US borrowers seek to ease pain of higher yields with secured debt

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Borrowers in the US junk bond market are increasingly securing their debt against company assets, in a bid to get deals done against a backdrop of much higher borrowing costs.

Almost two-thirds of junk bonds issued so far in 2023, worth $70bn, have been secured — meaning debt holders can seize assets ranging from ships, planes or buildings to intellectual property or equity in the business in the event of a default. That marks the largest proportion on record, according to data from Pitchbook LCD going back 18 years — with the next highest share in 2019 coming in at just over a third.

The greater share of asset-backed bonds this year underscores the creative methods that companies are resorting to in order to access funding in challenging markets, while trying to minimise borrowing costs that have climbed sharply since the Federal Reserve started raising rates last year to curb inflation.

It also demonstrates companies’ reluctance to sell unsecured high-yield bonds, traditionally the majority of the market.

With US interest rates soaring from near zero to more than 5 per cent in just 16 months, the average yield on junk bonds has climbed to 8.5 per cent — up from a low of 4.5 per cent in 2021, when Fed stimulus was still flooding the financial system. 

But secured bonds are typically cheaper to issue than unsecured bonds because they offer an extra layer of protection to buyers. 

“It’s a way for companies to lower their all-in borrowing costs,” said John McClain, a portfolio manager at Brandywine Global Investments, who added that securing debt can also improve a company’s credit quality in the eyes of rating agencies and attract more lenders. “Certainly you have far more comfort with collateral behind you that should give you an estimation of a floor for a recovery value, in the case that a company’s fortunes turn.”

High-yield bond defaults have increased this year, with $26bn of defaulted debt in the first seven months of 2023, according to data from Goldman Sachs — exceeding 2022’s full-year total of $18bn. 

As defaults rise, the amount of money bondholders get back has been falling. Investors have recovered on average around 35 cents on the dollar on senior unsecured bonds this year, less than a roughly 45 cents long-run average.

Secured bond issuance has also been driven by a wave of refinancing by borrowers in the $1.4tn junk loan market, where debt is typically secured but floating interest rates have driven an even sharper rise in defaults.

Companies including Norwegian Cruise Line Holdings, aerospace and defence group TransDigm, beauty products company Coty and billboard advertising business Clear Channel Outdoor have done some of the largest “bond-for-loan take-outs” so far this year, data from Pitchbook LCD shows.

In total, 59 high-yield bonds this year have been issued to refinance outstanding leveraged loans, according to numbers tracked by LCD. That figure, which covers all varieties of loans, equates to $38.8bn of loans being refinanced — up from 25 bonds totalling $10.2bn over the entirety of 2022.

Waning demand for loans from collateralised loan obligations — the vehicles that own roughly two-thirds of America’s low-grade corporate loans — has made refinancing “challenging” for loan issuers, according to Elizabeth Han, a senior director at Fitch. “We are seeing issuers go to alternative markets,” she added, including secured bonds.