Leveraged borrowers feel pull of loans over bonds as rate hikes loom

While inflation risks and rate volatility are not likely to go away anytime soon, borrowers in the leveraged finance markets are staying agile in identifying the best avenues for pricing execution, with loans evidently gaining significant traction versus bonds in the shadow of impending Federal Open Market Committee rate hikes.

Fertitta Entertainment LLC, formerly known as Golden Nugget LLC, last week completed a $5.55 billion financing package across new loans and bonds, backing a plan to refinance roughly $4.6 billion of existing debt, fund a $250 million dividend to the company's owner and add cash to the balance sheet.

The final structure of that loan and bond placement was very different from the first pitch, which initially called for $1.85 billion each of a seven-year term loan B, seven-year (non-call three) senior secured first-lien notes and eight-year (non-call three) senior unsecured notes.

After gauging the market, Fertitta opted to shift $1.45 billion of the bond portion to the loan offering. Final pricing included $3.3 billion of loans, $1 billion of 4.625% seven-year senior secured first-lien notes and $1.25 billion of 6.75% eight-year senior unsecured notes. Pricing for the bond portions came at the midpoint and wide end of talk ranges, respectively.

The Fertitta deal follows a swath of bond-and-loan financing efforts last year in which issuers retooled deals during marketing in favor of loans, as the latter asset class boomed following on a fallow 2020. LCD tracked 14 transactions in 2021 featuring an increase in loan sizes at the expense of initially proposed bond amounts. On the other hand, there were just four loan-and-bond financings in 2021 where the issuer shifted loan amounts to bonds.

By volume, $5.21 billion was cut from high-yield bond pitches in favor of larger loan components in 2021, nearly double the $2.65 billion in 2020, according to LCD. At the same time, just $745 million was trimmed from loan pitches in 2021 in favor of bonds, down sharply from $4.81 billion in 2020.

Against that backdrop, secured high-yield bond issuance in 2021 accounted for less than 20% of overall secured issuance in the leveraged finance markets, down from 32% in 2020.

In addition, bonds issued to take out existing loans declined steadily over the final three quarters of 2021, reaching a 12-quarter low at $10.1 billion in the fourth quarter.

Overall, leveraged finance issuance volume swelled to $1.08 trillion in 2021, up from $724 billion in 2020, and marking the first-ever breach of the trillion-dollar threshold. The record volume reflected unprecedented issuance of both leveraged loans ($615 billion, up from $289 billion in 2020), and high-yield bonds ($464.5 billion, up from $435 billion in 2020). The share for bonds slid to 43% of the overall amount — a low since 2018 — from roughly 60% in 2020.

On a performance level, too, the pendulum has swung in favor of variable-rate loans as the Fed girds for battle against inflation.

Leveraged loan assets under management at retail investors stood at $147 billion in November, up $53.5 billion in 2021, and the most since May 2019, in a sharp reversal from steep declines in the pandemic months of 2020.

At the retail fund level, U.S. loan funds recorded an inflow of $1.839 billion for the week ended Jan. 12, marking the largest weekly inflow since 2013. That inflow was a fifth consecutive gain for the asset class for a total of $5.03 billion over that span. High-yield funds, meantime, posted a $2.24 billion outflow for the week to Jan. 12.

Last year, leveraged loan funds pulled in a net $33.8 billion of investor assets, after a net outflow of $19 billion in 2020. Conversely, high-yield funds posted outflows of more than $13 billion last year, versus inflows of more than $38 billion in 2020.

As rates lurch higher in January, year-to-date total returns through Jan. 12 were negative 0.71% for the S&P U.S. High Yield Corporate Bond Index, and positive 0.43% for the S&P/LSTA U.S. Leveraged Loan Index. The loan index returned 5.20% in 2021, up more than two percentage points from 2020, and narrowly outperforming the 5.02% return for the S&P U.S. High Yield Bond Index last year.

Those return dynamics are reflected among liquid issues. The average bid for LCD's sample of 15 flow-name loan issues reached 99.71% of par as of Jan. 13, a high since last February. At the same time, the average bid for LCD's 15-bond sample of liquid high-yield bond issues slumped to 102.47% of par as of Jan. 13, down more than 2 percentage points since the first reading of the fourth quarter last year.

At the broader index level, the price for the S&P U.S. High Yield Corporate Bond Index touched 102.49 on Jan. 10, a low since early November 2020 amid turbulent markets surrounding the U.S. presidential election.

At the same time, the bid level for the S&P/LSTA U.S. Leveraged Loan Index on Jan. 13 touched 99% of par for the first time since July 2014. That average bid was 96.22 on Jan. 1, 2021, and 78.35 at the pandemic-era nadir in March 2020.