When it Rains, it Pours (Again and Again)

I'm not sure if it is a universal law, but it does seem like bad news comes in waves. It's like being told, for example, that you lost your job -- and, by the way, the car also needs new brakes and tires.

The same goes for the unfolding credit crisis. At a time when lenders and investors are doing what they can to boost liquidity, minimize the prospects for further losses and cut risk exposure, they face a steady stream of adverse headwinds that make it difficult to achieve those aims.

They also have to deal with the after effects of dumb decisions made at a time when the going was extraordinarily good. In "PIK and Roll: Companies Seize On Perks of Loose Lending Terms," the Wall Street Journal's Serena Ng details the latest episode of "piling on" for the beleaguered financial sector.

Some risky debt structures created during the leveraged-buyout boom are coming home to roost.

A number of companies that issued debt with easy terms are now making use of those options to conserve cash. That doesn't always mean the companies have serious problems, but it is creating concern for investors, who fear losing more money.

Last week costume-jewelry retailer Claire's Stores Inc. told investors it intends to pay interest on $350 million of its bonds with additional debt rather than cash. Last year Claire's, which was taken private in May 2007 by Apollo Management LP, issued some bonds with "payment-in-kind toggles," or PIK toggles. Those allow the company to shut off cash interest payments and issue more debt instead. At the start of 2007, the credit markets were flourishing and investor demand was so strong that companies easily sold debt with low interest rates and favorable terms.

Bonds of Claire's Stores, which traded at 98 cents on the dollar last May, have dived to 58.6 cents, according to data from Reuters Loan Pricing Corp. John Lahman, a credit analyst at KDP Investment Advisors, said Claire's "may be trying to conserve some cash as it looks to execute its plans" to expand its business abroad and increase revenue. Standard & Poor's Ratings Service, however, said Claire's move was "indicative of ongoing performance difficulties" at the company.

The retailer's decision follows a similar one in March by Realogy Corp., a franchiser of real-estate brokers that was also acquired by private-equity firm Apollo Management last year.

Seven companies have flipped the switch on $2.4 billion in PIK-toggle bonds, according to Standard & Poor's Leveraged Commentary & Data. Univision Communications Inc., which recently tapped its revolving-credit agreement with banks for $700 million in cash, also may switch to paying interest on some of its PIK-toggle bonds with debt, a Fitch Ratings report suggested.

"Private-equity firms were bound to take advantage of these terms to tide them over tight spots," said Martin Fridson, chief executive of Fridson Investment Advisors, an investment-management firm that specializes in corporate debt. "I expect there will be a lot of acrimony as we move into tougher conditions," he said.

One potential area of conflict: Just how much more debt a company can issue without tripping existing debt covenants.

The riskier debt structures haven't gone down well with investors since the credit crunch began nearly a year ago. Over the past few months, they have pushed down prices of PIK-toggle bonds and other debt with looser terms, such as "covenant-lite" loans that impose few performance standards on corporate borrowers. On average, PIK-toggle bonds have declined more than corporate bonds that are committed to paying interest in cash, according to S&P's LCD.

Companies that have elected to pay interest with additional debt "are in cash-preservation mode, and, fundamentally, that's not a good sign as their financials could be deteriorating and there's not much lenders can do," said Jamie Farnham, head of credit research at Metropolitan West Asset Management, a fixed-income manager.

Comments

[roger]

In the beginning there is 1 2 or 3 bubbles that's the simmering stage it is followed by a rapid violent boil and it ends by a complete evaporation...so yes I would say it is a UNIVERSAL LAW. 2000 years ago the Greek philosophers understood the process of change to days apprentice sorcerers think that it's all in our heads and that change is a matter of psychology ; they completely ignore the material world

[fyego]

I think these PIK bonds are brilliant for the issuer. Claire's now has the opportunity to pay its interest in bonds at a value of "$1" while the market prices it at 58 cents. Meantime it can use the cash flow that would have gone to pay the interest to instead buy back the bonds in the market at 58 cents! Great scam!!! I know the idea is that they don't have the cash flow to make the interest payments but even if they did the only smart move would be to buy the bonds in the market at half price and issue bonds at full price to payoff the interest.