Apollo Shareholders Rule

One trend in corporate finance is that many companies have moved to unequal voting rights. For example, Comcast, Alphabet, Facebook, Lyft, Pinterest, and many others have some type of dual class share structure, with different voting rights for each share class. Investment management company Apollo Global Management is feeling different. Recently, former CEO Leon Black proposed that the company move to one share, one vote. As Mr. Black stated:

Moving to a “one share, one vote” structure to ensure that the voting rights of our shareholders align with their economic interests by eliminating the Class C voting stock, as well as examining a move to a single class of common stock.

Apparently, Mr. Black feels that shareholders should be counted by the number of shares owned.

The Popularity of BBB Bonds

S&P, one of the major bonds rating agencies, has categorized bonds by credit ratings, and BBB bonds compose the largest chunk of corporate bonds. BBB bonds account for $3.2 trillion, or 53 percent of the outstanding investment grade bonds. Total BBB corporate debt, including term loans and revolving credit facilities, tops $7 trillion. One risk with this much debt just above the junk level is that an economic downturn could result in a large part of this debt being downgraded to junk status.

Defaulting On Bond Covenants

Windstream Holdings, a rural telecom company, is expected to file for bankruptcy after the company recently lost a lawsuit filed by Aurelius Capital. The lawsuit stems from Windstream's 2015 spinoff of the company's Uniti Group. Aurelius filed the lawsuit arguing that the spinoff violated protective covenants in the company's bond indentures. Windstream was forced to pay Aurelius $310 million. Since the ruling legally means the company has defaulted in its debt, other bondholders can now force immediate repayment on the bonds they hold.

Cryptocurrencies Are Securities

One problem with cryptocurrency has been that the lack of regulation has led to several incidents of fraud. Recently, a Federal judge ruled that cryptocurrencies are securities and thus fall under the regulation of the SEC. Whether an asset is a security falls under the "Howey Test," that is whether it is an investment in a common enterprise and profits are earned from others' efforts. The SEC has announced that bitcoin and ether are exempt from regulation. A common argument from cryptocurrency founders is that the offer a promise to a network, platform, or service instead of profits.

Activist Bondholders

Because bondholders have a fixed claim on assets and no vote in company operations, they tend to be passive investors in companies. However, a new type of investor, the net-short bondholder, has become more prevalent. A net-short bondholder will buy a bond and at the same time take a larger short position in the same company's bonds. A short position benefits when the asset value decreases. Thus, the investor will lose in the long position but gain a larger amount in the short position. The investor will then implement a claim if the company violates any covenant. For example, Aurelius Capital Management took a net-short position in Windstream's corporate debt and then claimed a violation of a covenant two years prior. Windstream had even undertaken actions to satisfy bondholders that held the bonds when the violation occurred. In short, companies now must be even more careful when writing covenants for bonds. 

Bondholders Lose Protections

With the recent low interest rates, investors are searching for yields. As a result, borrowers are able to reduce protections offered to lenders. Moody's Investors Services tracks bond covenants and recently the Moody's Bond Covenant Index reached 4.51, a record high. In this index, 1 indicates the strongest covenants, while 5 indicates very weak covenants. In other words, investors are willing to give up protection in an effort to increase yields.

Sweet Home Chicago?

Moodys' cut the credit rating on Chicago's debt to Baa2, two steps above junk status. The city's debt still has a negative outlook, meaning that another rating drop could happen in the future. The rating cut was caused in large part by the city's underfunded public pension plan. Only Detroit has a lower credit rating than Chicago among the largest U.S. cities, and Illinois is lowest credit rated state. S&P and Fitch maintained their credit rating on Chicago.

Credit-Ratings Agency Regulations

It appears that the SEC is close to increasing the regulations on credit-ratings agencies. Traditionally, credit ratings for bond issues have followed the "issuer pays" model, that is, the bond issuer pays the ratings agency fee. This arrangement can lead to a conflict of interest as a credit-ratings agency that awards low ratings could lose business in the future. The new rules are designed  to "take additional steps to ensure that the firms’ interest in winning business doesn’t affect ratings analysis." Additionally, the new regulations require more disclosures to investors, never a bad outcome.

Johnson & Johnson's AAA Bonds

Johnson & Johnson announced that it would sell $3.25 billion in bonds. The proceeds will be used to repay existing debt. Johnson & Johnson is one of four AAA credit rated nonfinancial companies in the United States. The other three AAA rated companies are Microsoft, Exxon Mobil, and Automatic Data Processing.

A Corporate Bond Market Primer

According to a recent article in CFO, about $4 trillion in corporate debt was issued in 2012, besting the previous high of $3.89 trillion in 2009. But what may be more interesting in the article is a primer in the workings of the bond market. Before shelf registration was adopted in 1982, investment banks spent considerable time and effort premarketing bond offerings, essentially a road show for bonds sold in the primary market. After the advent of shelf registration, investment banks had less time for premarketing bonds so they essentially purchased an entire bond issue off the shelf and sold the bonds, taking all of the pricing risk of the new issue. Recently, investment banks appear to have gone back to premarketing bond issues. The downside to this model is that investment banks have reduced incentives to sell smaller, more complex bonds and instead focus on larger, regular bond offerings. Additionally, there appears to be evidence that the current method of using a syndicate to premarket bond offerings increases the yield premium on new bonds about 10 basis points higher than it should be.

Twinkie Goes Stale?

According to the urban legend, a Twinkie never goes stale, but its parent has gone stale. Hostess, in the middle of bankruptcy filing, has asked the bankruptcy judge to force a new contract on one of its employees' unions. Hostess is in its second bankruptcy since 2004 and has argued that without a new labor contract it will be unable to continue operations. Fortunately for junk foodies, even if Hostess does not emerge from bankruptcy it is likely that most of the company's iconic brands such as Twinkies, Ding Dongs, and Cupcakes will be sold to another company.

Bank Loan Covenants

Bank loans are an important source of financing for small and mid-sized businesses, but the loan covenants are an important consideration in accepting the loan. Many bank loan covenants are similar to bond covenants. For example, a financial covenant in both can require the company to maintain a minimum current ratio. Since a bank loan is financing obtained from one source, the covenants can often be more restrictive. A recent white paper sponsored by the Small Business Finance Institute discusses common bank loan covenants and the implications. http://www.cfo.com/whitepapers/index.cfm/displaywhitepaper/14642721

A Trillion Here, A Trillion There

So what happens to corporate debt when it matures? To maintain its capital structure, most companies refinance the maturing debt with new debt. In the next four years, the total amount of debt needed to refinance existing debt as well as fund growth is expected to be $46 trillion combined in the U.S., Euro zone, U.K., Japan, and China. $30 million is expected to be needed to refinance maturing debt, and $13 to $16 trillion needed for growth. China leads the way with $16 to $18 trillion, while U.S. companies will need only $13 to $16 trillion. http://www.standardandpoors.com/ratings/articles/en/us/?articleType=HTML&assetID=1245333370039