Wednesday, June 10, 2009

Bondholders Agree to Let Bio-Rad Repay Loans First

Bio-Rad Laboratories Inc. is a life sciences company with sales of over $1.7 billion. In May of 2009, it issued $300 million of 7-year notes in a 144A offering through Credit Suisse. The company refers to the new debt as Senior Subordinated Notes. Does this mean the debt is senior or subordinated? How do we know the intercreditor priority of the notes?

Contractual Subordination
The notes are governed by an indenture, a contract signed by the borrower and by a trustee (in this case, Wells Fargo) who represents the noteholders. In addition to describing the notes and listing various covenants and defaults, the indenture includes a section on subordination. In that section, the noteholders agree that in the event of the borrower's bankruptcy or a payment default on the borrower's senior debt (or certain other events), the borrower will not make any payments on the notes until the default is cured or the senior debt is repaid in full. This arrangement is referred to as contractual subordination (see also our entries on structural subordination and effective subordination).

The Details Matter
The document creating contractual subordination can be a subordination agreement or indenture (as with Bio-Rad, and commonly used for public bonds and 144A issues), or an intercreditor agreement, which is more common with mezzanine finance and other privately placed subordinated debt. The terms of subordination vary from agreement to agreement. For example, the ability of subordinated debtholders to receive payments after a covenant breach in the senior debt can vary, as can the amount and type of allowable senior debt. Finally, the term senior subordinated debt (which is common for high yield bonds) means that the bonds are subordinated to all senior debt (typically bank loans) but it is senior to any junior subordinated debt (typically, mezzanine finance).

Who Issues Subordinated Debt, and Why?
Subordinated debt is more expensive than senior debt, so why would a company issue it? The big issuers of subordinated debt are:
  1. Non-investment grade companies, who often need more debt or longer-term debt than the senior market will provide, and
  2. Regulated entities, such as banks, insurance companies and electric utilities, who issue subordinated debt instead of equity in order to satisfy their regulatory capital requirements.


Anonymous said...

For matters of priority refer to the bankruptcy code

Peter Melichar said...

Interesting but I have a couple of questions:
1. Is senior subordinated debt like 2nd lien or is there a difference?
2. Is the role of the trustee similar to that of an Agent bank in syndicated lending?
3. What is the difference between the indenture and interecreditor agreements common in leveraged finance?
4. What is a 144a offering?

Ron Carleton said...

1) Technically, 2nd lien loans are senior debt (i.e. they are senior to any subordinated debt). However, they agree to effectively subordinate themselves to the 1st lien debt, so it is like subordinated debt (except, unlike real subordinated debt, is it still ahead of any unsecured claim, like trade credit). You won't see much new 2nd lien paper today, but when it was used (before the credit crunch), it was often done instead of high yield bonds (e.g. for companies too small to issue the bonds).

2) On paper, the indenture trustee for a bond looks like the (administrative) agent for a syndicated loan. In practice, the trustee is a passive role (it will do nothing not specifically stated in the indenture) whereas the agent bank is an active role - it will lead any amendment discussions over the life of the loan.

3) An indenture and an intercreditor agreement can accomplish the same thing - making some debt senior and some subordinated. There are some technical differences - for example, an indenture is typically signed by the borrower and the subordinated debt (not by the senior debt), whereas an intercreditor agreement is typically signed by the different classes of debtholders (i.e. senior debt and subordinated debt) and not necessarily by the borrower.

4) A 144A offering refers to Rule 144A under the Securities Act of 1933 (in the U.S.). It is a way for companies to issue bonds without registering them with the SEC. Sometimes this is referred to as an "institutional private placement." Most high yield bonds in the U.S. are done as 144A issues, and then later registered with the SEC. A 144A issue allows the issuer to get to market much faster than if they were selling a registered bond.

Peter Melichar said...

Many thanks!