Street firms are pushing a new toggle note structure to high-yield issuers after selling it alongside the landmark buyout financings for HCA andFreescale Semiconductor this month. The bonds give issuers the option of paying a straight cash coupon or making a payment-in-kind. Holders are rewarded with a fatter coupon on the PIK bonds.
Observers expect toggle notes to become a fixture of large high-yield deals. “They got away with it on the two of the biggest deals ever done,” said Thomas Haag, who manages a high-yield portfolio at Seneca Capital Management in San Francisco. “You can rest assured that until something cracks these are going to be part of the landscape.”
The structure was created by Credit Suisse last year when it put the feature on $700 million in senior notes as part of the $1.2 billion bond financing for the buyout of Neiman Marcus. Deutsche Bank was the first to follow, including $1.5 billion in 9.625% toggle notes in the HCA financing. Credit Suisse returned this month to sell $1.5 billion in 9.125% toggle notes for Freescale. Other banks have now caught on. JP Morgan, GE Capital and UBS are reportedly marketing a $1.35 billion high-yield mix of senior and toggle notes to support Apollo Management‘s buyout of General Electric‘s materials business.
“I think you’re going to see more of them come,” said Lex Malas, a managing director on the high-yield desk at Deutsche Bank. “With the success of these [HCA and Freescale] tranches, you’ll see more sponsors look at them and more of these tranches come to the market.”
The notes appear as private equity firms pick up companies in technology, retail and other cyclical sectors with less stable cash flows. Banks have pitched them as a way to give flexibility to highly leveraged business that might face a liquidity crunch. In Freescale’s case, the semiconductor company can avoid paying roughly $145 million in accrued cash expense during any of the first five years after the issuance by paying another 75 basis points on the bonds.
The disadvantage, from the standpoint of bond buyers, is that it allows issuers to build up the debt ultimately owed. The extra yield doesn’t seem like enough reward for the risk to some portfolio managers. “We wouldn’t touch it with a 10-foot pole,” said Jayme Wiggins, who manages a high-yield portfolio at Intrepid Capital Management in Jacksonville Beach, Fla. “It just goes to show you what lengths buyers will go to for any extra yield in the market.”
Pen Pendleton, a spokesman at Credit Suisse, declined comment.