Secured bond issuance skyrocketed in January, as the increased cost of leveraged loan funding drove borrowers toward cheaper alternatives. Issuers such as TransDigm, Commscope and Dun & Bradstreet all pivoted to print large secured bonds, in a dynamic stemming partly from the Fed’s increasingly dovish outlook.
Issuers have priced USD 8.8bn of secured bonds this month, including deals from Tenet Healthcare, Transocean, Acrisure and Charter Communications. TransDigm and Dun & Bradstreet both increased the size of their secured bond tranches on the back of ravenous investor demand.
The spike in issuance makes January the biggest month by volume for secured bonds in more than a year — since September 2017’s USD 10bn in issuance, according to Debtwire data.
Secured bonds made up roughly 54% of total high yield new issuance in January, the highest proportion in at least two years, and significantly higher than the 38% monthly average in 2018.
The use of secured bonds in large LBO and acquisition financings such as TransDigm, Commscope and Dun & Bradstreet also marks a departure from the typical playbook for secured issuance as a way for lower quality borrowers to access the market when unsecured debt is prohibitively expensive.
The last time secured issuance represented more than 50% of bond issuance — last June and July — issuers included troubled acute care provider Community Health and Enterprise Development Authority, a single asset project financing backing construction of a casino on a remote tribal reservation in California.
“A lot of secured issuance in the past has been special situations or somewhat distressed, layering transactions,” said a portfolio manager. “But for these recent deals, it’s more just that you have a large deal and the ability to spread stuff around between unsecured bonds, secured bonds, and loans.”
Issuers have largely turned to secured bonds as replacement financing for secured loans — rather than in lieu of unsecured funding — as accessing the loan market has grown more expensive. The cost of loan funding jumped by 100bps during the fourth quarter, according to a 25 January report from analysts at BofA Merrill Lynch.
That’s partly because demand from institutional loan investors for new paper has waned amid low CLO issuance and mutual fund outflows, sources noted.
CLO issuance declined 70% year-over-year in January, according to sister publication CreditFlux. And fund flow data shows an exodus from floating rate mutual funds — to the tune of USD 5bn so far this year — while high yield funds have received inflows of roughly USD 3.5bn, according to Lipper.
The flight from loans comes as the Fed takes a more accomodative stance after a painful market selloff in late 2018, with chairman Jay Powell on Wednesday signaling that the central bank was done hiking rates for the time being.
“If you think rates aren’t going higher, the key catalyst for owning loans goes away,” said a portfolio manager.
Weighing the costs
Many investors had expected TransDigm to use cash and term loans to finance its acquisition of Esterline, in line with the wording of a press release from when the deal was announced last November, buysiders said.
Several issuers have recently been forced to widen pricing expectations on new loans, and in some cases — such as with Inmar’s recent add-on loan — this has meant concurrently repricing their existing loans wider.
In the bond market, by contrast, some recent secured deals have mostly priced tighter than initial expectations, even after being upsized.
Dun & Bradstreet, for example, downsized the loan and unsecured bond portions of its buyout financing, and widened pricing on the USD 2.53bn loan to Libor+ 500bps with a 98 OID. It made up the difference by upsizing the secured bonds by USD 200m and tightening price guidance to 7% area.
The deal finances the 178-year old business information provider’s buyout by a consortium of new private equity sponsors, who are aiming to turn around the company’s flat earnings through an ambitious cost saving program.
The borrower had already downsized the loan portion once, from USD 3.13bn, to make way for the USD 500m secured issue it announced last week. The 7% coupon on the upsized USD 700m secured bonds is roughly 70bps tighter than the L+ 500bps coupon on the loan, based on current Libor levels.
A similar demand dynamic is at play in CommScope’s nearly USD 7bn debt raise for its acquisition of ARRIS International, with the secured bonds quicker to gain traction than the unsecured tranche, according to buysiders following the deal.
For investors, the latest crop of secured bonds offer more than just lower risk. They also offer better returns, given that high yield spreads are yet to fully retrace after widening sharply in the final quarter of 2018.
Bonds in the ICE BofAML US high yield index currently offer an average of 436bps over Treasuries, down from a high of 544bps on 3 January but still well above 316bps on 3 October, before the selloff began.
However, the resurgence of the secured bond market also increases the risk of existing unsecured bondholders being primed in new deals.
In TransDigm’s case, some holders of the borrower’s existing subordinated bonds were disgruntled with its decision to scrap a proposed sub tranche and increase the secured offering since it exacerbated the extent to which the deal primed their position.
Transdigm’s USD 949m 6.375% subordinated bonds due 2026 traded down nearly four points after the announcement to trade at 95.125 for a 7.288% yield, before rising slightly by Friday to trade at 95.5 and 7.170%, according to MarketAxess.
“It’s not friendly to anyone who is on the long end of the subordinated notes, so it’s not surprising to see them trade off,” said another buysider.
The trend towards secured bond issuance is of particular importance for investors holding the unsecured debt of more troubled companies, said the portfolio manager.
“Right now what unsecured bondholders are going to be thinking about is, ‘Am I going to get layered?’” the portfolio manager said. “If it’s a company with some hair on it and a pressing maturity, there is a decent chance that [refi] goes to secured rather than unsecured.”