I've got slight problem here, having brainfreeze on how to value debt tranches.
I've got 3 tranches of debt:
- 150mm RCF - effective interest rate 3.61% (trading at 90) expires 2014
- 150mm TLA - effective interest rate 10.5% (trading at 95) expires 2014
- 75mm PIK - effective interest rate 15% (trading at 55) expires 2016
Current date is year end 2010. All are bullet repayments.
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The RCF is currently modelled to be undrawn, or at most only drawn about $30mm - $50mm (depending on whether it is extended).
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The TLA is going like a normal bond (eg (150)mm cash out in 2010, accrues interest to 2014 and is paid back in 2014).
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The PIK starts out at (75)mm cash out in 2010, and the eventual principal repayment is 200mm in 2016 (all interest compounded and added back onto principal).
I'm trying to think back to finance classes on how to value bonds, but none of this seems to fit those simplistic examples from school...
Any suggestions are hugely welcome/appreciated and urgent.
Thanks.
Hm, that's a tough one bro. Typically we just call up the Lev Fin / DCM desks for that, I know there is BLMBRG screen that has a calculator that will value these tranches. I would say ask your Associate // VP or HELP HELP.
Will say, something doesn't seem right with your PIK notes, is company tripping the covenants taking on additional principal go get that end principal amount?
Why is the term loan accruing interest instead of paying a coupon? This makes it similar to the PIK bond. Also be careful of the undrawn fee on the revolver.
Stringer - I might have to call someone there to help, am low on resources however so trying to do it myself! Re. the PIK - no breach of covenants. Its just that adding 15% of the principal each year for 6 years (compounded) gets us there - pretty sure my formulas are correct (the exact number comes to 199.5).
PTS - my mistake with the terminology - the TLA is paying a regular coupon, not accruing interest.
Currently no undrawn fee factored in for the RCF.
My approach at the moment is to compare the IRR of the pricing to the IRR of the cashflows.
EG for the TLA:
Current price is 95. cash flows of (95)mm in year 0, interest (at 10.5% of 100mm face value) in years 1-5, and principal repayment also in year 5 = IRR of 10.11%.
However the cashflows of the whole loan are (150)mm in year 0, interest at 10.5% of 150mm in years 1-5, and principal repayment also in year 5 = IRR of 10.50%.
Therefore the current market price of 95 is too high.
Does that approach make sense?
It would probably make more sense to compare your computed IRR (in your case 10.11%) to the market demanded yield for that particular type of security. No point comparing your IRR to a market yield calculated at issuance. For instance, if par term loans were being issued at 8% currently in the market, then your particular term loan yielding 10.11% at a price of 95 would be a great buy.
To workerbee's point, yes, calculating a YTW would be more accurate than calculating a yield-to-maturity like you are doing, but also much more challenging since you need to know the dynamics of potential early redemptions, calls, defaults, etc.
Also, I'm getting 11.88% IRR using your numbers and a simple IRR function in Excel (t=0: -95, t=1 though 4: 10.5, t=5: 10.5+100), not sure where the difference lies.
Could be off base, but the un-drawn RCF sounds fine. They probably don't want to dip beneath their borrowing base or have some ABL contingencies attached // min cash balance that necessitates the full availability of the RCF.
Again, just thinking out loud, but have you taken into account the interest on the TLA forcing the bond to a lower market rate? Did the TLA price at a premium at issuance?
I don't think you'll be able to get the IRR on the cash flow and of the pricing to reconcile due to the discount. Your current approach would tie out for for par but not at the current market discount.
Yield to Worst. Calc that.
If the market price is 95, the cash outflow in year 0 would be -95%*150, not -150
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