PitchBook: Slim CCC bond issuance volume belies demand for marginal credit and structures
With a historically strong US economy and robust markets, investors are growing increasingly comfortable with the risk trade, pouring money into high-yield bond funds and extending down the ratings scale to find valued yield. But supply has yet to rise commensurate with demand for lesser-rated bonds.
High-yield corporate credit spreads closed in on all-time tights this week in a sign of growing investor confidence in the US economy and in line with a surge in other risk assets after a Republican election win. The spread on the ICE BofA US High Yield Index dipped to 261 bps off the curve on Nov. 13, a low for the benchmark since June 2007 and 132 bps below an early-August peak when the Japanese economy faltered, triggering a global market rout and wild price swings along the Treasury yield curve.
As high-yield spreads have contracted, the volume of distressed debt has shrunk dramatically, with those assets accounting for 3.99% of the Morningstar US High-Yield Bond Index on Oct. 1. That marks the first time the distress ratio has fallen below 4% since LCD began tracking the index in August 2022. Meanwhile, triple-C rated bonds continue to outperform the broader index by around 50 bps, according to Bank of America research, returning roughly 10.1% in the third quarter, while single-B and double-B rated bonds returned 4.6% and 4.3%, respectively. Add in diminishing investor concern that a weakening economy will affect edge credits, and it would seem the door is open for marginal borrowers to access capital at favorable terms.
This accommodating market has played host to a steady stream of single- and double-B deals that have priced at the money and made little headway in the secondary market. Shearer’s Foods broke the monotony in September, inking a CCC+/Caa2 rated dividend deal that drew demand enough for the pricing to come through guidance and with a small upsize thanks to a relatively juicy 9.625% yield. Those par-priced notes
due 2032 are still trading north of 105, while a $700 million tranche of like-rated dividend bonds that Alliant Holdings inked a few days later joined the multitude of deals lingering around par after at the mid-point of talk in the 7.375% area. That deal, downsized to $700 million after the borrower shifted $300 million to a concurrent term loan B, has sported a 99 handle since late-October following an early foray north of 102.
Sources said there was little to differentiate the Shearer’s and Alliant deals beyond the yield disparity, but with steady inflows supporting the market ($30.7 billion for the year, per Morningstar) and new-issue volume well above its year-ago levels, investors can pick and choose which deals best fit their parameters.
“If you have this perfect storm of calm markets and deal flow, then you’re likely to see more levered capital structures that are availing themselves of loose terms and tight spreads,” said Brian Gelfand, co-head of global credit at asset manager TCW. “As value investors, you know those aren’t necessarily the best opportunities at new issue, but they do sow the seeds for future investment opportunities into volatility in the secondary market.”
One example of such a deal is Garda World Security’s Oct. 29 offering of 8.375% eight-year senior notes (CCC+/Caa2/B-), which cleared at the tight end of 8.50% area guidance and is trading on the highs, at 101.75 to yield about 7.94%. The average yield-to-worst for issues rated CCC and lower stood at 11.08%, as of Nov. 12, according to the S&P US High Yield Corporate Bond Index, having tightened by just over 3.5% since the beginning of the year. Proceeds were earmarked to redeem the borrower’s $604.4 million of 9.5% senior notes due 2027, to finance the cash consideration of its purchase of Stealth Monitoring, and for general corporate purposes.
“It’s not the best all-in yield to absorb the historical volatility, if not credit loss, that you tend to observe with credits with that ratings profile,” Gelfand said. “It comes down to whether we believe we’re being compensated to take risk that ends up being a fruitful opportunity set that we want to underwrite and invest in.”
In Garda’s case, the risk is a management buyout with many moving parts that might lead it to a ratings downgrade, with S&P Global Ratings flagging the possibility of “the creation of a holding entity with significant debt or debt-like financing that contributes to higher leverage for the broader group” beyond Garda World and its subsidiaries.
Even more of a test of investor tolerance was Chobani’s Oct. 15 $650 million offering of CCC+/Caa1 rated 8.75% senior pay-in-kind (PIK) toggle notes due October 2029, which hit top trades on Nov. 12 at 105.75 after pricing through talk at 99, to yield 9.008%, and with a $150 million upsize. That deal came on the heels of two tranches of sustainability-linked PIK-toggle notes from IHO Verwaltungs GmbH that still trade more a point above par pricing, and a July offering of dividend-backing senior notes from Calderys that hit a fresh high at 102.25 on Nov. 13. The CCC+/Caa1 rated Calderys deal was the first PIK-toggle offering to clear the US high-yield market since Advancion Corporation (fka Angus Chemical) in November 2021.
The Chobani deal included some bells and whistles, including special call rights in the event of an IPO, but nothing new or unusual, sources said. Because proceeds were earmarked to pay a dividend to the issuer’s indirect parent, which then would use the funds to refinance preferred stock, the deal did not add significant leverage. In fact, S&P Global Markets analysts said they expect leverage to decrease from 6.8x at time of pricing to the mid-5x area by year-end due to EBITDA expansion and the reduction in preferred equity. Finally, at 9.50%, the PIK coupon is 75 bps wide to the cash coupon and slightly lower than the PIK interest on the preferred stock.
"There's not a lot of controversy in the primary markets these days,” said Sinjin Bowron, a portfolio manager at Beach Point Capital Management. “Certainly, any sort of holdco PIK-toggle is going to raise eyebrows, but in general, with the right company and at the right pricing, there seems to be significant demand driven by the technical tailwinds to the market."
While PIK-toggle issuance in the high-yield market looks to have surged after two barren years, the $1.9 billion of bonds priced so far this year is well below the average annual rate for the past 20 years of $4.8 billion. By and large, sources expect structural creativity to remain the preserve of the private-credit markets.
Similarly, triple-C rated issuance has jumped from $2.4 billion in 2023 to almost $11 billion, year to date, but discounting last year’s meager contribution, is at its lowest level since 2009.