U.S. leveraged debt markets are growing more bifurcated, as institutional investors flock to higher-quality issuers while shutting out lower-rated borrowers, according to a new report from Moody's Ratings.

The divergence marks "classic late-cycle characteristics" with slowing growth, rising rates and increasingly selective financing conditions. Investors are rewarding stronger issuers while lower-rated, more leveraged borrowers are facing mounting credit stress, Moody's said.

The approaching 2028-2029 maturity wall is likely to increase reliance on liability management exercises and distressed debt exchanges among weaker borrowers, according to the report.

"While such transactions can buy time, they are rarely enough to address underlying issues, often leading to repeat defaults," it said.

The ratings firm added that distressed exchanges are often followed by additional defaults. So far this year, 50% of defaults have come from issuers that had previously defaulted. And the pace of redefaults has accelerated to 1.8 years from a historical average of 3.5 years, it said.

The dynamic is eroding underlying fundamentals in the U.S. collateralized loan obligation market. Among the 200 most widely held CLO borrowers rated by Moody's, leverage ratios are rising and interest-coverage metrics are worsening. Moody's, however, said that near-term financing risk remains limited to a smaller group of stressed debt rather than posing a systemic concern.

Borrowers unable to find support from the broadly syndicated loan market are likely to resort to distressed exchange transactions. Direct lenders, while remaining a viable option, are growing increasingly cautious, Moody's said.