Topic selection is a critical step in our investment process and includes many different aspects. A key factor in our process is a thorough review of all of a problem`s covenants. While we never invest in the hope that an issuer will default, the reality is that defaults do occur and we need to think about how to protect our investments long before a problem becomes apparent. Identifying issues that involve potential candidates for a tender or call is another reason why commitment analysis is so important. In this report, we will discuss key bond covenants, analyze the restrictive covenant sets of several new bond issues, and show how Western Asset integrates covenant analysis into its investment process. Another possibility is that a coupon is paid “in kind” or with additional bonds instead of cash. These transactions, known as “PIK” notes, give the issuer, as with zero-coupon bonds, room for the issuance of cash. PIN CODES allow a company to borrow more money – leverage – without immediate concerns about cash flow. Today, however, the market is also a good part of its own refinancing mechanism, with the product often repaying older bonds, bank loans, and other debts. If there are bond transactions that settle between coupon payment dates, the buyer owes interest to the seller – including – the last coupon payment date, up to – but not including – the settlement date of the transaction (usually t+ 3 for corporate bond transactions and t+1 for treasury bills). Hold and outstanding tests are two categories of restrictive covenants that require a borrower to meet certain limits on financial parameters. Maintenance tests, usually found on leveraged loans, require a company to comply with financial measures to avoid defaulting on its debt.
A common example of a maintenance test would be a maximum leverage of 6.0 times the debt on EBITDA, which, if the company were to exceed for any reason, would result in a technical failure. This contrasts with incurrence tests, which are used in high-yield bonds and only begin when a company incurs additional debt or makes limited payments to the detriment of bondholders. A company with a debt test of 6.0 times debt/EBITDA would default if the company actively adds debt that causes it to exceed 6.0 times leverage, but not if its EBITDA decreases and its debt ratio increases. While high-yield bonds suffer from the negative image of “junk bonds,” they actually have higher yields than investment-grade bonds over most long holding periods. For example, the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) posted an average annual total return of 6.44% between the beginning of 2010 and the end of 2019. Example: To calculate accrued interest on a corporate bond, the formula would often be that the process is often smoother and less accurate than other fixed income securities because the issuer has a “story” to tell to market the transaction, because issuers and underwriters are subject to more questions given the higher risks, and because the structure of the transaction can be revised several times. A good understanding of bond protection is crucial for a high-yield investor. However, the dense and sometimes confusing nature of a binding commitment can make it difficult to understand. Many basic restrictive covenants, . B such as a debt limit in the debt limitation criterion, contain written exceptions (also called exclusions) that can dilute their value for bondholders.
An example of this would be a split in credit facilities, which allows a company to take out additional loans on its bank line, even if it were to violate its criterion of overall indebtedness or hedging-based debt limitation. Particularly in the context of the company`s insolvency in 2009-2010, we believe that this weak covenant package posed excessive risk to new bondholders and was not offset by an anemic coupon of 6.75% (40 basis points lower than the high-yield market at the time). Debt buybacks (LBOs) typically use high-yield bonds as a funding mechanism, and sometimes retail investors use additional bond investments to fund special dividend distributions. This part of the market experienced explosive growth in 2005-06, in the midst of a buyback boom not seen since the late 1980s, then back in the bubble in 2005-2007, only to die out in the crisis that followed. In fact, high-yield LBO issuances peaked at $51 million in 2007, falling to zero in 2009. He returned in 2010, but certainly not at the Lehman summits. The priority of a bond can be changed by a number of factors, including: The following three case studies illustrate the potential benefits and risks that restrictive covenants can represent for investors in high-yield bonds. Offers of high-yield bonds are generally not registered with the SEC. Instead, transactions most often enter the market with the exception of Rule 144A, with future registration fees once the required documentation is required and an SEC review is completed. A small percentage of transactions enter the market under the name “144A-for-life”, i.e.
without registration fees. In both cases, the issuer is not required to provide public information during the broadcast under the rule. Retailer Neiman Marcus was the first to test the waters with a PIK tipping agreement in late 2005. Flooding followed, reaching a peak in 2007. In the following years, the issuance of pik toggle was naturally uneven, as was the new issuance market, as issuers were often in debt restructuring mode. PIK tipping activity increased in 2011 and 2012 against a backdrop of low interest rates and a flood of investor cases. However, the first real market boom occurred in the 1980s, when leveraged buybacks and other mergers made high-yield bonds suitable as a funding mechanism. Perhaps the most famous example is RJR Nabisco`s $31 billion LBO by private equity sponsor Kohlberg Kravis & Roberts in 1989 (the financing was detailed in the bestseller Barbarians at the Gate).
The most common types of transmitters are listed below. Other capital-intensive companies such as oil exploration also find investors in the high-yield bond market, as well as cyclical companies such as chemical producers. High-yield bonds (also known as junk bonds) are bonds that pay higher interest rates because they have a lower credit rating than investment-grade bonds. High-yield bonds are more prone to default, so they have to pay a higher yield than higher-quality bonds to compensate investors. Default itself is the biggest risk for investors in high-yield bonds. The main way to manage default risk is diversification, but this limits strategies and increases fees for investors. High-yield bonds are generally divided into two sub-categories: Since then, more and more companies with the development of the high-yield market have found acceptance among a growing pool of investors. High-yield bonds are still used to fund M&A activities, including LBOs (you`ll find that most of the transactions in the table above support leveraged buyouts) and often dividend distributions to private equity sponsors, and the market still supports the financing of capital-intensive projects such as telecommunications expansion, casino development and energy exploration projects. The steady growth of the high-yield bond market has seen few significant speed thresholds. There was the savings and lending scandal in the 1980s, the correction after the “technological wreck” in 2001 and, of course, more recently, the collapse of subprime mortgages, the credit crunch and the financial crisis of 2008.
This year`s issuance was just $69 billion, the lowest in seven years, according to LCD. In our view, this robust set of restrictive covenants will protect bondholders in a bearish scenario from a combination of excessive debt, subordination to new secured debt, and exhaustion of asset coverage through limited payments. The worst-case return is the lowest return obtained given the calls made before maturity. Because trading reports are widespread, companies such as MarketAxess Holdings and TradeWeb Markets, which are owned by Thomson Financial, in turn offer high-yield bond prices on their platforms in near real-time. “Junk Bond” or “Speculative Grade Bond” are simply other terms for a high-yield bond. These terms helped give the asset class a negative connotation in its most formative years. However, the asset class has become a large liquid market that now attracts a wide range of investors and a variety of issuers. .