Hertz Bankruptcy Was Too Good for Shareholders

Here’s a bad idea. You’re a big public company, and you have some debt: A year ago, you sold $1 billion of bonds, due in 10 years, that pay, say, 7% annual interest. But now, a year later, things have changed. Specifically interest rates have gone down: Let’s say that the 10-year US Treasury rate was about 4% when you issued the bonds, but a year later let’s say it’s 2%.1 Meanwhile your business has gotten better: When you issued the bonds last year, you had to pay an interest rate that was 300 basis points higher than Treasuries (7% vs. 4%), but if you issued today you’d only have to pay a 200 basis point premium, because your credit has improved. So if you issued $1 billion of 10-year bonds today, they would carry a total interest rate of only 4% (the 2% Treasury rate plus a 200 basis point spread), not 7%. If you could get rid of the old 7% bonds and replace them with new 4% bonds, you could save $30 million of interest per year.

Can you? Mostly, no. In general, corporate bonds are not freely prepayable: You can’t just send the 7% bondholders $1 billion and say “never mind.” The bondholders loaned you money because they wanted 10 years of guaranteed 7% interest payments; if those payments went away as soon as interest rates dropped, they’d be losing out. They’d have to go invest their money somewhere else — maybe in your new bonds — at only 4% interest. They bought a fixed-rate bond, and they want that fixed rate for 10 years.