Aggressive high yield deals call for heightened vigilance

Urbaser, a Spanish waste management specialist, came to the market last week with a controversial new deal. The company launched a €1bn payment-in-kind (PIK) toggle note to fund a dividend to its owner Platinum Equity, just six weeks after it issued a new €2.3bn debt package to refinance its existing debt and fund a further €1bn of dividends.

The volume of dividend recapitalisation deals (where a company raises new debt to pay dividends to shareholders) has been rising gradually since 2021, but it has surged in the last year (see Exhibit 1). Dividend recaps have accounted for around 8% of total European high yield (HY) bond supply year-to-date, versus a range of 0-2% over 2019-23 and around 6% in 2024. Dividend recap issuance in June alone was €3.7bn, the highest volume in absolute terms since 2019 and accounting for 15% of all European HY bond supply that month. The trend continued into July as ice cream producer Froneri brought the largest dividend recap deal of all time to the European market, issuing a cross-border debt package comprising bonds and loans to fund a €4.3bn dividend (slightly ahead of the dividend deal from Belron in late 2024 which was the largest at the time).
 

Dividend recaps have historically had a bad reputation with bond investors due to their nature of taking value from creditors to give directly to shareholders, and companies bringing them to market previously risked being punished with a higher cost of debt. Single-B rated specialty chemical producer Polynt, for example, paid a 9.5% coupon on its own recap deal in June 2023 as investors’ discomfort with the aggressive use of proceeds outweighed the strength of the business profile.

However, with strong demand for credit being fuelled by supportive technicals, appetite for these historically unpopular deals has been strong. With Euro HY spreads increasingly tight (the index now yields around 4.9% versus a peak of 6.6% in April and 5.5% at the start of 2025), investors on the hunt for higher coupon deals now seem comfortable transacting with shareholders in deals from solid issuers, provided the post-dividend capital structure is appropriately levered and cashflow generation remains strong.

Dividend recaps have picked up just as the proportion of leveraged buyout (LBO) deals has been slowing (see Exhibit 2). LBOs accounted for only 7% of total European HY issuance in 2024 and 2025 so far, versus 12-18% in 2021-23 and below even 2020 levels. While the investment grade market has seen a fair amount of M&A activity, deals have been more limited in European HY (and particularly the single-B rated space), and a number of private equity owners have been struggling to monetise their portfolios via an exit. Packaging producer Trivium, for example, owned by Ardagh Group and Ontario Teachers' Pension Plan, has reportedly been up for sale on-and-off since 2022, while Permira has reportedly been looking to exit chemical producer CABB since 2021. As their own funds mature and pressure mounts for private equity houses to return money to limited partners in one way or another, we may see more aggressive deals in the near future.

 

Taking the PIK?

Urbaser’s new deal has proven controversial, since it comes just six weeks after its last issuance despite no prior warning and involves a payment-in-kind (PIK) toggle note, a more aggressively structured type of bond that allows the issuer to choose between making interest payments in cash or deferring them until maturity, typically at a higher interest rate. PIKs are usually unsecured and deeply subordinated, with a lower expected recovery rate than the rest of the debt stack.

For an issuer, PIKs allow more flexibility, at a price. For a performing company such as Urbaser, PIKs tend to be a shareholder transaction where they take a dividend using ownership of the company as collateral. The notes are typically issued at the acquisition vehicle or holding company level, allowing the sponsor to layer on additional debt outside of the restricted group. PIKs may also be issued when a company goes through a restructuring, with the objective of giving the new restructured entity breathing space in case cashflows do not recover according to plan. For an investor, PIKs offer a risk premium, with higher yields as compensation for the subordinated position in the capital structure and weaker recovery prospects (Urbaser’s PIK, for example, has been priced at a coupon of 10.5%, or 11.25% if the interest is deferred, versus the 5.5% coupon on the senior secured notes it issued in June).

PIKs are rare in the European HY space. BB rated auto parts manufacturer Schaeffler is a regular issuer and has a strong track record of paying the interest in cash. Single-B rated paper and packaging firm Fedrigoni, on the other hand, plans to defer all interest payments on its €300m of PIK notes for the foreseeable future in order to prioritise M&A in the near-term. While liquidity preservation is theoretically a comfort for bondholders, the prospect of repeated interest payment deferrals raises concerns of continuously increasing leverage, which will eventually need to be serviced. PIK debt is also included in rating agency leverage metrics, and Urbaser was swiftly downgraded by all three rating agencies when it announced the new deal.

While the macroeconomic outlook remains uncertain (evidenced by recent weak job data out of the US), exit opportunities from companies at the lower end of the quality spectrum are likely to remain scarce. With private equity sponsors under pressure to return cash, aggressive and shareholder-friendly financial policies will be increasingly tempting for some firms while market conditions remain supportive. The growing gap between shareholder and creditor interests calls for heightened vigilance in our view. Selectivity remains key, and investors will have to avoid the temptation to stretch for yield in an increasingly tight market.