* Investors bemoan lack of subordinated bonds
* Senior secured refinancings dominate
* But racier deals could be on the way
By Robert Smith
LONDON, May 8 (IFR) - European high-yield investors eager for diversification are crying out for riskier credits and structures, to move away from a market that has become dominated by bank debt refinancing deals.
Bond-backed LBOs have been few and far between in 2014, forcing investors to subsist on a steady diet of refinancings, and pushing them into more loan-like senior secured structures.
“The low volume of European LBOs and the deleveraging of the region’s banks has created a glut of senior secured loan-to-bond deals with small scope for price appreciation,” said Peter Aspbury, a high yield portfolio manager at JP Morgan Asset Management.
“High-yield investors would welcome an increase in traditional subordinated LBO debt just for the opportunity to have good credit selection rewarded with returns that are more equity-like than loan-like.”
So far this year, there have only been three Triple-C rated high-yield bonds in European currencies, compared to eight by this point in 2013. Volumes have dropped from 2.6bn last year to 2bn this year.
Investors are becoming increasingly frustrated at the lack of diversity, faced with a growing concentration of senior secured deals. One fund manager describes some of these all-senior secured capital structures as “putting lipstick on a pig.”
“Their unsecured rating would be Triple-C, but they’re labelled with a bit more security to keep the rating agencies from assigning a lower rating,” he said.
The problem for fixed income investors is that these borrowers want their bonds to be as loan-like as possible. Shorter non-call periods, for example, make debt easier to repay for borrowers, but cap price appreciation for investors.
For example, Paroc’s 430m six-year senior secured bond due to price this week has just two years of call protection on its fixed rate tranche and only one year on its FRN.
“Issuers are having their cake and eating it when it comes to shorter call structures,” said Aspbury.
“That’s great for the borrowers, but for investors your risk/reward profile is increasingly asymmetric.”
While price appreciation is capped by the first call price, prices can still plummet if the issuer runs into difficulties or the wider market sells off. To avoid this problem, known as negative convexity, European investors are having to become much more versatile.
“It would be nice to see a wider range of structures, but this just shows why you need to have a flexible mandate so you’re not beholden to Europe’s primary market,” said Fraser Lundie, co-head of credit at Hermes Fund Managers.
“The US has seen much more diversity and far less call protection erosion and if you can invest in CDS you can get around Europe’s negative convexity.”
While issuance of Triple-C rated instruments has dropped this year, the dearth of subordinated supply is at its starkest in the PIK space where not a single PIK toggle has priced in euros or sterling.
By May 2013, four PIK toggles had priced in European currencies, while the second half of 2013 saw seven more, including Schaeffler’s record breaking 1.5bn-equivalent deal.
“The lack of PIK supply is largely to do with the increase in IPO activity,” said Henrik Johnsson, head of EMEA high-yield and loan capital markets at Deutsche Bank.
“The bulk of PIKs return capital to private equity firms, and as I understand it LPs [limited partners] would rather this be done through an exit instead of adding more leverage given the strong equity market conditions.”
Investors with narrower mandates may find some respite in coming weeks, however, as LBO and PIK deals may finally emerge.
“There’s been relatively little LBO activity in Europe, and these are the trades that usually offer subordinated debt,” said Johnsson.
“Thankfully this is set to change, as there are a few LBO bond deals coming to market soon.”
In Europe, buyouts of Parex, CABB and GEA are approaching the debt markets and all three buyers favour the bond route. One bank is also understood to be pre-marketing a new PIK toggle deal with select investors this week.
Trickier refinancing trades may also appear, as banks mull recycling their riskier legacy loans in the bond market.
“It sounds like there’s a few racier deals on the way,” said a high-yield syndicate banker.
“We’re being asked to consider a lot of these stretched bank mezz and PIK deals that are sitting out there.” (Reporting by Robert Smith, Editing by Helene Durand, Julian Baker)