The number of bond exchanges occurring in Europe is gathering pace as issuers take advantage of declines in the value of subordinated securities to reorganise debt and boost capital.
Bloomberg reports that among the banks that have already taken deals to market in the perpetual sphere are RBS, UBS, Lloyds Banking Group, Standard Chartered and Barclays. Accordingly, it’s worth taking a closer look at what credit analysts say about these sorts of offers, especially in the case of distressed exchanges.
Barclays Capital notes:
So far, we have seen much fewer bond exchanges in Europe compared with the US. However, we expect more in Europe, primarily because of creditor unfriendly bankruptcy regimes. The only alternative is to go through an administration/insolvency process, which is generally unattractive to creditors. Many of these exchanges involve a combination of reducing principal, extending the maturity term, lower interest, and in return, sometimes giving greater seniority. However, bond covenants will determine a company’s ability to exchange and the type of exchange offered. In terms of specific covenants, we would look at the following.
Additional indebtedness — if an exchange results in a higher overall debt burden for a company and whether this breaches the covenant.
Restricted payments basket — covers any repayment on debt principal prior to the final maturity date.
Permitted liens – Rather than exchanging, some borrowers, such as Ardagh Glass, have issued secured notes (especially with the loan markets generally closed). However, the ability to do this or offer secured bonds in exchange for unsecured depends on how much flexibility they have under this covenant.
They go on to write that the success of an exchange depends largely on what is on the table and the “prisoner’s dilemma” of investors basing their vote on how they think everyone else will vote. As they explain:
The dilemma that noteholders face in any exchange is essentially one of game theory as shown in Figure 1.
And here’s the rather nifty chart they present to help bondholders in their decision process, using European semiconductor maker NXP’s bond exchange offer earlier this year as an example:
In the case of callable perpetual bond exchange offers, presumably the investor has to factor in the chances of the issuer declining to call the bond in at the first available date and opting instead to turn the notes into floating rate securities – quite an incentive in the current low interest rate environment. What’s more, the previously rare event has now been somewhat popularised by Deutsche Bank.
Nevertheless, Barclays conclude that if you’re long European distressed issues it’s probably a good idea to keep hold of your paper if prospects for exchange are good. This, they say, will at least raise your chances of recouping some of your losses in an environment where Chapter 11 bankruptcy doesn’t exist. As they put it:
Bond exchanges have been a frequent occurrence in the US high yield bond market since late 2008 in particular. These have now come to Europe as corporates seek solutions to term out liquidity and delever. Better quality credits will try to term out amortisations by renegotiations with lenders, buying back their bonds at depressed prices, or issuing senior secured notes (covenants permitting). However, stressed/distressed names have less choice. We recommend that investors should stay invested (ie, if they are already) in the names that have a chance of exchanging. They will have to offer concessions to bondholders for exchanges to pass, potentially recouping some lost value or generating alpha for investors who have bought in at depressed levels. Bondholders will arguably have a greater say on the more distressed names that are desperate to exchange and stave off default.
We would expect most borrowers to be watching exchanges with interest especially given the potential legal ramifications. If cash burn rates continue to rise and fundamentals deteriorate, going into late 2009-10, we expect more exchanges of maturities going forward (involving possible longer maturities) as corporates try to preserve liquidity. Exchanges in Europe will have a role to play if they are meaningful in staving off defaults given that there is no Chapter 11-like bankruptcy regime in Europe. Upon the equivalent of a filing, most companies in Europe go straight into liquidation, which given falling recovery expectations, is more likely to give back bondholders less in a recovery scenario than an exchange.
Related links:
Lloyds offers exchange for Clerical Medical debt – Reuters
Deutsche does it again – FT Alphaville
Deutsche rattles the bond market – FT Alphaville
Of Deutsche bonds and conspiracies – FT Alphaville