Junk-rated companies that are tapping bond markets now ahead of a potential flood of issuance in a few years are paying higher interest costs than on much of their existing debt.
Before the financial crisis, a boom in collateralised loan obligations, structured investment vehicles, allowed many companies to borrow money through bank loans tied to Libor, a rate that has plummeted to just 0.32 per cent.
Since July 1, junk-rated companies that have refinanced their loans with bonds have been paying an average of 4.4 percentage points more in annual interest costs, according to Standard & Poor’s Leveraged Commentary and Data.
In spite of current low interest costs on bank debt, many of these companies, which mostly raised the original money to finance the leveraged buy-outs of the past decade, are turning to the buoyant junk bond markets to lock in attractive long-term rates even
if these rates are higher than what they are paying on existing loans.
“At day’s end, companies will pay more to replace bank debt with high-yield debt, a clear negative for corporate profitability,” said Peter Cecchini, chief strategist at BGC Financial. “But it may be the difference between not having access to credit at all versus paying a bit more to have certain access now.”
The rationale behind switching from cheap short-term loans to longer-maturity junk bonds is to get ahead of what is known as the “maturity cliff”, the hundreds of billions of dollars of LBO related debt that comes due in the next few years.
“You get breathing room,” said Steven Miller, managing director of S&P LCD.
Companies on average have added four-and-a-half years to repay their debts, S&P LCD says.
First Data, a provider of transaction processing services, this month sold bonds with a coupon of just less than 9 per cent to 2020 to replace $510m of loans borrowed for its 2007 LBO, which had interest of just 3.2 per cent, but it was a floating rate and the loans are due in 2014.
The junk bond sale was a “first step” in tackling its debt maturities and a condition by its lenders to agree to a series of transactions meant to bolster its balance sheet between now and when much of its LBO debt begins to mature in 2014, the company said.
Investors who are scrambling for yield in an environment of low base rates have been big buyers of junk bonds, allowing companies and their private equity sponsors to chip away at the maturity cliff. One week this month registered as the all-time record for junk bond sales worldwide.
That comes against a backdrop of a collapse in the banking sector and drying up of CLOs.
Bankers describe the surge in junk bond sales as a rebalancing of the leveraged loan and bond markets which tilted heavily toward loans in the run-up to the financial crisis.
In 2007, junk bond sales were $140bn while institutional loans totalled $386bn, according to S&P LCD. This year, junk bonds are running at $163bn while institutional loan sales are $88bn. Institutional loans are largely syndicated to investors, including CLOs.