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Accessing Leveraged Capital Markets – Part I

Issuing High Yield Bonds

For levered companies that do not fit the investment grade bucket, there are still robust capital markets options available for debt issuance through the leveraged finance divisions of global investment banks.

As discussed in other leveraged finance posts, a large suite of buyers invest in high yield bonds ranging from pension funds, mutual funds, hedge funds, retail investors and insurance companies. If sufficient market appetite exists, a corporate can hire an investment bank with extensive relationships with these buy side accounts to raise high yield debt for a variety of reasons.

Purpose for High Yield Bond Issuance (and Leveraged Capital Markets Broadly, Including Leveraged Loans)

High Yield Bonds for General Corporate Purposes (GCP)

For a cash flow injection, working capital needs or funding for capital projects which would case a funding gap (capital expenditures will exceed operating cash flow), a high yield bond or leveraged loan can be a good way to plug the deficit until projects start to pay off.

With a maiden (virgin or new) bond or loan issue, there needs to be a lot more work marketing the credit story to investors – for example, there is good cash flow from the company right now and once the warehouse is complete debt to EBITDA (leverage) will be fairly low.

For companies with a track record of successful execution for similar projects, this becomes a much easier fundraising effort with far lower marketing efforts required from the investment bank and company executives.

Refinancing High Yield Bonds

For corporates with existing high yield bonds, once they approach maturity, they may ask their lead investment bank to start soliciting demand for a refinancing. This implies that the credit story is already known to investors and they are following the credit closely so the current yield that the bond is trading at is representative of where the company can refinance at.

If the company does have cash on hand and credit markets have deteriorated, they can choose to just redeem the bonds opportunistically.

Leveraged Buyout Financing

Private equity firms will use leverage to acquire companies in order to boost returns. Usually this will involve taking out (or assuming) existing debt of the firm and paying a premium for publicly traded companies or negotiating a price with an exit EBITDA multiple that is amenable to the current private owner of the firm.

Dividend Recapitalizations

If a company is owned by a private equity firm/financial sponsor, sometimes the sponsor will want to kick out some money in the form of a large, one time dividend. So the proceeds from the high yield bond issuance (or leveraged loan) will be used to fund this dividend.

Obviously, as this is a very equityholder friendly transaction (for the purposes of boosting the IRR opportunistically), potential credit investors will have to make sure they are comfortable with the new leverage after the distributions to the financial sponsor.

Private equity firms are generally financially savvy and usually do not NEED to issue debt just to fund a dividend, so they can afford to wait until there is appetite for the credit before issuing debt.

Financial sponsors can also do repeated dividend recaps on companies that they previously did a leveraged buyout of – basically just doing the LBO repeatedly after paying down the debt. Great!

Leveraged Finance for Mergers & Acquisitions

High yield bonds and leveraged loans are also excellent acquisition finance vehicles. There may also be a leveraged bridge loan that is fronted by investment banks that must be taken out by high yield bonds later (a bond bridge) and within a certain time as the utilization fees on the debt tick up until they are paid down.

The catch here is that since they have to take out the debt, this debt offering will rarely be pulled even if credit markets are very bad because they have no other choice. So while with many of the other categories the cost of debt is generally acceptable (otherwise the transaction is just pushed back or killed until credit markets open), acquisition bonds can have very onerous coupons.

Choosing Between a High Yield Bond and Leveraged Loan

Leveraged loans are more flexible from a prepayment perspective and usually come with lower interest rates (that are floating versus a benchmark rate, such as LIBOR + 450 – although many corporates will elect to swap this to a fixed rate coupon and indeed because banks want certainty of cash flow they will sometimes force the corporate to swap it to fixed). There will also be some amortization factor or mandatory early repayment for leveraged loans.

However, they tend to come with exacting covenants where certain thresholds have to be routinely met (financial or maintenance covenants). Covenant-lite (cov-lite) term loans sometimes will mirror bonds instead (a bullet structure or close to bullet with very limited early amortization and weaker incurrence covenants), but the payoff has to be reflected in the form of a higher yield.

Sometimes this prepayment flexibility is key for corporates, especially ones with volatile cash flows that want to get rid of the debt early if possible – or be able to access more attractive financing if credit markets open up at a later date. However, for some corporates having looser covenants are more important so that they have breathing room to operate once the initial financing is secured. This depends on the CFO and treasurer’s philosophy.

Conversely, high yield bonds are bullet maturities but have strict non-call periods (no early repayment before the call period). Junk bonds have fixed interest payments and are usually subordinate to bank debt (but this is all in the contract or indenture – it depends from bond to bond) and accordingly have higher coupons.

Fixed IncomeSpreading Investment Banking Comps: Net Debt · High Yield Bond Characteristics · Introduction to Green Bonds · Understanding the Yield Curve · Interview with: Private Debt Analyst · Interview with: Credit Rating Agency Analyst · Fixed Income Analyst Interview Questions ·
Leveraged FinanceCLOs at the Center of the New PE Industry · Incurrence Covenants for High Yield Bonds · Accessing Leveraged Capital Markets – Part II · High Yield Bond Characteristics · What Makes a Good Leveraged Buyout (LBO) Candidate? · What is a Leveraged Buyout? Introduction to LBOs · Introduction to High Yield Bonds · Interview with: Private Debt Analyst · Options for Distressed Debtors: Refinancing and Restructuring · Differences Between Leveraged Finance and DCM · Debt Refinancing Options for Issuers ·
ex investment banking associate

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