Toys R Us spreads to narrow on term loan, refinancing

Wed Jul 24, 2013 7:11pm BST

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July 24 (IFR) - Toys R Us CDS spreads are set to narrow after the company decided to take a new senior unsecured term loan that is currently being syndicated.

The loan is a six-year USD985m term loan B with proceeds expected to refinance its USD950m 10.75% senior notes due July 15 2017.

The decision to raise cash via the loan market to refinance Toys R Us Property Co I's, or prop co debt, 10.75% due 2017 bonds instead of issuing a high-yield bond will offer flexibility by achieving a better pricing than a bond while also lowering interest costs. Both will factor into tighter CDS spreads.

The term loan B is expected to be non-callable with call protection for the first two years at 102 and 101, according to Reuters Loan Price Corp (RLPC). The 10.75% due 2017 are continuously callable at $102.69 with July 15, 2014 as the next call date. A market source said there was no expectation the bond will be called and it is trading above its call price at $106.68.

Although it has no near-term maturities, Toys, like many high-yield companies, was expected to take advantage of the low interest rate, low volatility environment to further enhance its credit profile by refinancing and tighten its CDS spreads.

But for Toys this is harder to achieve. The private equity owned-company abandoned its IPO offering earlier this year and also has no permanent CEO. In addition, it suffers from weak fundamentals and revealed in the lender meeting its same store sales fell 4.8% domestically and 3.6% internationally during the first eleven weeks of the second quarter.

As such there has been growing speculation Toys would face an increasingly difficult environment if it opted to refinance via the debt market.

"Rising interest rates and general weakness in the retail sector lately, are other factors which would hamper Toys' ability to refinance in the bond market at a lower rate than their current coupons," said a high-yield trader.

Moreover, the June ratings downgrade to B2 from B1 by Moody's "also means the company's bond rate is going to go up," said the trader, therefore making refinancing via a bond a more expensive prospect.

So the decision to go the term loan route is seen as a more optimal choice as borrowing costs are likely to be below the call premium of the 2017 bond and the term loan has the flexibility to be pre-payable.

Synthetic investors are expected to respond positively not only to the refinancing, but to the term loan as well. This type of asset is considered to be of "better quality" than a senior unsecured bond, since a secured or unsecured bond is secondary to a loan.

The recovery rate of a CDS is improved by a term loan as the overall capital structure is moved higher. This will eventually impart a positive drive on its spreads and tighten synthetic.

Toys CDS is at 787.25.

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