One of the more interesting deals we saw in the European high yield market last week was a £600m B3/B+ rated senior secured note from Punch Pubs. Aside from suggesting renewed confidence in the hard-hit UK leisure sector (initial price talk of 6.5% was ultimately tightened to 6.125%), the deal was also noteworthy for being the first whole business securitisation (WBS) to be entirely refinanced in the bond market.
WBS transactions emerged in the late 1990s, before the high yield market had properly been established in Europe. They offered a way for issuers that possessed high quality collateral to run relatively high levels of leverage at relatively low financing costs, by securitising their operating assets and offering strict covenant protection to investors. Given the expected cash flows from these assets typically comfortably exceeded the required payments on the issued notes, and bondholders were in priority positions that could not be subordinated, investors were able to enjoy strong credit ratings (often A or BBB) on certain WBS tranches – even if the underlying assets of the business would have been rated multiple notches lower on a standalone basis. WBS issuance became more common in industries considered to have stable, predictable cash flows, and it has been used frequently in the UK pub sector where many companies own large freehold real estate portfolios that can serve as collateral.
Despite offering investors a handsome pick-up in yield versus comparable investment grade indices (sometimes 100bp or more), the WBS structure itself was relatively inflexible for issuers, which meant the product was rather left behind as European high yield issuance went from strength to strength in the 20 years after the first WBS was priced. Given the extra flexibility high yield bonds offer to issuers, we expected corporate treasurers to look to refinance WBS deals in the bond market at the first opportunity, but this can be easier said than done given they tend to have very long maturity profiles (which are non-call for life) and expensive take-out premiums. In fact, an analysis of pub WBS deals by Stifel showed the take-out premium required was generally pretty prohibitive, ranging from 8% to 36% of the total debt stack (the redemption premium on the Punch refinancing was 6%).
All told, while we think relative value in WBS can be attractive, we believe the trend of refinancing in the bond market is only going to continue in the coming years, though it will be gradual. We believe many issuers will be happy to pay up to increase the flexibility of their capital structure, particularly given how useful that flexibility has proven to be during the COVID-19 period. While this certainly means covenant protection for these companies will be weaker than in WBS form, the underlying asset pools of these businesses look much stronger than they did 20 years ago, so this shift to bonds could provide some attractive relative value opportunities for investors in a low yield environment.