Junk bonds: collateral thinking


Sell everything that is not nailed down? In 2020, there was a better option when it came to raising cash: keep the assets while leveraging them as much as you can. Airlines and cruise companies had little trouble tapping capital markets even as their businesses were largely put on ice. Collateral included ships, planes, spare parts, rights-to-routes and even frequent-flyer miles. Investors were so happy to send cash that government aid was often barely required.

The infusions of liquidity helped the likes of Carnival and United Airlines to avoid bankruptcy. In 2021, as consumers start to travel again, these companies can either pay down debt or refinance more cheaply and push out maturities. But if the recovery is slower than hoped, debts will resemble a Gordian knot that cannot be defeated with a simple sword swipe. Complex negotiations will be needed.

Issuers sold junk bonds worth more than $400bn in the US this year. In December, AssuredPartners, sold CCC-rated unsecured bonds at a yield of 5.6 per cent, the tightest pricing ever for eight-year notes of such a low rating, according to S&P LCD.

High-yield debt is typically unsecured. But the proportion with a collateral claim was 14 per cent, ahead of the 9 per cent on average in the previous five years according to analysis from Moody’s. American Airlines, for example, sold to Goldman Sachs notes secured against the “aa.com” URL and “American Airlines” trademark. Just what an investment bank would hope to do with such assets if seized is unclear. Goldman must hope it never needs to find out.

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Status as a senior lender with a collateral claim is not all that it is cracked up to be. The boom in leveraged loan issuance means companies have less “cushion” — unsecured junior debt — to absorb losses. Moody’s data show that such cushions in 2019 halved from levels in the late 2000s. Loose loan documents also allow for “priming” transactions where one group of lenders can push down the collateral of another. 

Several lawsuits over priming deals were filed in 2020, including one involving mattress maker Serta Simmons. The next set of court fights will involve companies forced to file for bankruptcies where creditors scratch and claw for assets they think they are owed but whose real ownership is far from clear.



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