At first glance, the answer to the question of whether high-yield bonds or leveraged loans provide the cheaper cost of capital for borrowers is clear, as leveraged loans regularly offer a lower average cost of senior secured debt, and this differential has become particularly pronounced in the last six months. A closer look at the data though reveals some interesting nuances, which point to a bond market that is available to storied credits, and a loan market that mostly remains the preferred route of sponsors raising finance for their better-rated portfolio companies.
Early this year before the COVID-19 pandemic struck, secured single-B rated bonds were on average a little cheaper for borrowers, thanks largely to corporates from the Technology, Media and Telecom (or TMT) sector using the bond market, such as Altice and United Group.
From April onwards, single-B rated term loan B facilities have on average priced 143 basis points lower than secured bonds. This might suggest that companies should have been turning to the leveraged loan market for liquidity during this period, but it is the high-yield bond market that has been the asset class of choice since then.
This situation arose because high-yield generally has a higher tolerance for risk, as companies that are in dire need of liquidity — or that have a chequered past or uncertain future — are more likely to be offered financing by the bond market, at a price.
Merlin was the first example of this dynamic at play in the pandemic era. The company was a darling of the loan market that was held widely in collateralized loan obligations and managed accounts, but it was the bond market (partly through reverse-enquiry) that the borrower turned to when it needed liquidity to get it through a period of zero revenue generation.
Since then, the roll call of firms turning to high-yield has featured borrowers of a similar ilk. Algeco Global Finance 2 PLC, Diebold Nixdorf, Gamenet SpA, Stonegate Pub Company Bidco Ltd., Center Parcs (UK) Group Ltd., Maxeda and Profine are all names that are tough sells in their own right, whether from a credit perspective or the new pandemic-impacted world in which we all live and companies operate. Consequently most of these issuers had to add some yield to their deals to make them palatable, which distorted the average yields for some ratings classes.
The loan market also provided liquidity financing during the initial chronic phase of the COVID-19 crisis, and this was primarily — though not entirely — on a private basis through small groups of lenders. This difference makes comparisons with the bond market difficult in such cases, given loan financing terms were not only generally kept quiet, but were also not subject to typical market syndications.
Comparisons are much easier when taking the 'par market' for loans, though (i.e. names that tend to be quoted in secondary markets at or near par value), and since markets reopened after the March sell-off it is bonds that have consistently offered the cheapest headline price for borrowers. This is not only the case for yield at issue, but also in terms of subsequent trading performance.
H&F-backed alarm monitoring firm Verisure provides a case in point. The group placed a €1.8 billion secured financing in July, split equally between a six-year bond and loan tranches priced at 3.875%, and E+400 with a 0% floor offered at 99.5, respectively. Final pricing on the loan suggested a yield of 4.16%. In the secondary market the loan was initially a little sluggish, though it eventually gained some traction — even if the bid has never really moved much beyond par. The bond too was initially soft, though the bid subsequently hit highs of 101.5 in September. Both tranches took a hit last week in line with the weak sentiment in broader markets, with the bond now bid at 99.75 and the loan at 99.50.
Another example of this market dynamic is Adevinta's €2.4 billion financing backing the acquisition of eBay’s classified business, which closed in October. Among the various tranches, the deal included a €900 million term loan B that priced at E+325 with a 0% floor offered at 99, and a €400 million issue of 3% seven-year notes. The deal was heavily supported across the stack, with lenders in general syndication on the loan receiving roughly 30% of their commitments, according to sources. This strong demand fed through when the offering freed to trade, with the loans popping by more than a point on the break into a 100.250/100.625 market, and the bonds soaring even higher into an initial 101.875/102.125 market.
Secondary turbulence last week hit these levels, however, with the loan dipping below par to around 99.75.
Meanwhile, for those investors able to play across asset classes the capital appreciation offered by bonds means the headline price is not the only consideration when committing in primary. "Even the best-supported loans will never get that far beyond par," said one manager. "But bonds have the ability to provide an immediate return on the break."
Such factors are just part of the picture, however, with other considerations such as repayment flexibility and the ability to reprice the debt at any time also likely to be taken on board — and this is why sponsors still typically want loans. Even looking at names in the table above, MasMovil upsized its loans at the expense of bonds, as did Ineos last week. And in the case of Adevinta, the loan part of the financing comes with three margin step-downs, meaning the headline spread is not the end of the story. Moreover, the flexibility afforded by minimal soft-call protection means this cash-generative borrower will have an opportunity to revisit the facility at will in the future.
As such, while sponsors' appetite for high-yield waxes and wanes it tends to be fairly constant for loans, though when M&A/LBO activity dries up — or sponsor-backed refinancings or repricings are out of the money — then activity in the loan market dries up too. "High yield is there for opportunistic borrowers that want to lock in cheap long-term financing," said one manager. "But sponsors will always prefer loans," he added.
And that, to a large extent, explains why the European high-yield market has posted larger monthly volume totals than the loan market in five of the last seven months. High-yield's greater risk tolerance during this difficult period has also been an important driver, as has the fact that for the best credits, it offers borrowers cheaper financing than loans.