More Debt Exchanges Loom as Buyout Loans Come Due

NEW YORK (Reuters) – Bondholders may face losses from debt exchanges for years to come as companies scramble to head off over a trillion dollars of junk bonds and loans coming due between 2011 and 2014, analysts said.

The rush to deleverage, or pay back that debt, will create strong competition for capital, and companies are already worried about being left out in the cold, analysts said.

“What we’re seeing are a lot of corporate entities in the market trying to deal with their capital structures in advance of this maturity phase,” said CreditSights analyst Chris Taggert. “They certainly recognize this problem.”

Distressed debt exchanges soared in 2008 to nearly $30 billion, up from $15 billion in the previous 24 years combined, according to Edward Altman, finance professor at New York University’s Leonard L. Stern School of Business.

In a distressed debt exchange, companies restructure their debt to avoid bankruptcy or to get more time to pay it back. Investors swap their debt for new notes, often with longer maturities, but sometimes receive only a fraction of the original value of their bonds.


The new twist is that debt exchanges are becoming more coercive, analysts said, meaning that bondholders participate not to receive benefits such as higher coupons but out of fear of harm if they hold out. In these kinds of exchanges, investors who swap their debt are often bumped higher in the capital structure, weakening the holdouts’ claim on a company’s assets if it goes bankrupt.

Senior lenders of Freescale Semiconductor [FSLSM.UL] last month sued the company, saying its debt exchange “unjustly enriched” noteholders because they swapped nearly worthless notes for a valuable term loan backed by collateral. The noteholders will have a substantially better chance of recovery if Freescale files for bankruptcy, the lawsuit said.

Some debt exchanges are transferring wealth from bondholders, who are taking losses, to equity investors, who benefit when debt is extinguished, Taggert said.

“You’re not seeing a giveup on the side of equity that you’d see in a default scenario,” he said.

More relaxed covenants, or lending terms, negotiated in the credit boom are giving companies more leeway in how they exchange debt.

“There are contracts called indentures or credit agreements that determine whether a company can launch an exchange offer, and managers of bond and loan funds should be aware of what those contracts say,” said Adam Cohen, founder of research firm Covenant Review. “Some asset managers just don’t read their contracts.”


Debt exchanges may be prevalent for years as companies address refinancing needs that start around 2011, according to Taggert.

The problem stems largely from a credit boom in 2006 and 2007, when an estimated $1.6 trillion of junk bonds and leveraged loans were issued, much of it to fund record-sized leveraged buyouts, according to Thomson Reuters and Loan Pricing Corp data.

While some of that debt will have defaulted, been paid down or otherwise dealt with before it matures, much of it will not, and the battered structured credit market, which soaked up debt during the credit bubble, is unlikely to regain its former health in time to help.

In addition to Freescale, LBO companies that have made exchange offers include Harrah’s Entertainment Inc [HAMLEH.UL], Station Casinos [STN.UL] and Neff Corp. More are likely to follow.

Energy Future Holdings [TXEFHE.UL], for example, has about $20 billion in debt due in 2014 and may need to swap some of its bonds for equity, analysts said.

The company has said it does not need a debt exchange.

“What I think is the next wave is companies that are investment-grade doing exchange offers,” said Cohen of Covenant Review. “They’re going to say, ‘our debt is so cheap, how could we not take advantage of that?’

By Dena Aubin

(Editing by James Dalgleish)