Boots: debt is back in the market
Several instances of this in recent months, such as Danish phone operator TDCs purchase of 200 million of its own debt in March and private equity group PAIs purchase of second-lien debt used to finance its own LBO of Lafarge, have highlighted what could become a growing point of contention in the loan market. Indeed, the trades have prompted the Loan Market Association itself to examine whether steps should be taken to address the practice. "We will have to look at standard documentation in light of what the market is doing," says Mike Johnstone, associate director at the LMA in Canary Wharf.So why does it matter? The answer to this depends on whether the sponsor or the borrower is doing the buying. Under standard LMA documentation, sponsors are generally permitted to buy back their own debt, and many in the market do not see this as a problem. "Some banks might argue that sponsors should not be allowed to buy back their own debt as it gives them rights in a restructuring where they may have different interests to the rest of the group as they would be looking to preserve equity value," says a partner at an international law firm in London. "This seems like rather an extreme view to me." Indeed, the consensus view of those interviewed by Euromoney was that sponsor buybacks, where the buyer remains outside the syndicate lending group, are generally acceptable even if the sponsor is purely motivated by the wish to have a place at the table in any restructuring.
But if it is the borrower doing the buying, the situation becomes rather more opaque. In this case the purchase can be viewed as a prepayment something that might not be permitted under standard loan documentation and can run counter to the spirit of the syndicate group. "This is quite a controversial issue at the moment," says a senior banker in the leveraged finance team at a European bank. "Lawyers will spin it depending on whether they are representing the sponsor or the lending banks. It is a big topic lawyers for the private equity firms will tell you that it is not a prepayment and lawyers for the banks will tell you that it is."
Why does it matter if the borrower does prepay? Surely, in a market like this, borrower buybacks free up liquidity for the banks themselves? Borrower buybacks achieve de-leverage (something that is desperately needed in many of the deals undertaken during the past few years) and presumably leave the company in a better financial position to meet its remaining debt obligations?
Maybe, but not everyone is comfortable. First, if a traditional prepayment of the loan is allowed under the documentation, it will usually be at par and proceeds will be applied across the lending group. But if the borrower comes to an arrangement with one of the syndicate to purchase a chunk of debt at a discount, this is seen as a very different matter. "A syndicate member may contend that allowing a borrower to pick off one or more of their fellow lenders and take their part of a loan out through a debt buy back would offend the basic commercial principle, or spirit, of syndicated lending," contends Neil Murray, banking partner at Travers Smith in London. In March 2008, Citadel Broadcasting requested the repurchase of $200 million of its own debt at a discounted rate but undertook the purchase via a public tender. This is seen as a less contentious approach as all syndicate lenders are given a chance to sell.
A bilateral approach is contentious not just because of the distribution of proceeds (a traditional prepayment is made to the agent bank and redistributed among syndicate lenders on a pro-rata basis) there is also the issue of the fee. The principle is that repayments should be shared amongst the syndicate, so loan documentation would typically prohibit the prepayment of an individual lender to the exclusion of the other syndicate lenders other than at par and on a pro-rata basis. So in addition to buying back debt on the cheap, the borrower can also dodge a costly prepayment fee by buying back in this way.
Merger of self interest
Technical problems can also arise. According to standard LMA documentation, the assignment and transfer of debt is only permitted between the syndicate bank and "another bank or financial institution... engaged in or established for the purpose of making and purchasing... loans/debt instruments." So unless the borrower falls into this category it will be prohibited from buying its own debt. TDC of Denmark is a telecoms group, but was able to buy back 200 million of its own debt at between 90 and 95 cents on the euro because it makes inter-group loans and therefore could classify as a buyer under the above definition. But when the borrower does this it becomes a lender as well essentially owing money to itself. "Legally, a person cannot contract with himself, it is not possible for him to owe money to himself," explains Murray. So the debt cancels itself out and is extinguished by a merger of interests, but it has not been repaid so it doesnt need to be shared amongst the lenders. The money goes to the lender that sold it.
Even in the present liquidity-constrained market, the banks dont like buybacks. "We do not actively promote debt buybacks," says the leveraged finance banker. "We wont do it and I know a lot of sponsors that wont do it as a matter of policy," he says. "They do not want to run the risk of angering investors." But clearly some sponsors do not see a problem: KKR Financial is understood to be in discussions to buy back a chunk of KKRs own Alliance Boots debt that has recently been reintroduced to the market after the deal was postponed last summer. While liquidity in the loan market has improved, the debt will very likely be sold at a substantial discount to par.
If borrower buybacks start to gain pace, bank consternation will grow. But the phenomenon is a product of the liquidity crisis it is hardly surprising that borrowers have chosen to take advantage of the fact that their loans are trading at very attractive discounts it is a finite borrower opportunity. "If the market stays super-depressed then we may see more of these but I dont think it will become a massive problem," says the banker. "However, if there are many more then people will become nervous." If and when these discounts disappear, buybacks should become far less appealing. "I give this a years worth of opportunity," reckons a market expert.
Just because borrowers may see their debt trading substantially below par does not mean that they will automatically try to buy it back. Many will not have the means to do so. "Companies usually want to keep cash rather than retire debt," says the banker. But even if debt buybacks do not become the problem that some fear, it is likely that standard LMA documentation will be tightened up to address the confusion and inconsistency that now exists. "Borrower buybacks have cropped up because of the covenant-lite phenomenon of recent years," explains one lawyer. "Banks involved in cov-lite deals demanded that the transfer clause state that the debt was transferable to any person in order to ease syndication. But any person includes the borrower so they have now rather shot themselves in the foot." Murray agrees that the provisions of documents that were designed to accommodate lenders desire to syndicate as widely as possible may now rebound on them. "They wanted the widest possible group of people that can be syndicated to," he muses. "They are now dealing with the ramifications of that in that the group could include borrowers themselves or their shareholders."