When a bond issuer defaults

If the bonds or the issuer are listed on the Singapore Exchange, keep a lookout for announcements and financial reports to keep up-to-date on the issuer's financial situation.
If the bonds or the issuer are listed on the Singapore Exchange, keep a lookout for announcements and financial reports to keep up-to-date on the issuer's financial situation.ST FILE PHOTO

The Sunday Times highlights three possible outcomes

Q What are events of default?

A The issuer will define the "events of default" in the terms and conditions of the bond which should be disclosed in the offer document given to you.

When a bond issuer fails to make an interest or principal payment by the due date, the bond issuer is generally considered to have defaulted and it means an "event of default" has occurred, said MoneySense, the national financial education programme.

Failure by the issuer to observe financial covenants, such as ensuring net borrowings to total equity do not exceed a certain ratio, could also constitute an "event of default".

Q How can I know when a bond issuer is in trouble?

A Monitor your own investment. If the bonds or the issuer are listed on the Singapore Exchange (SGX), keep a lookout for announcements and financial reports as it is prudent to keep up-to-date on the issuer's financial situation.

If the issuer is not listed on SGX but its bonds are, its financial statements must nonetheless be disclosed regularly as approved by SGX. Such disclosure arrangements can be found in the offer documents for the bonds.

There could also be news reports on the financial position of the issuer or on the issuer's industry outlook. You need to assess whether to hold on to the bonds or to sell part or all of your investment. Seek professional advice if needed.

Q What are the possible outcomes when an issuer defaults or is likely to default on its bond payments?

A There are three possible outcomes - debt restructuring, winding up or judicial management.

Debt restructuring: When an issuer faces financial distress, it may decide to restructure its debt. The objective is to re-negotiate and modify the terms of the bond to provide relief to the issuer, who could otherwise default on payments.

Some of the ways the issuer could conduct debt restructuring include:

•Reducing the amount owed, such that the investor will be paid less than what was originally promised;

• Extending the tenure of the bonds, such that the issuer can repay the principal at a later date;

•Exchanging the debt for equity, such that the investor will receive shares in the issuer in exchange for the bond and will no longer be entitled to repayment of the principal or the coupon payments.

To achieve this, the issuer typically engages bondholders in a consent- solicitation exercise to seek bondholder approval for modification of the terms of the bonds.

If a financially distressed issuer is unable to restructure its debt and is unable to pay its debt, it may eventually be wound up.

Particularly where individual bondholder investments are relatively small, collective enforcement of the bondholders' rights through the trustee allows bondholders to act as a cohesive group.

Winding up or liquidation: In general, a company can be wound up in two ways - voluntarily or by the court. When a company is wound up, it ceases to operate its business and the assets are sold off. The proceeds from the sale of the assets would be paid to creditors (including bondholders), ahead of shareholders.

An issuer may structure its debt into different classes - senior (secured) debt and junior (unsecured) debt. Among bondholders, senior debt is paid first, followed by junior debt.

Bondholders may not necessarily get all or part of their monies repaid. It depends on the amount of proceeds from the liquidation. Holders of unsecured bonds, for instance, may not be paid at all if the issuer's assets are not sufficient to pay the holders of secured bonds.

Judicial management: For a firm incorporated here, an alternative to winding up is for the company or its creditors to apply to the court to put the issuer under judicial management. In general, when this happens, the firm is protected from claims by creditors.

Bondholders are unlikely to receive their coupons or principal payments on their bonds. During this period, the judicial manager takes on the role of the firm's board of directors and runs the business with the aim of ensuring its survival or to realise the assets for the benefit of creditors without liquidating the company.

The judicial manager will provide creditors with proposals for achieving the firm's survival and the creditors will decide at a meeting whether to approve them.

Swiber is an example of a firm that defaulted last year on its bond coupon payments, went bankrupt and is under judicial management.

Q Which option should I opt for?

A MoneySense notes that if a debt- restructuring proposal has been tabled, some investors prefer to accept the proposal because they take the view that it gives them a chance of recovering at least part of their investment sum.

Furthermore, liquidation can be a long process and there could be significant legal costs involved.

Some may take the view that there is too much uncertainty and prefer to require the issuer to repay the amounts owed under the bonds, failing which the issuer should be liquidated.

Others may be inclined to give the issuer a chance for its financial position to be improved through judicial management, which could mean eventual repayment of their investment sum.

Q What is a trustee and what is its role?

A A trustee is normally appointed by the issuer to represent the bondholders. Trustees are expected to exercise reasonable care and skill in carrying out their duties.

The duties and obligations of trustees in any bond issue are provided for under the trust deed (between the issuer and trustee) and the law. The trustee acts for the bondholders on the terms and subject to the conditions contained in the trust deed. Bondholders should read the key terms and conditions of the trust deed provided in the offering document.

The issuer is obliged to promptly inform the trustee when it is aware of any event of default or when any condition of the trust deed cannot be fulfilled.

Q How can bondholders enforce their rights when an issuer defaults?

A When the issuer is unable to meet its obligations under the bonds, bondholders would have to enforce their rights under the trust deed.

Particularly where individual bondholder investments are relatively small, collective enforcement of the bondholders' rights through the trustee allows bondholders to act as a cohesive group. It also serves as a safeguard in situations where individual bondholders, acting on irrational fears or in self-interest, may prematurely call for the repayment of debts against the issuer and cause overall greater losses for all bondholders.

Bondholders may sometimes choose to form an ad hoc committee and retain legal counsel to consider the course of action and to communicate with the issuer and the trustee, said MoneySense.

Another form of assistance comes by way of the Securities Investors' Association Singapore (Sias), which has extended its reach to bondholders.

Late last year, Sias chief executive David Gerald encouraged bondholders to approach Sias and use it as a platform for discussion as the organisation has access to pro bono lawyers and financial advisers.

This initiative came about after some bondholders approached Sias to seek advice on their rights.

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A version of this article appeared in the print edition of The Sunday Times on February 26, 2017, with the headline 'When a bond issuer defaults'. Print Edition | Subscribe