Barings

A bond is a debt obligation sold to investors. If a corporation defaults on its obligations, it can be forced into bankruptcy liquidation, in which case its assets are sold off to repay its debts. Debts are repaid in a prescribed order of priority. “Senior” debt is repaid first, ahead of junior, or subordinated, debt. If a bond is classified as “secured”, it is backed by issuer collateral, or some form of assets. Therefore, senior secured bonds are high yield bonds that are both senior and secured in the capital structure (Figure 1).

Figure 1: Global Senior Secured Bonds Offer Capital Structure Seniority

Senior secured high yield bonds for North American non-financial companies have historically offered higher recovery rates relative to unsecured bonds. During the period from 1987–2022, the average recovery rate for defaulted senior secured bonds was 61.2%, compared to 47.1% for senior unsecured bonds and 27.8% for subordinated debt (Figure 2).

Figure 2: Senior Secured Bonds Have Historically Offered Higher Recovery Rates

The senior secured bond market has experienced substantial growth over the last decade, the value of the market is around US$515 billion, equivalent to about one third of the global high yield bond market¹.The growth of the asset class is largely due to its emergence as a viable source of funding for companies as other capital-raising avenues—including loans and unsecured bonds—faced limitations.

On the other hand, senior secured bonds exhibit relatively low sensitivity to interest rate moves as evident by the low duration profile. This relationship can also be observed via the historically low and often negative correlation across total returns between the global senior secured bond asset class and U.S. Treasury bonds. That said, interest rate sensitivity can vary considerably on a more bottom-up basis across specific credits, sectors and ratings, which warrants careful security selection.It is also worth noting the relatively shorter maturity profile of the global senior secured bond market—less than 1% of the market has a maturity profile greater than 10 years². 

Figure 3: High Yield Prospects With Limited Interest Rate Sensitivity

Further, while senior secured high yield bonds are not recession-proof, they are higher in the capital structure than unsecured bonds, which means they can offer investors greater protection from principal loss in the event that a company defaults. The asset class, like traditional high yield bonds, is sensitive to the credit fundamentals of the issuing company, and economic slowdowns can put pressure on corporate cash flows and/ or profitability. 

Senior secured high yield bonds, like traditional unsecured high yield bonds, tend to be more highly leveraged than their investment grade counterparts and, therefore, may be more vulnerable in a recession. However, managers may seek to mitigate the credit risk associated with below investment-grade debt by carefully analyzing the fundamentals of the issuer and assessing the collateral attached to the bond.

_{¹ Source: ICE BofA. As of September 30, 2023.
² Source: ICE BofA. As of September 29, 2023.}

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