CFOs urged to buy back debt if it’s trading below face value
If you have access to cash and your debt is trading below par due to credit market turmoil, now may be the time to buy back your debt and deleverage your balance sheet, debt experts say.
“Buying back your debt below par is cheaper than prepaying the loan, so it could be a good alternative for using cash,” said John Markland, partner at global law firm Dechert LLC, in a webcast.
Since the crash of the financial markets a dozen years ago, it has become more common for companies to buy back their debt and most credit agreements today include language that allows this. “Credit markets have learned their lessons,” Markland said.
There are generally two types of debt buybacks: bank loans and corporate bonds.
For bank loans, there are two ways to structure a debt buyout. The first is a solicitation process in which you invite lenders to sell debt at a price and in an amount they choose and you are obligated to accept the lowest offer first. The second is an open order where you enter a price for the amount you want to buy and your lenders can choose whether or not to accept the offer.
These procedures are designed to give all of your lenders the opportunity to participate, helping you create a market for a reasonable price, but they can be time consuming and you cannot effectively choose your seller. “They don’t allow you to quickly and opportunistically choose forced sellers at attractive prices,” Markland said.
Securities Law Compliance
The big difference with bond buyouts is that they are governed by securities laws, so in addition to any restrictions in the covenants, you should be careful to structure the deal in a way that complies with the regulations. federal.
Transparency rules are an area that can lead to errors. If you are in possession of material non-public information, trading your own securities in a takeover may trigger disclosure rules. “You should consider your own internal insider trading blackout windows,” Dechert LLC partner Ian Hartman said in the webcast.
And if yours is a public company, you should consider whether the takeover itself is material information that should be announced in advance.
Hartman recommends incorporating standard information into quarterly and annual reports saying you could use cash to buy back bonds. This way, there are no surprises following a redemption disclosure in a 10-Q or 10-K.
You must also ensure that your purchase will not constitute a takeover bid; otherwise, you will need to meet additional requirements, some of which may delay the transaction.
“We often see companies and [their private equity] sponsors carefully structuring their buyout program to avoid being viewed as a takeover bid,” Hartman said.
Whether your takeover qualifies as a takeover bid is a gray area, but there are some characteristics regulators look for:
- There is a general solicitation.
- You are requesting a substantial percentage of the issue or securities.
- There is a premium to the market prices offered, although this probably isn’t the case if you’re looking to buy back below par.
- There are firm offer terms instead of negotiable terms.
- The offer is subject to the amount of securities tendered; for example, an entity will only buy from you if it can also buy a certain percentage from other holders.
- The offer is only open for a limited time.
- There is pressure on title holders.
- There is a public announcement made as part of the offers.
“Having one of these factors doesn’t automatically make a debt buyout a takeover bid; you’re looking at the entire transaction and evaluating it globally,” Hartman said. “There may be close calls.”
To avoid getting your business caught up in these rules, be sure to allow negotiations with the seller and avoid take-it-or-leave-it offers; do not impose a deadline; and focus your outreach activities on large institutions that are large holders rather than small individual holders.
Also, be careful with any announcement that you are looking to buy a large amount of tickets at a certain price.
With bank debt and bond buybacks, if you buy back your debt below par, you can expect some tax impact.
“Reducing the amount owed or satisfying the amount owed for less than the amount owed may result in the write-off of debt income, which is taxable income with some exceptions,” Hartman said.
You can also trigger debt cancellation if you negotiate a change in the terms of the debt, such as deferring payment, adding or removing a borrower or type of security, or increasing or the decrease in yield.
These types of changes can be considered a debt swap, and if an issuer has a deemed or intentional swap at a time when the debt is publicly listed and trading below par, the fair market value of that debt can be less than the amount borrowed, which may trigger cancellation of debt income. This is the case even if there is no reduction in the principal amount due.