Biggest LBO Financing of 2019 Shows Junk Bonds Regaining Fervor

(Bloomberg) -- The $10 billion financing for the car-battery unit of Johnson Controls International Plc is the latest signal that borrowers are keen to tap the high-yield bond market, which is seen as more favorable than that of leveraged loans.

When the banks kicked off the debt sale for the takeover of Power Solutions this week, the loan portion had been pared back to $5.45 billion in favor of more bonds. Just a month ago, initial whispers for the debt backing Brookfield Asset Management Inc. and Caisse de Depot et Placement du Quebec’s purchase had indicated a mix of $8 billion in loans and $2 billion in unsecured bonds.

The rest of the debt package, so far the largest for a leveraged buyout in 2019, is set to include $2 billion and 600 million euro in secured bonds and another $2 billion in unsecured bonds.

"Right now, companies would rather go to the high-yield bond market than the leveraged loan market," said Brit Stickney, portfolio manager at Allianz Global Investors’ income and growth fund team. "There is more certainty, looser covenants and the possibility of issuing subordinated debt."

The high-yield bond market is on fire this year -- spreads have tightened and the asset class has posted the best start to a year since 2001. Dedicated bond funds have seen $10.6 billion in inflows the last two months while loan funds’ losing streak has extended to 15 weeks. And while loans’ biggest buyers, collateralized loan obligations, have geared up, new deals on average are commanding fatter original issue discounts and higher margins over Libor than they were for much of 2018.

It’s little wonder then that the Johnson Controls unit, recently dubbed Power Solutions, rejiggered its debt mix. Power Solutions follows the likes of Dun & Bradstreet and CommScope Holdings Co. in adding more bonds than originally planned.

Senior secured bonds are expected to yield more than the loan piece of the financing since there should be a cost to the stiffer call protections that bonds command. But Dun & Bradstreet’s debt financing showed senior bonds can price slighter than loans in this environment.

It’s not all bad news for loans, though. Private equity firms will remain attracted to the flexible prepayment option they offer, and the asset class has less onerous securities requirements as well. With fund outflows abating for loans, junk bonds and loans may remain in a tug of war over issuance rather than seeing an overwhelming preference for one over the other.

©2019 Bloomberg L.P.