Europe's high-yield bond market has made up some ground lost during May's sell-off, but investors are wary of non-traditional bond structures, with tailored products such as mezzanine notes out of fashion.
Investors who were more focused on putting money to work in a strong market say they are no longer willing to risk giving away their chances of long-term gains on a bond. While decisions are made on a credit-by-credit basis, they say mezzanine notes remove many of those chances.
"In a strong market mezz notes can work, but it's not for this market," said one syndicate banker. "What isn't needed is to do anything that's going to limit the number of investors that are going to look at a deal, whether that's 'funky' call structures, or mezzanine notes, or triple-C rated credits."
Companies had succeeded in reducing the amount of time before they could forcibly buy their bonds back, or call them, giving them a quicker, cheaper way to cut debt and reducing the gains investors might make on the securities.
Mezzanine notes, introduced in 2003, are an example of a security where investors have less call protection, although they receive increased yields.
But as the market has re-priced itself, even the potential for generous yields may not draw investors to these securities.
Mezzanine notes were created as an alternative to a rapidly expanding mezzanine debt market.
They were conceived at a time when high-yield investors were pushing for a stronger position in the event of a default, while equity sponsors wanted the option to repay bonds early without large prepayment penalties.
They met both criteria, but in the year since their debut traditional high-yield bonds have evolved to include improved structural enhancements and better disclosure.
"Mezz notes have structural benefits which do cap the downside, but those are outweighed by the capping of the upside," said one major high-yield investor.
"They would be more attractive if they were just competing against old high-yield structures, but for the most part things have improved and we're not being offered those any more."
Mezzanine notes have been sold at a discount, at around 90 percent of their face value. They then accrete, or slowly rise in value, over their lifetime until they reach their par value at maturity.
They carry standard high-yield call protections based on their accreted value but if an exit event such as an initial public offering or a trade sale occurs, the issuer can call the bonds at 103 percent of their accreted value in the second year, 102 in the third and 101 in the fourth.
The first mezzanine notes were issued by Focus Wickes in June 2003. British heating and hot water systems manufacturer Baxi Holdings followed, raising 90 million pounds in March.
Fitch Ratings said at the time of the Focus Wickes deal that the mezzanine note may have limitations in the future.
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