Covenant clause removal fires up US bond investors
Orders surpass $25bn for Broadcom’s $13.55bn offer, the year’s largest corporate bond
US fixed income investors drew a line in the sand this week, forcing a number of companies to back away from weakening the terms of their debt sales at the expense of bondholders.
General Motors’ financial subsidiary, chipmaker Broadcom and the Brazilian pulp manufacturer Fibria Celulose dropped contentious language from their debt sales that sought to deprive investors of certain premiums should the companies breach their covenants and default.
The investor opposition, which one money manager characterised as a “groundswell”, also prompted Novolex — a maker of packaging products that private equity firm Carlyle is buying — to retreat from weakening its covenants.
“There is still power for the [bond] buyers,” said Matthew Brill, a portfolio manager with Invesco. This was “the start of a slippery slope. We said we had to hold the line.”
Bondholders are typically paid a premium if a company decides to pay off its debts before they are due.
The compensation, known as ‘make-whole’ redemptions, offset missed earnings when a bond is retired before initially agreed.
The make-whole provisions extend to breaches of covenants, which can occur if a group pays a dividend in excess to the bond document terms or if its debt eclipses agreed levels, triggering a technical default.
As the rebellion gathered momentum, there was concern among investors that they would simply miss out on deals if they sought to negotiate with underwriters on the language, which often reads: “No premium in respect of the notes shall be payable as a result of any default.”
The no-premium language first popped up in a corporate bond sale last October and has since featured in about a dozen deals.
Gautam Khanna, a portfolio manager with Insight Investment, noted that sharp inflows into US corporate credit had weakened investors’ hands.
“Often a deal is announced, particularly in the investment-grade space, and it is five-times oversubscribed in the first few hours and it gets done,” he said. “There's not much of an opportunity to push back on the covenant package.”
Insurance broker Marsh & McLennan, which successfully sold $1bn worth of debt earlier this week with the clause, amended its bond documents with US securities regulators on Wednesday to remove the language.
After Broadcom removed the clause, underwriters counted orders in excess of $25bn for the $13.55bn offering — the year’s largest corporate issue so far and one of a handful of $10bn-plus acquisition-related bond sales expected in 2017.
The sale, which was completed shortly after GM Financial’s $2.5bn debt was issued, came amid a wave of bond offerings that started the year on a record pace.
“So far issuance has been extremely robust this month and we haven’t even gotten to earnings season, when most of the US banks will come,” said Andrew Forsyth, a portfolio manager with BNP Paribas Investment Partners who purchased some of the new seven-year Broadcom notes.
“There is a little bit of fatigue in the investment-grade market.”