An already skittish market shows further signs of wariness following Japan’s quake and nuclear disasters.
The overall corporate bond market is still pretty hot but there are signs that high-yield debt issuance is starting to cool. This should give any treasurers considering venturing into this space a little pause.
Under ordinary circumstances companies avoid high-yield debt – either because of their mandates or because management would balk at the risk. But with a lack of yield being offered anywhere else in the investing universe, some treasurers have been tempted to add it to the company’s portfolio. Even those companies with the most conservative investment mandates may find themselves wading into high-yield debt.
But now maybe that curiosity should not be satisfied just yet. That’s because sentiment has soured considerably in the wake of the Japan crisis, persistent unrest in the Middle East and as weak economic indicators leave the strength of the economic recovery in doubt.
According to Standard & Poor’s Leveraged Commentary and Data (S&P LCD), several loans and refi deals have been shelved as the market slows while it absorbs the latest news from around the globe. The leverage commentary site reported that IT-products reseller CDW was looking to refinance two 2007 LBO issues – an $890mn issue of 11 percent senior cash-pay notes due 2015 and a $317mn issue of 11.5 percent senior (payment-in-kind) PIK toggle notes due 2015 – but has chosen to wait until the market improves.
Despite the negative bias to the market, the fact that PIK toggle securities (and covenant-lite deals, see related story here) are being considered likely means high yield still has an upside. And that investors still have an appetite for risk. S&P LCD reports that there have been seven PIK toggle note transactions since the beginning of the year, most recently with CKE Restaurants and Bumble Bee Foods deals. Issuing PIK toggle notes gives borrowers a choice paying interest on a bond immediately and continually or defer paying it until the bond matures – and in the process agree to pay an interest rate that is effectively higher. Although the $1.78bn in PIK toggle paper priced so far in 2011 is dwarfed by the $12-15bn of the 2007 and 2008 heyday, it’s more than the last two years combined.
But treasurers should be wary before dipping their toes in here. While high-yield debt may appear to be the better investment when adjusted for default risk, it obviously carries considerable interest-rate risk that may not be tolerated under the company’s investment rules.