Out from Under

Deeply discounted corporate debt may tempt companies to buy it back or exchange it, but such deals are far from easy.

Last fall, as the CEOs of the Big Three automakers were preparing to journey to Washington, D.C., in search of a bailout, auto supplier Metaldyne Corp. pulled off a minor miracle. The $1.7 billion company wiped out a crippling debt load by buying back its bonds at less than 30 cents on the dollar, clearing $300 million in debt and $40 million in annual interest expenses. The transaction staved off bankruptcy.

“While it entailed a lot of 18-hour days,” recalls Metaldyne CFO Terry Iwasaki, “we had support early on from customers, and we were able to get the financial sponsors and the debtholders on the same page.”

The Metaldyne deal stands out because many of the Plymouth, Michigan-based company’s customers themselves were barely hanging on, and other, higher-profile attempts to deleverage and take advantage of the large discounts in the corporate bond market had faltered. Indeed, debt buybacks, exchanges, or any attempt to provide creditors with a recovery of less than par by pushing out maturities or subordinating existing investors to new ones is meeting resistance in the current market.

“It’s not compelling for an investor to voluntarily convert to a less secure instrument that may pay better or not, without any confidence that the reorganized entity will survive,” says Jeffrey Manning, managing director at Trenwith Securities LLP. “Why should they do it voluntarily when they have the benefit of a court process to protect their rights?”

Given the difficulties in issuing new debt, many companies may find themselves in Metaldyne’s position: laboring to conserve cash and restructure existing debt more favorably. This year, a large amount of bond and bank loan maturities are hanging over nonfinancial companies in the Americas — $233 billion worth, estimates Moody’s Investors Service. To make matters worse, 10 percent of all rated, nonfinancial companies in the Americas face liquidity shortfalls.

Given that many bondholders have rejected offers from big-name issuers, CFOs may be wondering if wading into these waters — trying to restructure the balance sheet outside of bankruptcy — is worth it. The answer, say the experts: it depends.

Distressed-debt exchanges have become one popular approach. In this transaction, a company trades debt for debt, usually forcing creditors to take less than par, a lower interest rate, a longer maturity, a more junior ranking, or all of the above. In 2008, 20 percent of all bond defaults occurred due to companies offering debt exchanges to bondholders, up from 10 to 15 percent historically, Moody’s says. (The credit-rating agencies consider such an exchange a de facto default.)

When credit markets are calmer, managing liabilities using debt exchanges is straightforward. In March 2007, Minneapolis-based Xcel Energy, a $10 billion utility, cut a $600 million bond maturity in half. “We wanted to take out some of the refinancing risk and spread out our liabilities,” says Xcel CFO Ben Fowke. “Our motto is, ‘Get on top of risk before risk gets on top of us.’”

Xcel had to pay a slight premium to investors and throw some cash into the deal to lure participants. And, most important, bondholders didn’t take a haircut. The alternative was tortuous and risky: a combination of prefunding the large debt maturity, forward hedging, and “managing a negative arbitrage on a large cash balance,” Fowke says.

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