Ten things an issuer should consider when conducting a liability management exercise with respect to its bonds

Balance sheet management can be an attractive tool for issuers to either more efficiently use their cash resources or counteract stresses caused by macroeconomic and industry conditions that make it difficult to access the debt capital markets.

01 | Why consider a liability management exercise?

• Issuer is in trouble: a breach of the bond terms is imminent and an amendment needs to be agreed to avoid a default. In the current climate, this may be because the issuer operates in a sector under pressure, for example, commodities which are suffering from the effects of low prices where we are seeing investors prepared to defer maturity dates or agree to a temporary relaxation of certain covenants to prevent a company from defaulting (because the poor value of an issuer’s assets makes enforcement unattractive), but not prepared to lend more money.
• Spare liquidity: an issuer has available cash and wants to pay down its debt.
• Better market conditions: in a low interest rate environment, an issuer can exchange its bonds for ones which pay a lower interest rate, resulting in cheaper debt.
• Unfavourable/restrictive terms: e.g. an issuer has strict financial ratios in its bonds, but its financial condition has improved such that it can persuade bondholders to relax the covenants, increasing its flexibility with respect to its assets and releasing cash.
• Corporate restructuring: e.g. following a takeover, a group may wish to move the target’s bonds to the new parent level to manage cash flows in a different way.
• Regulatory changes: e.g. changes in the capital adequacy requirements of an issuer which is a regulated entity.

The reason for the exercise will help determine the type of liability management transaction to be undertaken.

02 | Consider some important facts about the bonds

When starting a liability management exercise, an issuer should consider the following points which may help determine the type of exercise:

• What do the terms of the bonds allow the issuer to do?
• Are the bonds listed and, if so, are there any stock exchange and public offer/securities laws and regulatory rules with which the issuer needs to comply, including insider trading/market abuse laws, in the relevant jurisdictions?
• Does the issuer or the guarantor (if any) have any constitutional requirements which may be relevant to the exercise?

03 | Choose the appropriate type of liability management transaction

Four basic types of transactions: buy-backs; tender offers; exchange offers; and consent solicitations, but transactions can be a combination of several of these.

• Buy-backs - discrete purchases made in the market by an issuer of its bonds or those of its subsidiaries. A bond buy-back programme must be limited in size to avoid crossing materiality thresholds to avoid the requirement for public disclosure and it being considered a tender offer with all that would entail so will only be appropriate where an issuer wants to buy back some, not all, of its bonds.
• Tender offers - There are two types of tender offer: a cash tender offer and an exchange offer. In both cases, bonds which are purchased or exchanged may then be cancelled, but the bonds of non-consenting bondholders will remain outstanding and paid in accordance with their original terms.
  • Cash tender offer - Approach by, or on behalf of, an issuer to bondholders to buy-back some or all of its bonds for cash - a more organised bond buy-back. Differences between a tender offer and a buy-back programme/open market purchases include: timing – open market purchases can be implemented immediately, whereas a tender offer will take more time; size and scope - tender offers provide the opportunity of retiring an entire bond issue; and flexibility - tender offers may be prohibited under senior debt/bank covenants.
  • Exchange offer - Like a cash tender offer, but instead of paying cash, the Issuer exchanges the existing bonds for new bonds issued by the Issuer or some other entity. Exchange offers are popular when issuers do not have available cash.
• Consent solicitation - Approach by an Issuer to request consent of bondholders to amend the terms of the bonds, i.e. asking permission to change the original deal. Amendments are made in accordance with the terms of the bonds, e.g., under English law, by way of bondholder meeting or written resolution. Once the resolutions have been passed by the requisite majority, all bondholders are bound which means, for certain types of amendments, a relatively small number of bondholders may impose changes on all other bondholders.

A tender offer is often combined with a consent solicitation to address the problem of outstanding bonds belonging to bondholders who reject the offer. Bondholders can be “encouraged” to take part in the tender offer (by inserting a call option or covenant stripping) because what they are left with is a much less attractive investment.

04 | Appoint the necessary parties

In a tender offer:

• One or more Dealer Managers (with one or more acting as lead): banks hired as agents to advise the issuer and conduct the liability management exercise on its behalf.
• Tender/Exchange Agent: bank or service provider appointed to provide information to, and communicate with, bondholders and to arrange payment of any cash or delivery of new securities to the bondholders.
• Tabulation Agent (often the same entity as the Tender/Exchange Agent) appointed to count the votes cast and to take receipt of any transfers of bonds.
• Trustee: if there is a trustee for the relevant bonds, then it will need to be involved in the exercise.
• Legal counsel: typically, the Issuer, the Dealer Managers, the Tender Agent and the Trustee (if any) will each have their own counsel.

In a consent solicitation:

• Paying Agent/Tabulation Agent: appointed to count the votes cast and to take receipt of any transfers of bonds and arrange payment of any cash or delivery of new securities to the bondholders.
• Solicitation Agent: an investment bank effectively acting in the same role as a dealer manager.
• Trustee/Fiscal Agent (as applicable): need to be involved to facilitate the passing of the relevant resolutions in accordance with the terms of the bonds.
• Legal counsel to the parties involved.

05 | Consider where the bondholders are located

Onerous procedures are placed on tender offers and sometimes consent solicitations made to bondholders deemed resident in certain jurisdictions (most notably Italy and the US) so where the bondholders are located can impact the documentation and the timing of the exercise. Given the difficulty in locating beneficial holders of bonds held through clearing systems, holders resident in those countries are often excluded from the offer. In addition to the structural considerations, there are anti-fraud provisions of the US Securities Exchange Act of 1934 which apply to tender and exchange offers and, in some circumstances, consent solicitations that affect the documentation for, and timing of, the transaction. If it is necessary to make the offer into the US and Italy, legal counsel will advise on the extra steps and timing considerations which need to be taken to avoid breaches of securities laws.

06 | Arrange for the documentation to be drafted

In a tender offer:

• Memorandum/Offer Document: describes the terms and procedural aspects of the offer, including detailed information regarding the timing, where the offer is being made etc. An exchange offer involves an issue of new securities and as such a prospectus containing a description of the issuer’s business, the exchange offer and the new bonds will be required and the considerations relevant to a straight bond offering need to be taken into account.
• Dealer Manager Agreement: similar to a subscription agreement, contains the terms on which the Dealer Manager(s) advises on and conducts the exercise.
• Tender/Information Agency Agreement: contains the terms on which the Tender/Information Agent coordinates the administrative elements of the offer process. Sometimes combined with the role of the dealer manager.
• Tabulation Agency Agreement: often combined with the Tender Agency Agreement, contains the terms on which the tabulation agent acts as processing agent for transmittal letters/ballots/consent forms; liaises with clearing agencies to distribute documents and receive consents/tenders and is consulted as to the mechanics of the offer.
• Exchange Agency Agreement: relevant in an exchange offer, contains terms on which the exchange agent is responsible for receiving, examining, processing and analysing the tenders and communicating this information to the issuer and bondholders.
• Transmittal Letter: only relevant in relation to bonds cleared through the Depository Trust and Clearing Corporation in the US (DTC) where the tender offer is not eligible for DTC’s automated tender offer program. It is the letter by which instructions from accountholders or participants are transmitted to the Tabulation Agent for counting. European clearing systems have their own forms by which instructions can be given by accountholders.
• Notices: published in accordance with the requirements of the underlying documentation and any stock exchange regulations notifying bondholders of the offer and certain steps.

In a consent solicitation:

• Consent Solicitation Statement is used to describe what is being requested and setting out the mechanics of the exercise.
• Tabulation Agency Agreement.
• Notices (including an initial notice notifying bondholders of the resolutions to be passed and background regarding why the changes are being sought).
• Supplemental Trust Deed/Deed of Amendment to the Fiscal Agency Agreement amending the original terms of the bonds.
• Solicitation Agent Agreement appointing the Solicitation Agent.

07 | Consider by which date the exercise needs to be completed

Usually the timetable for a liability management exercise is set by working backwards from the date on which the transaction needs to be completed (e.g. an Interest Payment Date or the Maturity Date) and needs to be appropriately staggered so there is enough time for each step, including drafting documents pre-launch. Timing steps include commencement of offer, the date before which a bondholder can revoke its consent (if applicable), deadlines for any incentives being given to bondholders responding early and the date the offer ends.

08 | Consider whether pricing incentives will be offered

Attractively priced tender offers may result in a high level of acceptances and incentive fees can be offered to encourage bondholders to respond to an offer more quickly or at all.

Incentive fees may be offered to bondholders in liability management exercises relating to English law governed bonds providing they do not offend the pari passu treatment of bondholders, i.e. they are offered to every bondholder, even if they are only ultimately paid to those who consent.

09 | Does the offer need to be conditional on any event?

Liability management exercises can be subject to a number of conditions, e.g. a minimum required take up of the offer by bondholders or regulatory consents being obtained. The issuer will usually retain the right to waive any condition imposed on the offer.

10 | Will bondholders be given the right to change their mind?

Does the issuer want to allow a bondholder to revoke its instructions, consents, waivers, tenders or are they “locked-in” once they have voted yes or no?

Conclusion

An issuer’s reasons for undertaking a liability management exercise will dictate the type of exercise to be undertaken and its timing. Companies in distress which take early action can strike better deals with creditors than those who wait until a default is imminent. Timing is often critical and being prepared by understanding the options available and the steps involved can be invaluable to a successful exercise.