Canada’s largest bond investors are demanding more safeguards against credit-damaging mergers as a rebound in energy deals signals a takeover freeze is thawing.
The Canadian Bond Investors Association, which represents 32 of the nation’s biggest fixed-income investors including Toronto-Dominion Asset Management, is proposing so-called poison put protections, according to a discussion paper released yesterday by the Toronto-based industry group.
Puts that allow creditors to sell debt back to the issuer at a premium in the event of a merger are lacking in 87 percent of the $425 billion of investment-grade securities sold by Canadian companies, according to data compiled by Bloomberg. In the U.S., these change of control clauses are a feature on $840 billion of corporate bonds with ratings in the BBB tier, representing 43 percent of debt most vulnerable in a takeover.
The arrival in Calgary this year of KKR & Co., the New York-based private-equity firm run by Henry Kravis and George Roberts, coincides with a resurgence of energy deals worth $6.4 billion in the first two months. That compares with $634.3 million in the comparable period in 2013.
The rebound is often an unwelcome development for bondholders when the acquirer is a lower-rated company or a buyout firm loading up a target with debt for its own acquisition.
“All of a sudden there’s a big announcement overnight and management is leveraging up,” Bill Girard, a fund manager at Bank of Nova Scotia’s 1832 Asset Management LP, a member of the CBIA, said in a telephone interview from Toronto. “If they’re going to consciously change risk, bondholders should have some sort of protection in the indenture whereby they need to bring us to the table. It’s very reasonable for investors to expect that. When decisions are made that make investors worse off they shouldn’t be trapped.”
Poison put provisions in the U.S. became popular at the height of the leveraged buyout boom in 2007. The bonds were sold with provisions that forced companies to repay securities at a premium to par, or above 100 cents on the dollar, if they were bought in a leveraged buyout. Such debt-fueled transactions often result in the borrower’s credit rating being cut to below investment grade, or junk.
With bonds in Bank of America Merrill Lynch’s Canada Corporate index trading at an average price of 107.7 cents on the dollar, investors risk losing gains accrued since the downfall of Lehman Brothers Holdings Inc. in 2008, often cited as the height of the credit crisis.
“The problem with weak covenants is that it allows management to take actions which benefit shareholders at potentially a significant expense to bondholders,” Joe Morin, chairman of the CBIA and director of research at Richmond Hill, Ontario-based Canso Investment Counsel Ltd., said by telephone yesterday.
A proposed buyout of BCE Inc. in 2007 threatened to strip investment-grade ratings from more than C$11 billion ($9.9 billion) of bonds, prompting MFC Global Investment Management and Addenda Capital Inc. to demand Canada’s biggest phone company buy back their bonds. While the takeover by private-equity firms ultimately failed and acquisitions cooled in the aftermath of the financial crisis, the incident is a reminder for investors girding for a new wave of leveraged buyouts.
“The change of control put option allows bondholders to reconsider their investment decision if the issuer is acquired by a new owner,” according to the paper, co-written by Mark Rasile of law firm Bennett Jones LLP. “Its purpose and rationale is obvious. However, many Canadian investment-grade bond indentures do not include such a put.”
The CBIA said it will soon make its recommendations to issuers, underwriters and regulators. Its proposals should act as “best practices” for investors to demand improvements, the group said. Compliance would be voluntary.
“Right now covenant protection is too weak,” Girard said. “Even low investment-grade bonds have little or no covenant protection.”