NEW YORK, Jan 13 (IFR) - Investors dug in their heels this
week on three investment-grade bond deals that tried to include
more issuer-friendly terms, signaling that - for now at least -
enough is enough.
Borrowers scrapped language in new bond offerings that would
have spared them from paying a make-whole premium in the event
of a default (from a simple covenant breach to actual
An uproar from the buyside led chipmaker Broadcom, auto
lender General Motors Financial and Brazilian paper company
Fibria Celulose to drop the wording mid-execution on Wednesday.
Junk-rated Novolex removed similar language from a bond for
its buyout from Carlyle this week, while professional services
firm Marsh & McLennan retroactively took it out two days after
"The investor community got very excited by this," said
Michael Kaplan, a partner at law firm Davis Polk, which helped
draft some of the contentious clauses. "Right now it's hard to
see why an issuer would want to brave that."
Make-whole premiums have long been a cherished clause for
bond investors, allowing them to demand all the payments they
expected when first buying the securities in question if those
securities are redeemed early.
But starting with a handful of junk-bond deals last year -
and at least one high-grade trade, from sports giant Nike - some
borrowers have inserted language to prevent investors from
demanding these payments if a company defaults.
"It's a classic pushing of the envelope to see how much you
can get away with," said David Knutson, head of credit research
for the Americas at Schroders.
Covenant Review, an independent research firm, warned that
breaching indentures without having to pay a make-whole premium
in effect marked "the end of bond covenants".
Two US court rulings last year appear to have changed market
perception of what is and is not acceptable when it comes to the
premiums in question.
In a ruling against pawn shop operator Cash America, the
court ordered the company to pay a make-whole premium to
bondholders because the sale of the majority of a wholly owned
subsidiary violated covenants in its bond indenture.
Later in the year, another court ruled in a case involving
Energy Future Holdings that a company must pay a make-whole if
notes are repaid in a bankruptcy.
Adam Cohen, the founder of Covenant Review, said the new
language sought to "opt out" of those rulings.
"This terrible language will vastly embolden issuers to
consider breaching covenants and lead to more risk for
bondholders and fewer premium redemptions," he wrote.
But Davis Polk said in a note to clients on Wednesday that
investors have "traditionally understood" they are not due a
make-whole premium when faced with a company's default or
Davis Polk's Kaplan pointed to previous cases, such as that
of Momentive Performance Materials, in which the courts ruled
that investors were not due a make-whole premium after the
company filed for bankruptcy.
"We simply codified what had always been market
expectations," he told IFR.
That argument did not distinguish, however, between events
of defaults such as covenant breaches (in which case investors
clearly do expect to be made whole) and actual bankruptcies (in
which investors may have little choice but to accept losing
Market participants gave various explanations for how the
language had been able to get through the market on junk deals
last year but was now facing a fight-back in high-grade bonds.
Raman Srivastava, deputy chief investment officer at BNY
Mellon investment company Standish, said the much larger
high-grade market necessarily received more attention.
"You have more investors' eyes looking at bigger deals," he
said. "If you see this happening in, for example, a Broadcom
deal, it's going to catch someone's attention."
Larger investors also have more sway over an issuer's
behavior, said Justin Cooke, a partner at law firm Allen & Overy
who was not involved in any of the deals in question.
"I suspect that one or more very large anchor investors
pushed back," he said.
One likely reason is that giving up the right to a
make-whole premium is potentially significantly more expensive
for investment-grade bond investors.
Missed future interest payments would typically amount to
much more when it comes to high-grade paper, which tends to have
longer maturities - and no other call options.
"Investment-grade bonds may mature decades after issuance
and typically have a make-whole for life, whereas high-yield
bonds typically mature in seven to 10 years and have a
redemption premium that reduces to par over several years," said
"A high-yield issuer may be able to redeem at or near par in
three or four or five years anyway."
(Reporting by Will Caiger-Smith and Davide Scigliuzzo; Editing
by Marc Carnegie, Natalie Harrison and Matthew Davies)