Fear drove Household International’s decision to sell out to HSBC last month. Executives and advisers on both sides have done a good job of presenting the roughly $14 billion deal as an ideal strategic fit for both the US consumer finance company and the UK banking group. And so it may prove to be, although as a first step executives need to sweep away the rumours swirling around at the end of November that the deal was in danger of collapsing.
But a deal struck at roughly 1.6 times Household’s book value smacks more of desperation than strategy. Household CEO Bill Aldinger now says that it was always his intention at some point to link up with a deposit-taking institution. This was not the preferred timing, though.
The company’s stock price closed at $22.45 the night before the deal was announced, more than $40 lower than its high for the year of $63.25 hit during the day on April 22.
Other independent finance companies – big issuers in the bond markets – had provided their own shocks to the market in recent months. Credit-card company Providian went bankrupt at the end of 2001, as did online peer Nextcard. Problems surfaced at two other credit card companies this year: Metris in February and Capital One in July. Both received cautions from their regulators
As sentiment soured on finance companies, Household – the biggest issuer of the lot, with around $15 billion of unsecured long-term debt to refinance each year – was one of the worst affected. It came under investigation for predatory lending practices and then, in a supreme example of unfortunate and bad timing, it announced an accounting restatement.
On August 14, the day Household’s CEO and CFO ratified its earnings in signed statements to the SEC, as was required under the newly enacted Sarbanes-Oxley legislation, they also announced that they were going to restate the company’s earnings over the past eight years to the tune of $386 million.
Its new accountants had demanded the change. KPMG had taken over from – you guessed it – Andersen, and took a much more conservative line on accounting for Household’s MasterCard and Visa co-branding and its affinity credit card relationships.
Senior management hosted a conference call to give more details about this and other issues it was facing, such as accounting tangles to do with re-ageing problem receivables and the state of the predatory lending lawsuits. It didn’t go down well, with bond spreads widening by up to 50 basis points during the call.
Less than three weeks later the situation worsened after newspapers got hold of a report on Household’s lending practices by the Washington State department of financial institutions noting that the company’s predatory lending practices, in Washington at least, appeared more widespread than previously thought.
The effect on the share price was bad enough. By July it had dropped below $60 a share. On August 2 it was below $45 and Household had to buy back all $1.2 billion of a convertible put back by investors.
But it was the company’s widening bond spreads that were the biggest cause for worry. Its benchmark 2011, 10-year deal was launched last year at a spread of 155 basis points, pretty typical for a solid single-A credit. But by the summer this had widened out to nearly 300bp over.
This was a life-threatening situation for Household: it’s the largest independent consumer finance company in the US, yet, with no deposit base to speak of, it relies for its funding almost entirely on raising debt capital.
Issuing new paper at such wide spreads was inconceivable, even with interest rates so low. And Household has $14.6 billion of unsecured bonds maturing in 2003, as well as more than $5 billion of commercial paper.
A string of last-ditch deals Household had to find a way to reduce its spreads drastically. It needed a deal over predatory lending. On October 11, the company announced that it had reached a proposed settlement with attorneys general from four states and Washington DC whereby it would set up a $484 million restitution fund. It would take a $330 million charge for it in its third-quarter results. The company also announced that it would sell its thrift subsidiary, which would generate a charge for the fourth quarter of up to $300 million.
That should have been good news for its bonds. But it wasn’t. Rather, Standard & Poor’s downgraded both its long-term and short-term debt ratings after news of the settlement. Spreads widened out to the point where trades were being struck just under 800bp over. Some traders claim to have heard about quotes of 1,000bp, although the widest trade struck on the default swap was 900bp. A year earlier its default price had been just 80bp.
If spreads stayed at such levels long enough, the company’s profit margins would have been erased completely. Executives decided to issue equity.
The company chose to do a bought deal via Goldman Sachs on October 24, rather than a competitive tender, after the stock price had mysteriously dropped nearly 15% in two days. It raised $900 million: $500 million via a mandatory convertible bond and $400 million via common stock. “While dilutive and smacking of desperation, the new capital hopefully will restore the debt market’s confidence in the future,” said Deutsche Bank’s speciality finance analyst Mark Alpert.
It partly worked. Spreads tightened to around 550bp over, with the mid-point default swap dropping to 675bp over. But that wasn’t enough. Over the next two weeks executives tried to reassure bond investors, hosting a conference call on November 6. Few were convinced.
“Again, we think the company is dribbling out the bad news in small bits instead of coming out with the plain cold and hard reality that the funding market will be difficult for 2003,” CreditSights bank analyst David Hendler said after that call.
By this time, though, talks were already well under way with HSBC. Whether these were active at the time of the equity offering at the end of October – news of HSBC’s offer boosted the share price by 25%, making this a great buy in hindsight – is unclear.
The effect of the announcement of the sale to HSBC was immediate: spreads tightened to around 220bp over and the default swap price came right in to 190bp bid, 210bp offer. “It’s been a long while since beleaguered corporate bond investors awoke to such happy news,” says Gimme Credit analyst Kathy Shanley. “Household International is throwing in the towel and selling itself to a stronger balance sheet.”
It could be a return to canny buying on the cheap for HSBC, assuming the predatory lending lawsuits are behind Household now. Household could be a good money-spinner, though investors in other finance companies, potentially exposed to rising consumer defaults, are more likely to look enviously at its wealthy buyer.
Household has already got something out of it, before the deal is closed. It was one of the companies to take advantage of the spread tightening after the deal was announced, launching a $1 billion five-year deal at 155bp over treasuries and a $250 million 30-year at 250bp over on November 20. Those kinds of spreads were just a pipe dream a few weeks before.
