How higher rates are changing the corporate bond market
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The high-yield bond market — where companies with lower credit ratings borrow money — is showing signs of life after all but shutting down last year. But in this new era of expensive money, many companies are doing deals a little differently in order to save on their interest costs.
State of play: A record share of speculative-grade deals placed this year have shorter maturities and stronger collateral packages.
Why it matters: "This is a whole new playbook for all these debt borrowers. And everybody's going to have to get very creative in what they do to get through the next couple of years," Oleg Melentyev, credit strategist at BofA Global Research, tells Axios.
Catch up fast: Think of last year as a period of rapidly growing sticker shock that kept most borrowers away, unless they absolutely needed to come to market.
- Now they’re coming around to the likelihood of a “higher for longer” environment and taking the plunge. New high-yield bond issuance is up 38% in the first half of the year compared with the first half of 2022, according to PitchBook LCD.
But, but, but: A sharply higher share of companies are placing secured bonds instead of the unsecured debt that was more commonplace before the Fed's rate hiking cycle. The chart above shows the jump over the last few quarters.
- What that means: With secured bonds, the bondholders have a lien on the company's actual assets. That lowers the risk that bondholders don't get paid back, since they can lay claim to the assets themselves; in return, they charge a lower interest rate.
- When rates were at rock-bottom levels, fewer companies felt the need to pony up assets — which strips them of future flexibility with said assets —in order to obtain affordable debt.
- These days, it seems worth it: Companies can typically save anywhere from 1 to 1.5 percentage points in annual interest by doing a secured deal rather than an unsecured one, estimates Melentyev.
Also: The average length to maturity for new high-yield deals this year is at a record low — shorter than it was in any other quarter since LCD began tracking the data in 2005.
- Again, a similar concept: shorter borrowing time, lower cost of capital.
- Melentyev estimates that issuing a 5-year bond instead of an 8-year bond can save a high-yield borrower of middling credit quality about 1.7 percentage points on average.
Zoom out: Why all the maneuvering to save a few bucks?
- Well, the average yield in the market has more than doubled since mid-2021 when it went below 4% — it's now at 8.4%.
Between the lines: Though the market's seeing more activity now compared with last year's doldrums, don't expect a huge rush any time soon.
- That’s because of the pandemic-era “pull-forward” effect. Borrowing costs were so low in 2020 and 2021 that just about every high-yield-rated company addressed its refinancing needs during those years.
- That blitz left little in the way of corporate bond maturities that need to be addressed over the next few years, as the chart below shows.
