Thomas Rentsch
Senior Portfolio Manager High Yield
Senior secured high-yield bonds suggest security, but without genuine subordinated debt they often bear the full burden of losses in the event of insolvency. In the European high-yield market, the proportion of secured issues has risen sharply in recent years, which has diluted the economic value of seniority. A close examination of the capital structure and collateral quality is therefore crucial in order to distinguish marketing from genuine protection.
European high-yield bonds have long been synonymous with unsecured, subordinated risks with correspondingly high coupons. In the last years of the 2010s, unsecured bonds dominated the market, but today the picture is completely different (see Chart 1). The majority of new issues are “senior secured”, often accompanied by terms such as “first lien” or “security package”. At first glance, this sounds reassuring – after all, collateralization suggests preferential access to assets in the event of insolvency. But in reality, seniority has been devalued economically.
Change in the European high yield market: rise in senior secured high yield bonds
Source: Bloomberg (Euro HY ex Financials BB-B 3% Capped H23969EU Index); own calculation (Is_Secured); period: 31.12.2016 to 31.12.2025.
Seniority without subordination – a deceptive security
How much protection is actually behind this if there is no longer any real subordinated debt or unsecured bonds in the capital structure? The crux of the matter is that “senior secured” only makes sense relative to something else. If a medium-sized European issuer only has a single tranche of secured high-yield bonds outstanding, then these bonds are formally senior and have collateral. In a crisis, however, it is not the label that is decisive, but the simple question: Are the proceeds from the sale sufficient to repay this one bond in full? If there are no other subordinated creditors to whom losses can be passed on, then the senior secured bond bears the entire economic write-down requirement. It is then only senior on paper.
Typical private equity structures are even more treacherous. Here, the senior secured bond is often topped by a super senior bank facility, such as a revolving loan for working capital. In the event of insolvency, this facility is serviced first, although it hardly takes up any space in the bond’s marketing document. In addition, there are non-financial liabilities such as pension provisions, tax liabilities or high supplier credits, which in practice often compete for the value of the company before or at least alongside the bond creditors. Again, the label “senior secured” is of little value if the collateral package is narrow or legally difficult to enforce.
Case study: 1 billion debt / liquidation value 600 million
Source: Symbolic representation; left scenario = 700m senior secured debt = 85% recovery (=600/700); right scenario = 100m super senior secured debt with 100% recovery, leaving 500m for 900m senior secured debt = 55% recovery (=(600-100)/900)
Organize labels – selection decides
That is why it is not enough to be guided by nice-sounding labels. Anyone investing in European high-yield bonds must take a detailed look at the capital structure, the quality and scope of the collateral, the guarantors, the covenants and the jurisdiction. A “security package” that looks impressive in the prospectus may, on closer inspection, turn out to be a pledge of brand rights and shares in a HoldCo, while the operating assets are left out.
In a market in which almost everything is called “senior secured”, active, bottom-up management is a must. Only those who dissect issuer by issuer, run through stress scenarios and can assess the actual chances of recovery can distinguish between genuine collateralization and a mere marketing label.
“Don’t blindly trust the label ‘senior secured’ – because where there are no subordinated creditors, your supposedly senior bond will bear the full brunt of the crash.”
– Thomas Rentsch
Risks
Price losses due to increases in yields and/or higher risk premiums are possible. A total loss cannot be ruled out.
Past performance is not an indication of future results, nor can future performance be guaranteed.
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