $46.64 billion, up from $44.94 billion a year earlier.

The Colombian economy grew 2.5% in 2008, according to the country’s
statistics department. In the fourth quarter, the economy contracted 0.7% and likely contracted again in the first quarter of this year.

The government’s total foreign debt rose to $29.94 billion, or the equivalent
to 14% of GDP, up from $29.19 billion in February 2008, or 12% of GDP,
following a $1 billion bond sale in January.

German Verdugo, a market analyst with local brokerage Correval SA, said the government’s debt will rise in the following months because of another $1 billion bond sale carried out in April, even though the money collected from the April bond sale will be used to finance the 2010 budget.

Besides the $1 billion in bonds, the government plans to borrow $2.65 billion from multilateral lenders, such as the World Bank and the Inter-American Development Bank this year to plug its widening 2009 budget deficit, which is expected to reach the equivalent of 2.3% of gross domestic product.

The ratio of debt to GDP will rise as the debt increase is happening when the
country’s economy is contracting, Verdugo said.

Overseas debt held by Colombia’s private sector was also higher in February, at $16.70 billion, or the equivalent to 7.9% of GDP, from $15.75 billion, or the equivalent to 6.5%, in February 2008.

Companies’ foreign debt is lower than the $16.85 billion registered in
January. In the first months of 2008, Colombian companies borrowed abroad but are scaling down since November as a result of the crisis, Verdugo said.

The Central Bank said that a large chunk of the country’s foreign debt,
$41.55 billion, bore long-term maturity, while the remaining $5.09 billion
carries a short-term maturity.