US CREDIT-Tyco bond suit may have wide-ranging impact

NEW YORK, June 26 (Reuters) - Holders of U.S. investment grade debt may find they are not as protected as they think against some risks that can reduce the value of their bonds, if a dispute between Tyco International Inc. (TYC.N) and bondholders is settled in the conglomerate's favor.

Tyco is being sued by the trustee of its bonds, The Bank of New York and a group of bondholders who argue that the company is breaking terms and conditions of the debt by not offering to buy back the debt at what they argue is its full value.

Investment grade corporate bonds often have covenants that can require companies to buy back the debt at a price that includes future interest payments in certain events such as restructurings or mergers or acquisitions, which can radically alter a company's credit profile.

"The court will need to rule one way of the other, and the entire high grade market is standing by wondering how much new structural risk will be injected into their markets be the de facto gutting of the merger and sale language," CreditSights analyst Glenn Reynolds said on Tuesday in a report.

"The action by Tyco if successful would open up overnight a target-rich environment among multi-industrial names for more of the same abuse," Reynolds said.

Tyco tendered for its debt as part of it plan to spin off its electronics and health care divisions into independent companies by the end of June, but said in May that the majority of U.S. bondholders did not accept the tender offer. For details, see [ID:nN11433205]

A group of Tyco's bondholders said on Monday that they had joined a lawsuit filed by the bond trustee against the diversified manufacturer.

"Tyco has honored its obligation to its bondholders and made a fair offer," Tyco spokesman Paul Fitzhenry said on Tuesday. The lawsuit "breaks no new ground," he said.

The impact of the Tyco court case could also extend to other covenants such as change of control language, which are increasingly being sought by investors concerned about leveraged buyouts, said a bondholder who declined to be named.

"The high grade market has very few covenants, this happens to be one of the few concession covenants," he said. If the covenant in Tyco's debt has no weight, "then you pretty much have the say the whole high grade market is overrated in the sense that there is nothing that protects them from credit event risk."

The lawsuit has been filed with the United States District Court of the Southern District of New York.

RATINGS IMPACT

Some analysts and bondholders are also critical that ratings agencies have not acted on what they argue is the breach of Tyco's covenants.

"The rating agencies have steered way clear of this consent issue at Tyco despite prodding by bondholders," said CreditSights' Reynolds in an e-mail interview on Tuesday. "The agencies are now in the covenant-opining business, so how does not this not apply to their core business?"

If a company breaks its covenants because it is unwilling to pay and also escapes any penalty from a ratings perspective other companies may feel encouraged to try similar moves, said the bondholder.

Standard & Poor's analyst Joshua Davis responded that, "there is a dispute over the interpretation and whether it applies to this situation and so we're not in a position to arbitrate on that."

"We feel that whether (Tyco) ultimately ended up tendering for a larger amount, say at the make whole level that bondholders indicate is required under the covenant, or if they tender for something less either way the outcome is unlikely to affect Tyco's financial profile and hence not affect the rating," Davis said.

Moody's Investors Service spokesman John Cline said the rating agency is working on a report regarding covenants, but declined further comment.

Fitch Ratings spokesman Brian Bertsch referred to a ratings statement from April that said Tyco's ratings will depend on the company's ultimate credit profile after the resolution of the conflict, but did not mention any other impact from the possible covenant breach.