PIK deals come despite slowdown in high-yield market

Thu Feb 14, 2013 3:22pm EST

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Feb 14 (IFR) - The US high-yield primary market has slowed this week, with just seven US issuers tapping the market for a total of US$3.95bn through Thursday afternoon.

But despite the lull in supply, overall risk sentiment has improved since last week, allowing even some riskier PIK toggle issuance to enter the market.

Bankers say a combination of factors has led to the slowdown in activity.

"Companies are in their blackout period, there's very little M&A activity ready to go at the moment, and a lot of issuers have already gone to market at the end of last year or the beginning of January, so there is not much pent-up supply," said one syndicate manager.

"Everyone keeps talking about upcoming M&A, like Constellation Brands and Dell, but that's not going to happen for several months."

The US$28bn Heinz acquisition, announced today by Berkshire Hathaway and 3G Capital Partners, may provide additional supply, although market participants are uncertain if the Baa2/BBB+ rated company will be downgraded to junk or remain investment-grade rated.

Heinz is taking on around US$7bn of additional debt to fund the acquisition.

HEALTHY RE-PRICING

The high-yield market weakened during the previous two weeks on the back of rising Treasury yields, but that back-up was not among the reasons that issuers have kept to the sidelines, as rates are still viewed as attractive to issuers, the syndicate manager said.

And an improved tone this week has already seen yields come back in. The average yield-to-worst on the Barclays high-yield index tightened to 5.95% on Wednesday after hitting a recent high of 6.02% last Friday. It reached an all time low of 5.61% on January 24.

Meanwhile the option adjusted spread was quoted on Wednesday at 479bp, 28bp wider than the recent low of 451bp recorded on January 25, but 11bp tighter than levels seen at the end of last week.

Overall, the recent widening was viewed as healthy, and helped return buyers to the market.

"The pull-back has been stemmed and buyers are back," said Michael Collins, senior investment officer at Prudential Financial.

"The reach for yield and the demand for relatively high-quality fixed income assets are so strong that any spread widening is going to be met with renewed buyers," he said.

Sentiment has improved to the point that companies felt comfortable forging ahead with some riskier pay-in-kind (PIK) toggle issuance on Thursday that will pay dividends to equity sponsors.

PIK toggles, abandoned as the financial crisis took hold, re-emerged late last year as investors moved down the credit curve in the hunt for yield. The structure allows an issuer the choice of paying interest in cash or in kind, effectively deferring payments.

Although they are considered riskier than a regular high-yield bond, the latest PIK toggle deals have come with less risk than those priced in the boom period of 2005-2007.

The recently priced PIK notes require the issuer to pay the interest outright if the company has enough cash to do so. In the past, an issuer could "toggle" back and forth between cash and pay-in-kind as it pleased.

Two PIK toggle deals launched on Thursday.

Burlington Holdings, the parent of Burlington Coat Factory Investments Holdings, announced a US$300m five-year non-call one senior PIK toggle deal through Goldman Sachs, JP Morgan, BofA Merrill, Morgan Stanley and Wells Fargo joint books. Pricing was set for later on Thursday, with proceeds being used to pay a dividend to Bain Capital, its owner.

Price talk on the deal is 9%-9.25%.

The deal raised some eyebrows, particularly after the company's new loan refinancing, a US$871m term loan B, was heard to have been pulled earlier this week.

Meanwhile Neovia Logistics Intermediate Holdings is also in the market with a US$125m five-year non-call two senior PIK toggle issue through UBS, Macquarie and Deutsche Bank joint books. Proceeds will be used to pay a dividend to equity sponsor Platinum Equity. Pricing is expected later on Thursday at talk of 10% area.

"These deals are indicative of the reach-for-yield environment that we are in," said Collins.

"It's a little disconcerting that these types of deals are potentially getting done, although there has been some pushback recently in the market with a few loan deal repricings that didn't come through and some higher-beta (high-yield) deals that have struggled a little bit."

Two other PIK toggle notes have priced so far in 2013.

Nord Anglia Education sold a US$150m PIK toggle issue at the beginning of the month, pricing the five-year non-call two issue at 8.5% at par through Goldman Sachs sole books.

Orion Engineered Carbons Finance priced a US$425m 6.5-year non-call one PIK toggle issue at 9.25% at 99 for a yield of 9.459%. Goldman Sachs was left lead, joined by Barclays, JP Morgan and UBS on the right.

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