Risky Debt is Starting to Look the Same in Junk

(Bloomberg) — Junk bonds are starting to look a little like leveraged loans in a new sign of investor fever for higher-yielding debt.
Private-equity owned companies Zayo Group Holdings Inc. and LifePoint Health Inc. have torn up the rule book when it comes to a high-yield bond structure known as the non-call period, which makes it harder for borrowers to redeem debt early without paying a penalty to investors. Zayo’s planned offering trims the period to just a year, bringing it closer in line to the structure in leveraged loans.
Some analysts have sounded the alarm that the deals could set a new precedent in a market that’s seen years of eroding investor protections. Yet demand has stayed strong with orders for Zayo’s $1 billion secured bond swelling to twice that amount before marketing even began on Tuesday, as investors clamor for deals in a market that has been dominated by refinancings.
Private equity firms Digital Colony Partners and EQT Partners are funding their purchase of Zayo in one of the biggest buyout financings to hit the junk-debt market in the last 18 months. The loan and bond package totals $8 billion, and the seven-year secured bond may price as soon as Thursday. Barring any changes to the terms, Zayo will be able to repay the debt at 102 cents on the dollar after one year instead of the more typical three to four years.
“The price appreciation potential of the high-yield bond market has come down with shorter non-call periods and lower call premiums,” said Bill Zox, chief investment officer for fixed income at Diamond Hill Capital Management. “This structure is another large step in that direction.”
Read more: Zayo bond seeks to remove investor protections
For issuers, the new structure is a win-win. Not only are they getting the same kind of prepayment flexibility as leveraged loans, which can usually be paid off after six months at no extra charge, but borrowing costs overall are cheaper in junk bonds. Early price discussions on Zayo’s secured bond were for the mid-4% area compared to an all-in yield of about 5% for the loan.
Without the shorter call protection, Zayo would have opted for a larger loan instead of the secured bonds, according to people familiar with the matter who asked not to be named discussing a private sale. The people added that a successful Zayo sale may spur more companies to issue secured bonds with similar call structures.
LifePoint Health, which was bought by Apollo Global Management in 2018, sold a seven-year secured bond last week that can be repaid after only two years.
Other borrowers have also shifted financing toward bonds to get cheaper prices. In January, BC Partners moved about $400 million of debt to bonds from loans for its buyout of Presidio Inc.
Representatives for Morgan Stanley, the lead bank on the Zayo bond sale, and EQT declined to comment. Representatives for Credit Suisse, Digital Colony, and Zayo didn’t respond to requests for comment.