Loans are cheaper than bonds for some well-rated companies
Some well-rated companies are turning to term loans rather than bonds for their funding needs, taking advantage of cheaper prices as banks adjust to rising interest rates more slowly than credit markets.
As the Federal Reserve on Wednesday approved a 0.75 percentage point interest rate hike, finance chiefs are doing the math as they assess alternative instruments to pay maturing debt, mergers and acquisitions or other transactions. The Fed’s rate hike was its fifth of the year, and banks’ funding costs generally react slower than bond markets to these Fed actions, with a lag ranging from weeks to months. said the bankers.
“We are seeing a resurgence in interest in term loans as it is a cheaper alternative for many borrowers,” said James Shepard, head of investment grade debt capital markets at Mizuho. Americas, an investment and corporate bank. He said the difference in financing costs can be as much as half a percentage point. “These are companies that would have opted for regular bond financing when financing costs were low,” he added.
Companies, including enterprise software company Oracle Corp.
feed manufacturer Conagra Brands Inc.
and Philip Morris International Inc.,
a maker of cigarettes and vaping devices, has secured financing through term loans in recent months.
Highly rated companies raised $998.8 billion in bonds in the United States this year through Monday, compared with $177.9 billion in term loans, according to Refinitiv, a data provider. For the whole of last year, fundraising through bonds was $1.46 trillion compared to $236.7 billion for term loans for companies rated as investments .
“It’s a small portion of businesses that really need capital right now, because a lot of them have already applied for funding,” said Don McCree, vice president and head of commercial banking at Citizens. FinancialGroup. Inc.
Banks often provide additional services to business customers — for example, cash management, hedging or underwriting — and therefore may charge less for term loans, he said. “As long as there are ancillary activities, pricing in the banking market can be supported by other sources of revenue,” McCree said.
Term loans often have shorter terms than bonds, with many ranging from three to five years. Companies that agree to take out a loan don’t have to draw on it, which can make it more of an insurance than an obligation, where investors pay the company soon after the deal closes. Revolving credit facilities differ from term loans in that the borrower can draw funds up to a limit, repay and draw again. In a term loan, the borrower generally makes a single withdrawal of funds and agrees to pay a fixed amount periodically.
Term loans and revolving credit facilities often have variable rates consisting of a fixed amount plus the guaranteed overnight funding rate, which moves up or down depending on market conditions, while issuers generally agree to pay a fixed rate when they sell a bond.
Conagra, the owner of top brands like Reddi-wip cream, Slim Jim meat sticks and Birds Eye frozen food, borrowed $500 million earlier this month in a term loan that it set up in August. The Chicago-based company said it plans to use some of the unsecured loan proceeds to pay down longer-term debt maturing in its 2023 fiscal year.
Conagra has about $937 million maturing in bond debt in calendar year 2023, according to S&P Global Market Intelligence, a data provider. The company, which had different financing options, said it chose a term loan because of the “relative strength of the bank loan market”. It last mined the bond market in August 2021, according to S&P data.
While highly rated companies have agreed to an average bond yield of 4% year-to-date, that average yield has risen to 4.8% for bond sales over the past three months, said Citizens. For bank loans, including term loans, companies with a simple A credit rating have agreed to pay a spread of SOFR plus 103 basis points, or 1.03 percentage points, on average since the start of the lending. ‘year. This average lending spread has fallen to SOFR plus 92 basis points over the past three months. SOFR was trading at 2.27% on Monday, according to the Federal Reserve Bank of New York.
Austin, Texas-based Oracle, a regular issuer of bonds in previous years, has also accepted funding through investment-grade term loans in recent months, including $4.36 billion in July at a cost 160 basis points plus SOFR, according to Refinitiv. The company has borrowed about $15 billion in term loans since the start of the year and has completely ignored the bond market. Oracle sold $14.9 billion in bonds in 2021, including about $2 billion maturing in 2028 for 2.3%, and $19.9 billion in 2020, including about $3.5 billion at maturing in 2060 for 3.85%, according to Refinitiv. The company declined to comment.
Philip Morris, which in June agreed to $5.8 billion in term loans alongside a bridge facility to finance its bid for Swedish Match AB, a maker of lighters and tobacco products, also did not back down on the bond market since 2020. The highly rated company declined to comment.
Bankers also noted increased interest in term loans among unrated companies. Energy Cheniere Inc.,
a producer and exporter of liquefied natural gas, in June refinanced and increased a $4 billion term loan and a $1.5 billion working capital facility. It has not announced bonds to investors this year as it did in 2021 and 2020, when it sold $750 million and $1.8 billion, respectively, according to Refinitiv. Cheniere, who is reducing debt to get a quality credit rating, declined to comment.
“We are seeing a growing trend for businesses to increasingly use prorated term loans,” said Kristin Lesher, head of middle market banking at Wells Fargo & Co., referring to a mix of credit facilities. revolving and term loans. “For companies with impending maturities, some are choosing to use term bank loans as a way to swap debt at a lower relative cost of capital.”
But term loans can have limitations. Royal Caribbean Cruises ltd.
, a New York-listed cruise line, last month placed $1.25 billion in bonds with a coupon rate of 11.625%, alongside a second offering of $1.15 billion at 6%. The company, which is struggling to reduce its debt to pre-Covid-19 levels and has a speculative-grade credit rating, uses term loans to finance its ships, but does not rely on these loans to obtain funds to repay maturities, said chief financial officer Naftali Holtz. “The long-term strategy is to arrive at an unsecured balance sheet. Term loans tend to be collateralized,” Holtz said, pointing to the mix of bonds and term loans that make up the company’s capital structure.
Businesses that mature in early 2023 and don’t want to wait for financing can take out a term loan now or hedge to sell fixed-rate bonds.
“If credit markets revalue, they can exit term lending and tap into the bond market instead,” Mizuho’s Mr. Shepard said. “It’s cheap insurance, take out a term loan now.” Nonetheless, businesses should cover transaction fees, which can vary by bank.
Write to Nina Trentmann at [email protected]
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