Avoca Capital Holdings to use cash hoard to buy high-yield debt

AVOCA Capital Holdings is planning to use a record cash hoard to buy high-yield debt that has plummeted 8.4% since July, the co-founder of the €6 billion Dublin-based fund said.

“We felt there will be better value later this year, especially in bonds, which haven’t fallen enough relative to loans,” chief executive Alan Burke said in an interview in London.

Avoca has €250 million set aside to buy junk bonds and leveraged loans, representing as much as 5% of the fund compared with less than 1% in the past. The firm, which manages 10 collateralised loan obligations, has also cut investment in junior-ranking debt to 4% from 12% a year ago and has no fixed-rate bonds at the moment.

Speculative-grade bonds in Europe have fallen to 89% of face value from 100.6% in July, according to a Bank of America Merrill Lynch credit index, as Greece flirts with default and threatens to derail the economic recovery. European leveraged loan prices fell to a 2011 low of 87.1% of face value at the end of last week, according to Markit Group.

High-yield debt, or leveraged loans and junk bonds, are rated below Baa3 by Moody’s Investors Service and BBB- by Standard & Poor’s and Fitch Ratings.

The fund finances buyouts.

Burke is building up a cash arsenal as Blackstone Group LP’s head of restructuring Timothy Coleman said leveraged buyouts will resume when idle investors put cash to work. “There is a lot of money out there,” Coleman, 57, said yesterday at the Bloomberg Dealmakers Summit in New York.

Debt prices may drop further as policymakers’ efforts to revive a flagging economy fall short, according to Citigroup Inc global head of credit strategy Matt King. The Federal Reserve’s decision to buy $400 billion of bonds maturing in six years or longer through “Operation Twist” may shave half a percentage point from 10-year government bond yields; it won’t persuade companies to hire and consumers to spend, King wrote in a September 26 note to clients.

Loans are trading at a premium of about 6 percentage points to benchmark lending rates, implying a default rate of 30%. Avoca forecasts a default probability for the market of 3%.

“Loan prices are offering way too much yield relative to their default risk. The fair value would be somewhere between 300 to 400 basis points over Libor, or about mid-90s in price,” said Burke.

Burke left Allied Irish Banks in July 2002 to start Avoca with Donal Daly. The Dublin-based manager has been “highly profitable,” according to Fitch, earning 17% annually for equity investors in its first CLO originated in 2003 and redeemed in December 2006.

The firm is looking to grow by purchasing assets from banks that need to reduce their €200 billion of loan portfolios to comply with new capital rules.