US corporate bonds ended the week weaker on Friday as struggles by some issuers selling debt to finance leveraged buyouts weighed on spreads and investors closed out positions ahead of the Independence Day holiday next week.
"The market opened up soft on a variety of concerns, news that there was a potential terrorist event in London, but also on some natural defensive positioning ahead of what I think will be a thin week next week," said Edward Marrinan, head of high grade strategy at J.P. Morgan in New York.
Police defused a car bomb packed with gasoline, gas canisters and nails outside a busy night-club in the heart of London on Friday, foiling an attack that echoed an earlier al Qaeda plot and could have killed or wounded scores of people.
"A defensive sentiment has swept over the investment grade asset class in these past two or three weeks on the re-emergence of subprime concerns and exacerbated by what people see as potential problems in the financing of some LBO deals, which have heavy forward calendars in both high-yield bonds and in leveraged loans," Marrinan said. "Skittishness in the high-yield market has clearly ticked over into the high grade market and has offset some of the recent upbeat economic data that suggests that growth is there and maybe inflation, at least for now, seems to be moderating," Marrinan said.
ServiceMaster has been forced to increase the interest rate on its LBO loan for a second time this week, banking sources told Reuters Loan Pricing Corp on Friday.
ServiceMaster had originally planned to sell $1.15 billion in payment-in-kind toggle notes, but this was split to make half of the issue notes that pay cash interest, Robert Lee, analyst at KDP Investment Advisors, said in a report on Friday. PIK bonds are considered among the riskier debt types as they allow issuers to make payment either in cash or by issuing additional debt.
Also, "several changes have been made to strengthen the covenants, including tighter limits on additional debt and restricted payments as well as a reduced toggle period for the PIK notes," Lee said.
"Given the change in covenants and current price talk, we consider the price of the notes to be attractive," Lee said. Price talk for the notes that pay cash interest is 10.5 percent, and for the PIK toggle notes it is 11 percent. The benchmark investment grade credit derivative index widened around 1 basis point to be bid at 41.75 basis points on Friday. It has widened from 39.5 basis points last Friday.