NEW YORK, June 4 (LPC) – Borrowers who have historically turned to the U.S. leveraged loan market are instead turning to high yield bonds to refinance existing loans as bank debt becomes more expensive and difficult access while demand for the asset class decreases.
Health insurer Molina Healthcare and food distributor Del Monte Foods raised a total of US $ 1.3 billion in bonds to repay their term loans in May. Artificial intelligence firm Cerence followed suit, raising $ 150 million in convertible bonds to partially repay a $ 270 million syndicated loan, banking sources said. Also last month, BMC Software issued $ 1.35 billion in high yield bonds to fund its acquisition of its Compuware counterpart, underscoring the attractiveness of bonds over institutional lending.
Weaker demand for loans from investors leads companies to pay higher margins or offer debt at higher initial issue discounts (OIDs). At the same time, sales of high yield bonds benefited from the US Federal Reserve’s (Fed) bond purchase program. The initiative aims to ensure that companies have access to capital while dealing with the economic fallout from the coronavirus. By the end of May, U.S. companies had already raised around $ 153 billion in high yield bonds, almost 50% more than in the same period in 2019, according to data from Refinitiv.
“Most CFOs (CFOs) plan to get into the bond market regardless of the time until maturity of their loans. This should be as good as it gets for issuers, ”said Tim Gramatovich, chief investment officer at fixed-income investor Gateway Credit Partners.
At the heart of the problem is weaker demand for secured loan bond (CLO) loans, the biggest buyer of new leveraged loans. With heightened economic uncertainty as a backdrop, CLOs are reluctant to add Single B rated facilities to their portfolios as these loans risk being downgraded to Triple C territory, a few notches above default, which may initiate tests within the CLO.
“In today’s market, there is simply no demand because the CLO engine is not as active as a buyer,” said Jim Schaeffer, global head of leveraged finance at Aegon Asset Management. . “This is significantly different from when the CLO market was more active when strong demand for loans allowed borrowers to obtain lower prices and more flexibility. “
About 34% of U.S. CLOs fail an over-collateralization test in part due to an increase in Triple C-rated loans and defaulted loans in their portfolios, according to a May 29 report from Bank of America.
“Borrowers rated B2 or B3 come under scrutiny and investors have little room in their portfolios for downgrades,” said Christopher Blum, head of leveraged finance for North America at BNP Paribas. “We are seeing this shift from loans to bonds as companies that may have entered the lending market face these technical issues and the support from the Fed is helping the bond market.”
Spokesmen for Molina Healthcare, Del Monte Foods and Cerence were not immediately available for comment.
SunTrust Bank led the bond transaction for Molina Healthcare, banking sources said. JP Morgan arranged the transaction for Del Monte Foods. And Jefferies, KKR and Macquarie worked on financing the acquisition of BMC Software.
Spokesmen for JP Morgan, Jefferies, Macquarie and SunTrust declined to comment. A KKR spokesperson was not immediately available for comment.
CHANGE THE SOUND
Additionally, market participants expect default rates to continue to rise and believe senior loan recovery rates will decline due to the economic downturn.
“Double-digit default rates are inevitable over the next 18 months, and collection rates will likely be half of historical averages for first liens,” Gramatovich added. Institutional term loan defaults stood at $ 13.5 billion at the end of May, the highest total since April 2014, according to Fitch Ratings.
Whether companies are refinancing term loans or looking to take on debt to support acquisitions, bankers are confident borrowers will allow a shift to bonds, primarily if companies can earn a favorable return, according to Blum.
“Some sponsors will benefit from the bond market,” Blum said. “There will always be a robust loan market, but we anticipate increased covered bond issuance as an alternative. “
Borrowers who have tapped into the leveraged loan market in recent weeks have had to pay.
Tech company Xperi made significant revisions to a $ 1.05 billion term loan to fund its tie-up with counterpart TiVo Corp on Monday. Xperi used funds from its balance sheet to offset the reduction in the $ 50 million facility, reduced the maturity of the facility from one year to five, and finalized the loan at 400bp to Libor and a haircut of 90 , 5 cents on the dollar after throwing it to 96 cents, according to bankers.
And unless the CLO engine can ramp up, some are skeptical about the ability of market players to revive a sluggish loan market.
“The high-yield market will be the benchmark because in the future the CLO machine is unlikely to exist in its historical form,” Gramatovich said. (Reporting by Aaron Weinman. Editing by Michelle Sierra and Kristen Haunss.)