High-yield companies are issuing bonds at record pace.
The increase in 2013 issues is noteworthy because the number of bonds issued last year was already a significant increase from past years, says Nicholas Leach, vice president of global fixed income at CIBC Asset Management. He manages the Renaissance High-Yield Bond Fund.
However, “What’s really important is the use of the proceeds,” he adds. “For the most part, these companies are using [them] to refinance debt. As they issue new bonds, [many] are paying off existing bank loans.”
Leach says about 60% of the new deals in 2012 were for this purpose. In 2013, the number of companies servicing debts has increased to 70%.
“If you look at the record-low levels of interest rates, it makes sense for these highly leveraged and investment-grade companies to refinance in the bond capital markets,” he says. “They’re locking in at low rates and extending their maturities.”
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He adds, “By refinancing these lower coupons, they’re reducing total interest expenses. In terms of credit quality, the primary market and new bond yields are in really good shape.”
New bond issuers are also using the proceeds to fund leveraged buyout transactions.
Leach notes, “That’s what we really have to keep our eye on. When [these] transactions become a larger part of the market, the market seems to get a little frothy.”
LBOs only account for about 10% of the market right now, compared to 40%-to-50% between 2006 and 2008. “That was in the heyday of credit quality, [and] we’re nowhere near those levels right now.”
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That said, LBO risk is a concern for investment-grade bondholders. That’s because they aren’t protected from mergers and acquisitions by change-of-control puts, which high-yield investors could use, he adds.
A change-of-control provision is a written clause in a bond agreement that protects investors when a merger, acquisition or LBO takes place. When a management change occurs that affects the bonds, investors have the right to sell them back to the company at a predetermined price.
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Since investment-grade bond investors don’t have this layer of protection, Leach says they should monitor the number of LBO deals. “If you look at recent headlines, Heinz was just acquired via a leveraged buyout transaction that involved Warren Buffett.”
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And another proposed LBO involves Dell. “These companies are in the investment-grade space, so [you’ll find they’re] companies with very low leverage, leveraging up for a buyout transaction.”
Leach also cautions high-yield bond investors. “When [LBOs increase]…in the high-yield market, [people] need to be more selective. Even on the margin, we might see more deals in terms of highly leveraged companies, but we don’t have to participate in that.”
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