(Bloomberg) -- Private equity firm Clayton Dubilier & Rice is buying $464 million of the riskiest part of the debt for its own buyout of Cornerstone Building Brands Inc., limiting potential losses for the banks that agreed to fund the deal.
CD&R is purchasing the so-called “payment-in-kind” notes that a group of lenders led by Deutsche Bank AG and UBS Group AG had arranged for the deal, according to a filing this week. That decision will help reduce the amount of debt that the banks will need to sell to investors, according to people with knowledge of the matter.
The lenders agreed in March to provide $1.675 billion of debt to help finance CD&R’s take-private of the building products company, including as much as $725 million of PIK notes, according to a filing. This is a risky type of debt, which pays interest with more debt rather than cash, that banks rarely commit to fund.
As fears of a potential recession intensified in recent months -- sending yields on junk-rated corporate bonds soaring -- it became clear that it would be extremely difficult for banks to offload the PIK to investors, according to the people, who asked not to be identified when discussing a private transaction.
Banks began sounding out investors on the financing more than a month ago, Bloomberg previously reported, and a $1.01 billion loan-and-bond offering was announced this week at steeply discounted prices. Debt sold at such discounts can erode or wipe out fees that banks earn when underwriting deals, and potentially result in losses.
Representatives for CD&R, Deutsche Bank, and UBS declined to comment, while representatives for Cornerstone did not respond to requests for comment.
Negotiations
Some private equity firms are willing to renegotiate terms when markets sour -- particularly if they’re frequent borrowers in the leveraged-loan and high-yield bond markets and need banks to underwrite future deals. The $464 million of debt CD&R is buying for Cornerstone is more than double the $195 million of new equity the firm is contributing to the deal.
The cost of borrowing has increased rapidly in recent months, hurting banks that committed debt at lower interest rates than the market would currently accept. A group of banks has lost money on the debt funding CD&R’s acquisition of Wm Morrison Supermarkets, and there are potentially more losses to come on other buyout financings.
The PIK note CD&R is buying carries an unusually low coupon of just 2.99%, according to bond documents seen by Bloomberg, which compares with rates that are typically in the double-digits. The Cornerstone PIK will sit at the holding-company level, making it structurally more subordinated to the company’s other indebtedness.
Read more: Wall Street Faces Billion-Dollar Losses on Sinking Buyout Debt
Cornerstone is marketing a $410 million leveraged loan at a discounted price of 93 cents on the dollar. Early pricing discussions on the $600 million secured high-yield bond are for a discounted price of around 92.4 cents, which equates to a yield of 10.5%. The debt offering is expected to market through July 19.
CD&R, which already owns 49% of Cornerstone, agreed to buy the remainder in March for about $5.8 billion, including debt. Cornerstone, based in Cary, North Carolina, provides products such as vinyl siding and windows. The Cornerstone deal is expected to close this quarter, according to an earlier statement.
Moody’s Investors Service and S&P Global Ratings downgraded Cornerstone by one notch because of the buyout, to B2 and B respectively, or five steps into junk. Both credit graders cited an increase in debt levels.
The buyout will add to the company’s existing roughly $2.6 billion secured term loan and $500 million of unsecured notes, according to S&P.
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