Bond-Buyer Rebellion Spreads Against Effort to Weaken Protection

  • GM, Broadcom said to abandon ‘no premium on default’ clause
  • Change restores penalty payments when issuers violate terms

Buyers have rebelled against bond offerings that tried to deprive them of penalty payments when a company breaches its credit pact, forcing changes to at least $17 billion in new debt.

Companies including General Motors Co., insurance brokerage Marsh & McLennan Cos. and chipmaker Broadcom Ltd. bowed to a firestorm of protests on Wednesday by dropping language designed to eliminate the penalties, according to regulatory filings and people with knowledge of the matter. The payments can be triggered by dozens of missteps, such as piling up too much debt or letting cash sink too low, that could make a company riskier than bondholders expected.

The simmering dispute erupted this week as the new terms were spreading from junk-rated bonds into investment-grade offerings, the people said, asking not to be identified as the discussions weren’t public. Debt-research firm Covenant Review beseeched clients to push back, calling the new wording "horrible," "terrible" and "dangerous," and warning of more breaches if the language becomes standard.

Corporate issuers have sought wording that curtails penalty payments following a court ruling last year that required pawn-shop operator Cash America International Inc. to cough up the so-called “make-whole premium” after a voluntary covenant breach. To avoid that fate, companies started deviating from the standard terms in credit documents to insert the condition, known as “no premium on default,” that could shield them from the additional payment.

‘Terrible Language’

"We are at a crisis -- as of today, we know of 18 deals that have been marketed with new language that works to basically ‘opt-out’ of the court’s ruling," Covenant Review said in a report Wednesday. "This terrible language will vastly embolden issuers to consider breaching covenants, and lead to more risk for bondholders and fewer premium redemptions."

Although investors were wary of the covenant language, demand for the new notes was strong enough to let companies lower the interest they’re paying on the new bonds. General Motors dropped rates on its $2.5 billion, three-part bond sale by as much as 0.2 percentage point, according to a person familiar with the matter, who asked not to be named because the deal is private. Broadcom sold $13.55 billion of notes with lowered interest rates in the year’s largest deal so far, according to a second person.

Marsh & McLennan, which sold $1 billion of notes on Monday, said in a regulatory filing Wednesday that it had also removed the offending language from its bond indentures. The notes settle on Thursday. The New York-based company is the largest insurance broker by market value.

Spokesmen for Detroit-based GM and Marsh & McLennan declined to comment. A representative for Singapore-based Broadcom didn’t immediately respond to requests for comment.

Protection Erodes

Last year, junk-bond issuers including Apollo Global Management LLC-backed Rackspace Hosting Inc. and ServiceMaster Global Holdings Inc. were able to add this language to their bond indentures. In these deals, language has limited bondholders to repayment at par. 

While the trend started in the high-yield market, similar language has been showing up in investment-grade bonds. It appeared in a $1.2 billion FedEx Corp. offering last week and a Nike Inc. sale last year, according to a Jan. 11 Covenant Review report.

“It really is a significant erosion of bondholder protection,” said Ken Monaghan, a money manager at Amundi Smith Breeden in Durham, North Carolina. “Bond investors who are aware of the prospective changes are pushing back for good reason.”

After Apollo agreed to buy Rackspace in a leveraged buyout, Rackspace’s bond investors were paid 115 cents on the dollar for their holdings because issuing new notes to complete the buyout would breach terms that restrict acceptable uses of additional debt.

When Apollo marketed its $1.2 billion of buyout bonds, it added the new "no premium on default" language, Covenant Review said in a report that traced the adoption of this new trend.

“This will prove to be an inflection point as bondholders will draw a line in the sand and band together to prevent this language,” said Bill Parry, a managing director of capital markets at Seaport Global Securities. “Investors understand that allowing this language is the beginning of the end of protective bond covenants. There is no going back.”

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