The biggest fear for most bondholders is a default, however, a default is not the end of the world for your investment. Based on bankruptcy laws in Singapore, there are various options the issuer and creditors have in the event of a default to achieve positive outcomes. In this article we explore these options and take a look at various examples of bond defaults in Singapore.
What is an ‘event of default’?
When an issuer is unable or fails to pay a coupon of a bond, or repay the bond principal back at the maturity date, this signifies an event of a default. This is different to a breach of financial covenants of a loan, whereby it may not constitute a default, but could trigger other actions such as early redemption of the bond or loan by creditors. While missing a coupon payment may constitute a default, this may not be always the case if there are special clauses such as non-cumulative coupon deferrals allowing the issuer to not pay coupons.
What options do defaulted companies have?
A company which has entered an event of default has 3 options; debt restructuring, winding up, and judicial management.
Debt restructuring involves altering the terms of the company’s debt for the best outcome for the company and creditors. This could mean paying back a smaller portion of the principal amount back to creditors, or extending the bond maturity payment date to a later date. In many cases, there could be discussions with potential investors willing to inject fresh funds into the company, allowing creditors to recuperate more funds.
A renown case of debt restructuring was the Hyflux default. After defaulting on its bond coupon payment in 2016, Hyflux started a court supervised debt reorganization process to restructure the company’s S$3 billion debt burden. This involved discussions with strategic investors as well as asset divestments. Bank moratoriums were also established to extend debt repayment dates. Utico, one of Hyflux’s strategic investors was in discussions over a S$400 million rescue deal, which could see retail perpetual bond holders and preferential shareholders receive up to S$1,500 in compensation. The deal, however, fell through.
Winding up or liquidation
A liquidation is where the company ceases to operate and all of its assets are sold off, with the proceeds from sales used to repay creditors. Higher ranking debt will be paid off first, started from secured seniors, to unsecured seniors, then subordinated loans. Creditors may not receive back their full investment if there is not enough sales proceeds. The liquidation could take a long time and incur high costs.
The company continues to operate under an appointed judicial manager that works towards the company’s survival or to realise as much assets to return to creditors. Under judicial management, creditors will likely not receive their principal back at their specified maturity, however may receive some compensation should the company recover in the future. The judicial manager will generate a strategic plan on managing the company for approval by creditors.
Swiber Holdings Limited was put under judicial management since 2016. The company is still operating today. Judicial management was recently extended 6 months from June 2020 after a previous extension to 20 April 2020. In May 2019, a restructuring deal was proposed by the judicial manager involving a strategic investor, Seaspan Corp, that would transfer assets from the existing Swiber group to ‘New Swiber’. Under the plan, unsecured creditors had a recovery rate of 8.8% to 10% of their investments. The deal was overwhelmingly supported by the creditors, does negating a liquidation process.
Which option should I pick?
There is no obvious better option. Judicial management allows the company a chance to be improved and could mean eventual repayment of your bond. Liquidation or debt restructuring could provide more certainty for a certain amount to be repaid to creditors. More information will be required, and investors must look at the details of restructuring before making a decision.
Should I invest in distressed bonds?
Distressed bonds are bonds that have already defaulted or are about to default. Their prices usually trade significantly below par. We often hear about hedge funds specializing in investing in distressed bonds. They invest at heavily discounted prices before a subsequent company recovery, booking a hefty profit.
But we as individual investors should not delve into this without the knowledge of how to do so. The advantage that fund managers of big funds have is the information and control over the distressed company when they invest into their capital. They will have control over the restructuring of the bonds, and will know if there are potential takeovers or mergers to save the company. They may also be willing to band up with other investors to provide liquidity to the company to ride out the financial difficulties. Funds and institutions are better equipped to invest in distressed securities than individual retail investors.
Having a bond default is not the end. There are options available for companies to assist creditors through the process. Not only can strategic investors step in to assist, but key stakeholders can also step in to help with funding. We’ve seen this with Perennial Real Estate Holdings taken private by its substantial shareholders, and GSH funded by its management through taking up the company’s new bonds issues. Having access to funding will help in times of financial difficulty.