Liquidity? Thank you

Two years ago, when the loan market was gushing with cash, the idea of a company buying back debt without paying for it pro rata at par would have been unthinkable. Par loans were trading at 97–98 cents on the dollar and the loan market was flush with excess capacity. Companies were more inclined to use excess cash or incremental leverage to repurchase stock.

Times have certainly changed. Amid a scarcity of liquidity, many loans trade at about 70 cents on the dollar. A growing number of companies are stepping up to repurchase debt at a time when investors desperately need to raise cash. When liquidity is scarce, any bid, even if it comes at a discount, is welcome.

“The accounts have realised that any new buyer is a good buyer, even if it happens to be the issuers themselves that are still providing liquidity into the market,” a banker agreed. “You have the market saying any liquidity is good liquidity. So why not let this happen?”

Supersize deleveraging

For a corporation, buying back debt at a discount to par has obvious merits of reducing interest expense and, potentially, providing additional flexibility on covenants. Importantly, discounted debt purchases offer a multiplier effect. “If you have US$100m of cash and you buy back debt at 50 cents, you can retire US$200m of debt. It’s a nice little way to supersize their deleveraging,” the banker added.

Another advantage is that buybacks alleviate pressure for forced selling. The corporate bid helps motivated sellers get out of positions without putting undue pressure on secondary trading levels. Over the past month, investors have been forced to sell positions to honour redemptions or meet margin calls, leading to a cascading effect in the secondary market.

“It’s the best corporate move right now,” a second banker said. “They can’t make acquisitions because they can’t raise new capital. They can’t sell assets because the buyers can’t get financing. All of these companies are highly leveraged.”

The buybacks frequently occur through a reverse auction, where a company provides a price range and an amount of loans it is seeking to buy. Lenders respond with the price and amount of loans that they are willing to sell. Unlike stocks and bonds that can be repurchased and tendered at will, loans need amendments from the lending banks. The result has varied depending on the company and the amendment.


Allison Transmission last week sought an amendment that would allow the transmissions maker to buy back debt at a discount during the life of the loan. But, unlike other recent similar amendments, Allison is offering investors a 2.5bp fee up front. Citi is leading the process.

The fee was necessary because investors would have to have a longer term view of the life of the credit, a banker explained. The amendment would allow Allison to buy back up to US$700m of debt for the seven-year life of the loan. The loan was put in place in the summer of 2007.

Some controversy has also stemmed from a cashflow sweep provision contained within the credit agreement. The provision obligates the company to target 50% of any excess cashflow in a quarter to repay debt. As part of the amendment that provision would be altered to include optional pre-payments at prices below par.

Investors could potentially object to the amendment since instead of the company using the excess cashflow to pay down loans at par, the cash is going to someone else. “Why give the flexibility to pay certain people if the cash is never coming back to you?,” asked one banker.

Booz Allen & Hamilton also saw some pushback when it offered to buy back its debt in the secondary market. The consulting firm did not require an amendment as the ability to buy back debt was built into the original credit agreement. The transaction failed after the company offered to buy the debt back at 87 cents on the dollar at a time when the loan was quoted at 86.

The loan traded up to the low 87 range after the announcement making the premium insufficient. Booz was trying to buy back US$50m of its debt. Credit Suisse led the transaction. “They went out at 87 and the investors said, ‘sorry it’s trading at 87’. They should have probably got it done at 89. So it didn’t get consummated,” a banker said.

LNR Properties relaunched an amendment last week after stumbling on an earlier effort to repurchase part of its US$600m term loans at a discount amid lenders’ hesitations on the structure of the buyback. The real estate developer reworked its proposal to 60–65 versus 50–55 originally. Deutsche Bank is leading the transaction.

Other amendments are expected to run more smoothly. Underwear maker Hanesbrands launched an amendment to buy back US$200m of its debt over the next 270 days. Citi is leading that effort.

Spanish language-media company Entravision Communications also received approval from its lenders. Reportedly, the company will have the ability to buy back up to US$75m of its debt before the end of 2009. They paid a 10bp fee. Union Bank of California is leading the buyback effort.

Last month, RH Donnelley, Manor Care and Rent-A-Center announced that they would be doing debt buybacks through reverse auctions. The three names were able to push their amendments though. JP Morgan led those transactions.

Despite any controversy, the buyback activity is not expected to subside. But besides Citadel Communications that has managed to repurchase significant amounts of its debt in the secondary market after starting in March, few companies are likely to be able to meet their buyback goals.

“My idea is that there are going to be a lot more amendments that pass than debt buybacks,” another banker said.