REFILE-Terra Firma leads PIKs down new ABS path

Wed Nov 21, 2012 3:28am EST

* Annington could mark biggest global PIK of year

* Unique hybrid has structured-style cashflows

By Natalie Harrison and Owen Sanderson

LONDON, Nov 20 (IFR) - Terra Firma's planned ABS-style Payment-In-Kind (PIK) bond may be easier to sell to investors than some market experts anticipate due to stricter rules on cash payouts to equity investors.

Guy Hands' Terra Firma buyout group this week agreed to buy Annington Homes from Nomura in a deal worth GBP3.2bn, which will be financed by GBP1bn of new equity, debt financing in the form of the PIK, and the assumption of existing securitised debt of GBP2.2bn.

The sheer size of the Caa1/CCC+ GBP500m PIK immediately sparked surprise because of the riskier nature of the instruments.

The deeply subordinated debt securities, that are widely considered to be bull-market instruments, usually only appeal to a select group of investors despite their double-digit yields.

However, a "cash-sweep" feature, which restricts payments to equity investors until cash interest and principal on the PIK are paid, means that bondholders are offered more protection than is usual with standard PIKs.

This should give investors confidence that the cashflows of the company will go to them before Terra Firma - though after the Annington Finance 1 and 4 securitisation structures.

Barclays, sole manager on the 10-year, non-call five PIK, declined to comment on details of the bond's structure, but sources said the cash-sweep feature will closely mimic the junior tranche in a securitisation waterfall.

In a standard ABS deal, cash flows from the underlying assets can only filter through to more junior tranches - like the Annington PIK - once payment conditions on senior tranches are satisfied.

A UNIQUE HYBRID

Not only will the Annington PIK mark one of the biggest single tranche sterling high-yield bonds of the year, but if successful, would also be the largest PIK of the year on a global basis.

Although a swathe of PIKs have launched in the red-hot U.S. market in recent weeks, the securities are rare in Europe, and the last to price - a 12.4% EUR250m PIK for Swedish cable company Com Hem - is trading two points below its launch price last week.

However, the unique structure of the Annington deal may be a supporting factor.

One high-yield investor said comparables for the PIK might include B notes from the HoldCo structures used by utilities such as Anglian Water or those issued by UK airports operator BAA.

"It's an odd deal for high-yield, and is a transaction that would be more familiar to an ABS investor," the investor said. But he said that Terra Firma's GBP1bn equity injection would provide some cash cushion to the PIK bondholders, and was therefore a positive.

"That's different to what a PIK is usually used for, mostly to de-risk the owners," he said.

The RegS/144A bond may appeal to U.S. investors, although the bulk of the transaction is expected to be anchored by UK investors.

Pre-marketing has already taken place, and meetings with a number of niche investors that have an in-depth knowledge of UK real estate and structured finance have been arranged.

MARRIED TO THE MOD

Annington Homes became one of the largest private owners of residential property in the UK when it purchased the Married Quarters Estate from the Ministry of Defence (MoD).

The company leases the majority of its 40,000 properties back to the MoD to provide accommodation for service families.

That leasing contract, which has around 180 years to run, is effectively an arrangement with the UK government, which should also help to give investors confidence in the deal.

Hands' knowledge of the business is also a major positive. He was behind Nomura's purchase of Annington in 1996 when he worked at the Japanese bank, and he has managed the investment on behalf of Nomura for the last 15 years - 10 of those while at Terra Firma.

Cashflows to the Annington Finance securitisations - and, eventually, to the PIK note - will come from properties that the Ministry of Defence designates as surplus. Annington will sell these at market value and use the proceeds to pay down the debt.

Adding a PIK to the capital structure, which mimics a securitisation but sits at holding company level, is potentially easier than adding new subordinated debt inside the securitisation structure as this would require consent of existing bondholders.

Cash interest on the PIK will not be paid until the Class B3 notes and Class M notes - which sit at the bottom of the Annington Finance 4 securitisation capital structure - have been redeemed in full or refinanced.

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