After more than seven years of an anything-goes market, corporate-bond investors are starting to flex their muscles.
Vodafone Group Plc shelved plans to sell as much as US$2 billion of bonds last week after investors demanded sweetened terms, including provisions that would've protected them against losses in the event the company is taken over, according to people with knowledge of the matter. Such requirements, once rare for investment-grade issues, are being added with increasing frequency as the tide begins to turn after years of easy-money policies that fueled an $11 trillion corporate borrowing binge, data compiled by Bloomberg show.
"I think that deal was a good indicator that investors might be getting a little more serious and saying, 'Hey we're not just going to buy anything'," said Timothy Doubek, a senior portfolio manager at Minneapolis-based Columbia Threadneedle Investments, which manages about $184 billion in fixed-income. "If you want our money, we need covenants to protect us."
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The pushback shows that even outside the risky junk-bond market, investors are becoming more selective. About $259 billion of high-grade bonds, or a third of those sold by nonfinancial issuers this year, offered so-called change-of-control provisions, according to data compiled by Bloomberg. That's up from 28 percent in 2014 and less than 10 percent in 2009.
Investors were burned at least twice this year by snapping up debt that didn't include such protections. EMC Corp. bonds lost more than $560 million in value right after news that lower-rated Dell Inc. planned to buy out the company became public in October. Investors who snapped up Qualcomm's bonds during its inaugural $10 billion note sale in May saw the value of those securities plunge by more than 4 percent by the end of July after the company said it was evaluating strategic alternatives including a split, a move that would threaten to siphon off cash flow.
The notes sold by both companies lacked protections that would have allowed bondholders to demand early repayment in the event of an ownership change.
"When there's a buying frenzy, the issuers have the leverage on deal terms," said Matthew Duch, the lead money manager at Calvert Investments Inc. Duch's firm marketed Vodafone debt when people with knowledge of the matter said the Newbury, England-based company was seeking to raise between $1.5 billion and $2 billion in 30-year debt last week.
While Vodafone's case shows money managers are having some success at pushing back on deals, there remains room for improvement in other areas.
Chris Gootkind, director of credit research at Loomis Sayles & Co. and spokesman for a group that was formed in 2007 by 50 fixed-income investors to lobby for stronger covenants, said borrowers should be required to pay higher coupons in the event of a ratings cut, limit other lenders from having a claim on a company's assets, and improve reporting standards.
Borrowers "want flexibility for their balance sheets, and right now they don't have to pay much to get it," Gootkind said.
Among the concerns is that companies have been using proceeds in many cases not to expand their businesses but to funnel money to their shareholders amid a record $1.24 trillion borrowing binge by investment-grade borrowers in the U.S. this year, Bloomberg data show.
Protections for Buyers of Whole Foods Bonds
Whole Foods Market Inc. doubled a bond offering on Monday to $1 billion and will use part of the proceeds to purchase shares, Bloomberg data show. The retailer offered investors change-of-control protection and a pledge to boost the coupon.
Michael Sinatra, a spokesman for Whole Foods Market, didn't respond to email and phone messages seeking comment on the offering.
Investors are hoping that with the U.S. Federal Reserve expected to end its seven-year policy of near-zero interest rates as early as this month, the balance of power may be swinging back toward them. The average borrowing cost for investment-grade companies rose last month to 3.6 percent, the highest in more than two years, Bank of America Merrill Lynch index data show.
"The interest-rate outlook has brought some uncertainty into markets so it's a bit more balanced than in previous periods, " said Duch.
Why the Vodafone Deal Faced Resistance
Vodafone was offering spreads that were higher than its existing notes with similar maturities. The company also offered to pay a higher coupon in case its ratings were lowered. But that wasn't enough to convince investors who also wanted safeguards that would protect them in the event the company's ownership changed, said the people, who asked not to be identified because the information isn't public.
"I'm not saying every deal right now allows greater pushback, but the Vodafone deal faced resistance," Duch said.
Vodafone may revisit a potential tie-up with John Malone's Liberty Global Plc after the companies called off talks to swap assets in September, according to Mark Chapman, an analyst at debt research firm CreditSights Inc.
Ben Padovan, a spokesman for Vodafone, declined to comment.
As the end of year approaches and the U.S. central bank gets closer to raising borrowing costs, investors are more careful about adding risk, said Stuart Hosansky, principal in Vanguard Group Inc.'s fixed-income group.
"There are some clear signs that credit is deteriorating and that you still have continued event risk out there, with M&A activity and companies continuing to do share buybacks," Hosansky said. "Investors have become a little bit more cautious."
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