If you have access to cash and your debt is trading below par as a result of credit market upheavals, now could be a good time to buy back your debt and deleverage your balance sheet, debt specialists say.
"Buying back your debt below par is cheaper than prepaying the loan, so this might be a good alternative for cash use," global law firm Dechert LLC partner John Markland said in a webcast.
Since the financial market crash 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 for it. "The credit markets have learned their lessons," Markland said.
There are typically two kinds of debt buybacks: bank loans and corporate bonds.
For bank loans, there are two ways to structure a debt buyback. The first is as a solicitation process in which you invite lenders to sell debt at a price and in a quantity they choose and you’re obligated to accept the lowest offer first. The second is as an open order in which you state a price for the amount you're interested in buying and your lenders can choose whether to accept the offer.
These procedures are designed to give all of your lenders the opportunity to participate, helping ensure you create a market to get a reasonable price, but they can take time, and you effectively can't choose your seller. "They don’t allow you to quickly and opportunistically pick off forced sellers at attractive prices," Markland said.
Compliance with securities laws
The big difference with bond buybacks is they're governed by securities laws, so in addition to any restriction within debt covenants, you have to be careful to structure the deal in a way that complies with federal regulations.
Transparency rules are one area that can cause mistakes. If you're in possession of material, non-public information, trading your own securities in a repurchase can trigger disclosure rules. "You should consider your own internal insider trading blackout windows," said Dechert LLC Partner Ian Hartman in the webcast.
And if yours is a public company, you should consider whether the buyback itself is material information that must be announced ahead of time.
Hartman recommends incorporating standard disclosures in quarterly and annual reports by saying you might use cash to buy back bonds. That way, there is no surprise following a repurchase disclosure in a 10-Q or a 10-K.
You also must ensure your purchase won't constitute a tender offer; otherwise, you'll have to meet additional requirements, including some that could delay the transaction.
"We often see companies and [their private equity] sponsors structuring their buyback program carefully to avoid being considered a tender offer," said Hartman.
Whether your buyback would be considered a tender offer is a gray area, but there are some characteristics to the deal regulators look for:
- There's a widespread solicitation.
- You're soliciting a substantial percentage of the issue or securities.
- There's a premium over market prices being offered, although that's not likely to be the case if you're looking to buy back below par.
- There are firm offer terms instead of negotiable terms.
- The offer is contingent on the amount of securities being tendered; e.g., an entity will only buy from you if it can also buy a certain percentage from other holders.
- The offer is open only for a limited time.
- There's pressure on securities holders.
- There's a public announcement made in connection with the offers.
"Having one of these factors doesn't automatically make a debt repurchase a tender offer; you look at the totality of the transaction and assess it overall," Hartman said. "There can be some close calls."
To help keep your company from getting caught in these rules, make sure you allow back and forth negotiating with the seller and avoid take-it-or-leave it offers; don't impose a deadline; and focus your outreach on large institutions that are significant holders rather than smaller individual holders.
Also, be careful with any announcement you're looking to buy a large amount of notes at a certain price.
With both bank debt and bond repurchases, if you repurchase your debt below par, you can expect some impact on the tax side.
"The reduction in amount owed or satisfaction of amount owed for less than the amount due may give rise to cancellation of debt income, which is taxable income unless an exception applies," said Hartman.
You can also trigger cancellation of indebtedness if you negotiate any change to debt terms such as payment deferral, adding or removing a borrower or type of collateral, or increasing or decreasing the yield.
These types of changes can be considered a debt exchange, and if an issuer has either a deemed or intentional exchange at a time when the debt is publicly traded and trading below par, the fair market value of that debt may be less than the amount borrowed, which can trigger cancellation of debt income. That's the case even if there is no reduction in the principal amount due.