Quest for yield brings back risk in PIK toggle bonds

Wed Dec 19, 2012 10:30am EST

Dec 19 (IFR) - Investors' desperate search for yield has opened the door for some junk-rated issuers to resurrect payment-in-kind or PIK toggle bonds, a staple of the riskier pre-crisis era.

PIK toggle deals, abandoned as the financial crisis took hold, re-emerged late this year as investors moved down the credit curve in the hunt for yield.

The bonds give issuers the choice of paying interest either in cash or in kind, effectively deferring payments - for which the lender thus assumes the additional risk.

This month, Taminco - a privately held specialty chemical producer - priced a US$250m senior unsecured five-year non-call one PIK toggle via joint bookrunners Credit Suisse and Citigroup.

The issue priced at 9.125% at 99 to yield 9.381%. (That steps up by 75bp if payment is made in kind.) Though pricing was not tighter than a PIK toggle by New Academy the previous week, the leverage on Taminco's transaction was much higher.

New Academy's deal included a short one-year call date and an equity claw of 100% at 102, and the Caa1/CCC+ rated transaction priced at 8% at 99.50 to yield 8.114%.

According to bankers and sponsors, most PIK toggles that have priced in Q4 2012 were either from vintage LBOs that delevered through the past few years and could accommodate a slight increase in debt, or others - from 2010 or 2011 - that were financed at lower debt levels and higher equity due to a fragile macro climate at the time.

Sponsors said that for both types, companies were only bringing leverage to a level that their balance sheets could bear, or back to the same level as the original LBO.

But the Taminco deal, however, showed that investors are willing to take more risk than that. When Apollo acquired Taminco at the beginning of the year for EUR1.1bn, leverage was quoted at 3.9 times. The company delevered after that, to 3.6 times, but the PIK toggle deal now takes it to 4.7 times.

"We are really starting to see a spike in risk taking," said one investor. "Even the more aggressive deals are being gobbled up by the market."

Buyers included investors who had been unable to get into the 9.75% opco bonds due 2020 issued by Apollo in January to fund the Taminco buyout.

The investors came in despite the fact that the PIK toggle deal, which will be used to pay a dividend to Apollo, was being done ahead of an expected IPO. The company expects to go public in the first half of next year, sources said.

In the event of any equity issued during the first year after the bond deal is issued, the equity clawback allows the issuer to use the equity proceeds to redeem as much as 100% of the notes at a premium of 102.

Under the standard structure, an issuer typically can redeem only up to 35% of the issue during the first three years at a much higher call price of par plus the coupon.

In the aftermarket, Taminco's bonds were quoted at 100, up a point from new issue price.

OTHER SIGNS

Another sign of bullish sentiment on the securities was a deal by Michael Foods. The company raised US$275m in senior PIK toggle 5.5-year non-call 1.5 senior notes.

Rated Caa1/CCC+, the deal priced at 8.50% at a discount of 99.50 to yield 8.611%. Goldman Sachs and BofA Merrill led the deal, which together with cash on hand will pay cash dividends to the parent's equity interest.

Goldman Sachs Group purchased the food supplier from Thomas H. Lee Partners in 2010 in a deal valued at US$1.7bn. THL retained a 20% stake at the time.

The Michael's deal was considered less aggressive with a 1.5-year equity claw at 35% at 108.50. It was a big winner in the secondary market, rising to 103.00-103.50.

Igloo Holdings, the indirect parent of Interactive Data , last week launched a US$350m senior PIK toggle notes offering due 2017, pricing the Caa1/CCC+ rated notes later the same day at 8.25% at a discount of 99 to yield 8.50%, on the wide end of talk.

Proceeds, along with cash on hand, will be used to pay a US$450m dividend to Interactive Data's shareholders and pay a distribution to optionholders. Silver Lake and Warburg Pincus are equity sponsors, having purchased the financial information provider in 2010 for US$3.4bn.

While the call structure mimicked New Academy's and Taminco's at five-year non-call one, the equity claw was a bit less aggressive, at 40% at 102 the first year.

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