NEW YORK, Oct 7 (IFR) - US junk bonds are still in demand,
but after a strong rally and heavy supply some companies are
finding it harder to sell debt as investors turn more selective.
A bond sale for burger chain Steak 'n Shake was pulled after
two weeks of marketing last month, while a deal for insurance
broker Confie is yet to cross the line a week after it was due
The toils of both trades, even in an environment where there
is still appetite for risk and yield, show investors are being
more discriminate - shying away from companies in particular
that might struggle to weather an economic downturn.
"As there has been more new issues for investors to choose
from, they have become focused on credit quality," one leveraged
finance banker told IFR.
"Some difficult transactions are getting done at wider
pricing levels, or are not getting done at all."
Companies with low margins and limited free cash flow
generation have had a harder time winning over investors at
yields they like - including those leveraging up to pay out
Steak 'n Shake faced pushback on a US$400m seven-year
non-call three bond sale because of its aggressive use of
proceeds in what is generally considered a tough industry.
More than half of the deal, which was rated B2/B-, was due
to pay parent company Biglari a dividend, while increasing
leverage at the Steak 'n Shake level by more than a full turn to
mid-to-high 5s, according to S&P.
That level was deemed too high for the already out-of-favour
restaurant sector, and the 8.5% price talk was not enough to
allay investors' concerns.
"If we are going to be involved in something like that it
has to be for a business that is reasonably stable, that has a
reason to exist and doesn't have a lot of substitutes," said one
portfolio manager who passed on the deal.
Confie, which specializes in high-risk auto insurance, also
appears to be struggling to sell a US$350m bond aimed at
refinancing existing debt.
While the company has been generating free cashflow, it is
likely to continue to operate at a leverage of around 7-times
and to use cash to pursue acquisitions, S&P warned.
The deal, rated Caa2/CCC+, was whispered in the high 9%
area, but price talk on the deal has still not be released.
Some of the nascent selectiveness has been attributed to a
buyside wary of taking on excessive risk as the year end nears,
and after many have made double digit returns they would prefer
to lock in.
Average returns on the asset class are almost 16%
year-to-date, according to Bank of America Merrill Lynch data.
"Investors have a bias to be fully invested over the next
several months as event-driven new issuance is expected to be
limited," Jim Bonetti, co-head of North American leveraged and
acquisition finance group, told IFR.
"But they are mindful that we may be getting into the deeper
innings of the credit cycle, and are cautious not to put money
to work in companies that are disproportionately impacted by a
weaker economy or higher interest rates."
There is also some fatigue setting in after more than
US$28bn of junk rated bonds were priced in September alone - the
third busiest month this year.
Still, few expect the primary market to freeze up and some
investors have tolerated high leverage on other recent deals.
A case in point was a bond backing the spin-off of an
intellectual property and science business by Thomson Reuters -
which owns IFR - that priced tighter than initial whispers last
month and then traded up four points in the secondary.
That bond was rated Caa2 by Moody's.
A similarly rated trade that financed Advent International's
investment in pharmaceutical research company inVentiv Health
also cleared the market easily.
Leverage on both was around seven times earnings, according
to S&P - and above the six times level that US regulators
typically consider problematic if the borrower is unable to pay
down debt quickly.
In both cases, however, underwriters and investors took
comfort from the companies' leading position in their respective
industries and strong cash generation capacity.
Positive market technicals, meanwhile, suggest most new
issues should be well supported over the coming weeks.
Almost US$4bn has poured into US junk bond funds over the
past two weeks, according to Lipper, and with a US rates hike
not expected until at least December, demand is expected to
remain robust barring any major shocks.
"Searching for yield should not be indiscriminate; and based
on recent trends our clients feel the same way," Bank of America
Merrill Lynch analysts wrote in a note.
"The lack of frenzy for paper is what so far has
differentiated this rally from those that existed in 2013 and at
the beginning of 2014."
(Reporting by Davide Scigliuzzo; Editing by Natalie Harrison
and Shankar Ramakrishnan)