Bondholders Tire of Losing Out When Funding Failed Acquisitions

Make-whole calls are typical in bond indentures and allow the issuer to redeem the debt at specific spread above a U.S. government bond or at par, whichever is greater. Rising rates can make the make-whole call cheaper, and give a lower-cost alternative to the special mandatory redemption clause.

"As bond investors, the only time we can negotiate these terms is at the new issues and that's where we're trying to educate the market," said David Knutson, a co-head for the Credit Roundtable, which is made up of 42 member firms. "If the language is in there, and management has the option to do things at the interest of shareholders but expense of the bondholders, this is where you're really transferring value away from fixed income holders."

To be sure, it's rare for bonds to be called back at a make-whole price under the 101%% premium guaranteed by the SMR, said Joseph Kaufman, partner at Simpson Thacher & Bartlett LLP. SMRs are in just 50% of M&A financing deals and there are only limited circumstances in which it could be applied. Such a bond would need a low coupon, rising Treasury rates and only then could the make-whole calculation come out below the SMR premium of 101 percent, Kaufman said.

In June, Credit Roundtable published proposals setting limits on the use on the clauses. Knutson says bondholders are accepting looser terms just as the credit cycle is reaching its latter stages.

"The market is generally pretty healthy and pretty strong and typically later in an economic cycle or market cycle, you get investors often willing to accept less — less return or less restrictive covenants or less robust indentures," Knutson said.

—With assistance from Brian Smith and Thomas Penaherrera.

— Read Wells Fargo Analysts See Big Refinance Risk in `Bad Boy Bonds', on ThinkAdvisor.

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