Junk-Rated Companies Accept Tougher Terms to Borrow
Investors are often getting greater protections in the form of collateral
Low-rated companies are learning to live with higher interest rates, finding ways to tap bond markets while minimizing the hit to their borrowing costs.
So far this year, companies such as American Airlines and Six Flags have issued $91 billion of speculative-grade bonds, according to PitchBook LCD, up 35% from the year-earlier period, when rapidly rising rates cut junk-bond issuance to a trickle.
But those bonds look different than during the borrowing boom of recent years. A full 62% of them have been secured—backed by collateral—offering investors greater protections if the company defaults. That is easily the highest percentage in records going back to 2005.
The average maturity of the junk debt has also shrunk to 6.1 years, down from an average of 7.4 years over the previous decade, giving companies a shorter leash than the historical norm.
Investors are thinking, “ ‘I want to be a little more defensive in an uncertain environment,’ so they’re buying this secured paper,” said Randy Parrish, head of public credit at the asset manager Voya Investment Management.
Wall Street tracks borrowing by speculative-grade companies—those with riskier profiles or larger debt loads that land them with sub-triple-B credit ratings—because those companies’ ability to pay back debt and avoid bankruptcy is important to the economy.
Since the failure of Silicon Valley Bank in early March, investors and economists have debated whether the U.S. could experience a credit crunch, with banks pulling back from lending due to concerns about the stability of their deposits.
In the U.S., however, a majority of corporate borrowing happens through public markets rather than banks, meaning a healthy bond market can do much to offset any reduction in bank lending.
One factor helping businesses right now is that many were able to issue long-term bonds at extremely low rates in the early years of the Covid-19 pandemic. Thanks to what some have called the Great Refinancing of 2020 and 2021, companies in the aggregate don’t face substantial speculative-grade-bond maturities until 2025. Many can therefore afford to wait to issue bonds in the hope that rates will drop from current levels.
Some companies, though, are pressing ahead now—in many cases, to pay back loans that are poised to mature in the near future, according to investors and analysts.
A few factors explain the surge in secured-bond issuance and the shortening of bond maturities this year. For one thing, both moves help to minimize the cost of debt, since investors will accept lower rates on bonds that are backed by collateral or will be paid back sooner.
In addition, bonds that mature in five years can typically be redeemed by the borrower at minimal extra cost in as little as two years. This is an attractive proposition for chief financial officers who believe that rates will fall within that time and who want the option of replacing their new, higher-cost bonds as soon as possible.
Speculative-grade companies that have issued bonds in recent months include the privately owned equipment-rental business EquipmentShare, which sold $640 million of five-year secured bonds to pay down loans. Issued at a 10.5% initial yield, the bonds nonetheless will lower the company’s cost of borrowing and minimize its exposure to future interest-rate increases by replacing floating-rate debt with fixed-rate debt, said Amy Susan, EquipmentShare’s director of public relations and communications.
The bonds traded with a roughly 10.3% yield Friday, according to MarketAxess.
A more familiar name to investors, the trucking company XPO, also issued five-year secured bonds in May as part of a larger refinancing package that included longer-term unsecured bonds and the extension of part of a loan.
Carl Anderson, XPO’s chief financial officer, said his team appreciated that the secured bond could be redeemed in as little as two years, which could help as the company seeks investment-grade ratings and considers reducing its debt. Eager to refinance a loan due in early 2025 before it came within a year of maturing, the company decided to “pull the trigger earlier in the process” partly because it was coming off a solid quarterly earnings report and thought it was possible that markets could become more volatile later in the year.
Some investors and analysts have cautioned against getting too excited by the uptick in speculative-grade-bond issuance this year. For the most part, they point out, the companies issuing bonds have been among the better businesses with low ratings.
Increased bond issuance can also be explained to some degree by weakness in the market for speculative-grade loans, where an important source of demand—pools of securitized loans known as collateralized loan obligations—has faltered in part due to rising financing costs.
Last month, the trailing 12-month, speculative-grade default rate was 3.07%, according to Moody’s Investors Service, still below the 4.5% level just before the pandemic started in early 2020 but marking a steady climb from the recent low of 1.22% in early 2022.
“Default rates are going up,” said Voya’s Parrish.
Companies, he said, have generally benefited from elevated inflation because they have been able to sell their products at higher prices. Next, though, they are likely to enter a period in which their pricing power diminishes but they still face higher financing costs, making it harder to service their debt.
There are also drawbacks to the recent borrowing trends. Companies that issue more secured bonds can be hindered from selling assets or issuing more secured debt in the future, when the need might be even greater. Issuing shorter-term bonds also means that companies will be forced to repay debt sooner.
“The more companies pledge collateral and issue short, the less flexibility they give themselves later on down the road,” said Michael Anderson, head of U.S. credit strategy at Citigroup.