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Take Your PIK

31 October 2016 by Felipe Villarroel

PIK notes are not the most popular product out there among fixed income investors. They are subordinated, ratings are lower, coupons might not be paid in cash and they usually involve a shareholder transaction, most of the time some sort of dividend for shareholders (for a quick explanation on PIK notes features click here New High Yield Deals). There are however some very good opportunities from time to time and we have just come across one of those. The issuer is the holding company of Together (formerly known as Jerrold), a name we have been involved in for some time now.

Together are a specialist UK based mortgage provider. They have been doing exactly the same thing for over 40 years. That is low LTV secured lending in segments of the market that are unattended by the larger banks. As these banks have been in retreat mode since the 2008/09 crisis this has translated into more opportunities for the likes of Together.

The new issue PIK note in question as usual has to do with a shareholder transaction. However, unlike your typical PIK dividend related transaction, the purpose here is that the majority shareholder (who is the founder) is buying out the minorities. Consolidated leverage will increase as a result, but the main shareholder is not taking cash out of the business, quite the opposite in fact.

The ability of the issuer to pay the coupons in cash depends on its ability to extract dividends out of the operating company. We are comfortable with this while at the same time we are not concerned that the amounts needed will have a significant impact in the liquidity profile of the operating company. In addition we spoke with the owner and founder and the management team at length and they have every intention of paying the coupons in cash. Given we have been involved in the bonds of Together for years we have seen management delivering in their plans and promises. Hence we think this PIK issue is very credible indeed.

The PIK notes are however riskier than plain vanilla bonds and people need a premium to invest in them. The senior secured notes from Together are trading with a yield of about 6.5% while the PIKs came last Friday at 10.5% which we deem attractive for B/B- rated paper. Normally we would expect this sort of bond to have a nice capital gain as results will most likely continue to be positive. We were not expecting a large capital gain for this one due to the technical picture in the £ High Yield Financials space being very poor, which is one of the reasons why pricing is so high. Also there have been a couple of accidents in the lower rated end of the HY sector in recent years (Phones 4 U for example) and there is a tendency of grouping together companies that have little to do with each other under the £ HY financials title. Additionally the HY financials sector remains under covered by research analysts and the investor base does not seem to be growing. We had a pleasant surprise, however, as bonds traded up nearly 2 points after pricing. As good as this sounds we are not tempted to take our profits here.

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