Treasury Today Country Profiles in association with Citi

High yield bonds back in fashion

The renaissance of PIK and sub-investment grade bonds on either side of the Atlantic suggests that investor appetite for high yield investments is growing. While this remains the case, there is unlikely to be a more opportune time for corporates with maturing bank debt to refinance using the debt capital markets.

Market analysts say the appetite among investors for high yield debt remains extremely bullish, evidenced by the issuance of the highest proportion of sterling-denominated sub-investment grade bonds since 2002. UK corporates have been some of the busiest in the market, where the search for yield has encouraged the issuance of ultra-low-grade triple-C rated debt.

Bond chart

In April, the Swedish private equity firm EQT took advantage of the propitious European market conditions when it issued a $288m PIK bond, the first in Europe for almost two years, to finance its $1.9 billion acquisition of the Dometic refrigeration group. Analysts say they expect the triple-C rated bond to provide a benchmark for other exotically structured debt issuances.

Peter Laurens, a New York-based risk consultant, ascribes much of the impetus for the movement toward high risk/high yield debt to the excess liquidity at hedge funds. The success of future of bond issues in particular, he says, will be determined by the responsiveness of hedge fund managers to the yields on offer.

“I think hedge fund assets under management are up to pre-crisis levels, if they have not already exceeded this. All this new money must be parked someplace, and alternative investments continue to be a major factor in asset managers’ search for yield,” he says.

Bond graph

With Moody’s predicting a sub-investment grade default rate of just 1.9% in 2011, the lowest for two decades, investors remain bullish and corporates in need of finance should take heart. Novelis, an aluminium rolling company, found this to be the case when it issued two tranches of debt totalling $2.5 billion late last year. The company’s CEO, Steve Fisher, described the covenants and maturities they negotiated as “extremely attractive”.

The market may be heading in the right direction, but Vicki Bryan, a senior analyst of high-yield debt at Gimme Credit LLC, sounded a note of caution. She cited the recent revival of interest in PIK bonds as evidence the high-yield market was starting to become frothy. “PIK bonds are one of the indicators that the high yield market is getting overheated. Another indicator we have seen over the past year is issuance of debt to fund fat dividends to equity, which layers on risk with additional borrowing which does nothing to benefit the company that must support it.”