The title of this post could be, but is not, referencing the Philadelphia Phillies’ unlikely rise to the national stage of the World Series, with game 1 against the Houston Astros set for tomorrow night. Rather, I’m referring to the decidedly more prosaic topic of my expectation regarding the potential for a material increase in the issuance of secured high yield debt in the next few years, which will “prime” unsecured debt holders.
Issuing secured or structurally senior debt is not something borrowers want to do, but is often necessary when market conditions are prohibitively expensive or unsecured access is not available. The bad news for unsecured debt holders is that recoveries in the event of default will be materially lower, while the good news about utilizing this source of funding is that it extends a company’s runway to better times.
Today’s Chart of the Week shows the maturity wall in the high-yield market. One of the reasons high-yield credit spreads continue to remain below 600 basis points at the index level (which is well below typical recessionary periods) is because of the benign maturity situation, with a small amount of debt needing to be refinanced in 2023 and 2024.
Loan market maturities, not shown here, are more troublesome. The low-interest-rate environment of the last few years enabled borrowers to access bank loans more easily and the market grew to be the same size as the high-yield market. Bank earnings are under pressure, with well-publicized losses being absorbed on underwater leveraged buyout deals that some have committed to.1 As fundamentals continue to deteriorate and liquidity tightens, banks may look to reduce exposure to lower-quality issuers, forcing them into the high-yield market.
The key question is not whether we enter a recession, but the length and depth of the downturn. A soft landing with a recovery in earnings in 2024 will not usher in a rash of defaults, and issuers can wait it out. If this scenario doesn’t materialize, I expect a wave of secured financings to bridge to better conditions in 2025/2026.
The risk/reward for secured high-yield debt issued in times of stress tends to be very attractive — high coupon, higher rated, short maturity and reasonably levered. What’s most important is the expectation of a full recovery, should the borrower have to restructure. The secured debt paper issued during the pandemic turned out to be great bonds. Along with being an active buyer of future secured debt, my goal is to avoid the unsecured issuers that are likely to access this market.
1Source: Bloomberg- The Party’s Over in Credit Markets; 10/7/22
The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.
This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
Opinions and statements of financial market trends that are based on current market conditions constitute judgment of the author and are subject to change without notice. The information and opinions contained in this material are derived from sources deemed to be reliable but should not be assumed to be accurate or complete. Statements that reflect projections or expectations of future financial or economic performance of the markets may be considered forward-looking statements. Actual results may differ significantly. Any forecasts contained in this material are based on various estimates and assumptions, and there can be no assurance that such estimates or assumptions will prove accurate.
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