* Sponsors seeking leeway embrace high yield FRNs
* CLO backstop waning as reinvestment periods end
* Cov-lite loans could trump FRNs' flexibility
By Robert Smith
LONDON, May 17 (IFR) - High yield floating rate notes, once
a niche product but now a more common feature in the market, may
already have had their heyday, as corporates eye a renaissance
in covenant-lite leveraged loans that could offer even more
A surge in FRN supply has been one of the key themes of the
high yield market in recent weeks, driven by demand from
collateralised loan obligations and a desire by leveraged
borrowers to keep financing as flexible as possible.
Traditional loan borrowers value the shorter, usually
one-year, call protection on FRNs, because it means the debt can
be paid off after that period without incurring payment
Fixed rate bonds, in contrast, usually have more restrictive
three- or four- year call periods.
Those factors have led to a doubling in FRN issuance, with
11 issuers pricing EUR2.3bn-equivalent of bonds compared to
EUR1.3bn priced by five issuers at this point last year,
according to data from Nomura.
Euro floaters have been dominant due to their natural
backstop in the CLO market, but deals have not been restricted
to that currency with sterling also seeing an influx, most
notably from helicopter operator Bond Aviation and insurance
broker Towergate more recently.
Towergate's GBP396m deal was the largest sterling floater to
date and the largest European FRN all year, and unprecedented
demand let the borrower drop a proposed fixed rate tranche,
leaving it with a flexible capital structure that will make it
easier to push ahead with plans for an initial public offering.
In the same week bathroom equipment maker Sanitec, which is
also eyeing an IPO, and UK retailer New Look priced euro
"When two sterling FRNs and two euro FRNs price in one week,
issuers, particularly sponsor-backed ones, are certainly going
to take note," said Kevin Connell, managing director of high
yield syndicate at RBS.
"However, there is a natural limit on how much will get done
in FRN form. It's still an instrument, particularly in GBP,
that you'd want to pre-market before launching in most cases."
FRNs have been particularly valuable to private equity
sponsors if they are mid-investment cycle and are planning a
potential exit from the business in the next year or so ahead.
They first made a comeback in early 2011, with bathroom firm
Grohe one of the first to issue such deals.
Market conditions have been so strong of late that Sanitec
was even able to use some of the proceeds from its EUR250m FRN
to pay sponsor EQT a EUR100m dividend.
Sponsors that fully recycle a loan capital structure in the
bond market are also able to strip out maintenance covenants.
An outright capitulation on covenant-lite loans, however,
could nip FRN growth in the bud because from an issuer's
perspective, loans are cheaper and give borrowers complete
freedom to prepay whenever you want.
In contrast to their American counterparts, European
investors have been disciplined in their opposition to these
loans, which offer less protection for investors against a
deterioration in a company's performance.
But investors have relented when a euro tranche sits beside
a dollar tranche, such as the recent Ineos refinancing. Ista's
recent LBO financing also had all but two loan covenants
stripped out, despite having no dollar component.
"There is still a certain contradiction in investors
accepting FRNs but resisting cov-lite loans, and so FRN issuance
is likely to be another driver of the European transition to
pure cov-lite," said Peter Hurd, managing director, acquisition
and leveraged finance, capital markets at Nomura.
STARING DOWN THE BARREL
The dynamics that have driven FRN supply are certainly
changing. The dwindling reinvestment capacity of CLOs, the main
buyers of the instruments, is regarded as the biggest threat to
the instrument's longevity.
According to Nomura, EUR22bn of the EUR45bn existing CLO
liquidity will expire by year end, with 76% expiring by July.
The CLO bid is staring down the barrel, fuelling the FRN
surge as issuers rush to tap the market before it expires.
Support from a broader investor base is therefore needed to
maintain momentum in the market, bankers say.
New European CLOs have formed this year, but only at a slow
pace, and the fact that some of those have larger bond buckets -
40% on Pramerica - frees managers to buy fixed rate notes over
FRNs, which could further cap demand for floaters.
Loan investors raising further money through managed
accounts have provided FRNs with more liquidity, but whether
they continue to buy after the CLO bid wanes is an open
The most likely scenario, at least in the foreseeable
future, is that FRNs will remain a tool for borrowers that
cannot print cov-lite deals, if that market springs to life.
Ultimately though, bond investors will determine whether
floaters become known as a fad or market staple in high yield.
From an investor point of view, FRNs are more liquid than loans,
and there is also the prospect of higher interest rates to
"Although FRNs lack convexity, an investor does get
greater interest rate protection. That could turn out to be
quite attractive in the future," said Connell.