Article 4.7 Trafigura raises $500m with perpetual bond

By Javier Blas in London and Jack Farchy

Financial Times April 10, 2013

Trafigura, one of the world’s largest commodities trading houses, has launched its first perpetual bond, tapping the public capital market.

The trading house raised $500m with its bond, up from an initial target of $300m. The note, which was five times subscribed, will yield a 7.65% coupon.

Trafigura is the world’s second-largest independent metals trader after Glencore, and the third-largest oil trader behind Vitol and Glencore.

The bond issue is the latest sign that the traditionally employee-owned commodity trading industry is opening up to new sources of capital, as European banks scale back their lending activities in the sector just as traders need more credit.

Louis Dreyfus Commodities, one of the world's top food commodities traders, last September tapped the public capital markets for the first time in its 160-year his­tory, raising $350m in a perpetual bond.

The perpetual bond, which international accounting rules count as equity, will strengthen the balance sheet of Trafigura without diluting existing shareholders. Claude Dauphin, chief executive and one of the founders of the group, owns less than 20% while more than 500 senior employees control the rest.

‘We want to get the long-term liquidity while maintaining our credit standing,' Pierre Lorinet, Trafigura chief financial officer, said in an interview. ‘[The per­petual bond] provides us with long-term money [with an] equity treatment.'

The bond will be listed on the Singapore Exchange, forcing Trafigura to release publicly semi-annual accounts for the first time. Until now the company has only released financial information to a small group of investors and bankers.

The new sources of financing in the Swiss commodities industry are partly driven by a change in the business model of the trading houses.

Companies have moved away from their traditional role as middleman - selling and buying commodities in a business of large volumes but razor-thin margins - increasingly to become vertically integrated groups, with interest spanning pro­duction, logistics, trading and processing.

The new areas, such as investing in oil refineries, require long-term capital that the trading houses in the past did not need. Some trading houses have not opened their equity to outsiders, but are seeking bond investors.

FT

Source: Blas, J. and Farchy, J. (2013) Trafigura raises $500m with perpetual bond, Financial Times, 10 April.

Despite their name and the characteristic of irredeemability at the insistence of the holders, they are often callable (usually after the first five years), thus the issuer can redeem them. They therefore pay a higher rate of interest to compensate investors for the extra risks: (a) that the amount invested will never be repaid and (b) that if the bonds are called the investor may not be able to reinvest at a similar rate of interest.

Puttable bonds

The holder has the right but not the obligation to demand early redemption of the bonds on a set date or dates. The benefit to purchasers is that if interest rates rise, they can cash in their bonds and reinvest in another investment offering a higher rate of interest. The disadvantage is a slightly lower rate of return in the first place.

Deep discounted bonds

Bonds that are sold at well below the par value are called deep discounted bonds, the most extreme form of which is the zero coupon bond. They are sold at a large discount to the nominal value and the investor makes a capital gain by holding the bond instead of receiving coupons. These bonds are particu­larly useful for firms with low cash flows in the near term, for example firms engaged in a major property development that will not mature for many years.

Bearer bond and registered bond

With bearer bonds the coupons are traditionally attached to the paper bond held by the investor.

During its life, a registered bond is usually held in a dematerialised form, that is ownership, trading and settlement are merely a computerised book­entry. The largest organisations that run global electronic clearing systems are Euroclear and Clearstream. Settlement (when the money for a trade is transferred) for corporate bonds is generally either two or three days after the deal is struck.

Debentures and loan stocks

In the UK and many other countries the most secure type of bond is called a debenture (it is different for the US - see page 135). Debentures are usually secured by either a fixed or a floating charge against the firm's assets. A fixed charge means that specific assets (e.g. buildings, machinery) are used as security, which, in the event of default, can be sold at the insistence of the debenture bond holders and the proceeds used to repay them. Debentures secured on property may be referred to as mortgage debentures.

Bonds secured through a fixed charge often have legal provisions in the debt agreement that allow the issuer to dispose of a proportion of the property or plant (such as a crane or fleet of cars) used as collateral, but when they do so they must make provision for the redemption of a proportion of the fixed- charge bonds. These are known as release of property clauses.

A floating charge means that the debt is secured by a general charge on all the assets of the corporation, or a class of the firm's assets such as inventory or receivables (debtors). In this case the company has a high degree of freedom to use its assets as it wishes, such as sell them or rent them out, until it commits a default which ‘crystallises' the floating charge, i.e. the floating charge is converted to a fixed charge over the assets which it covers at that time. If this happens an administrative receiver or administrator will be appointed with powers to manage the business, to either pay the debt through income generation, or dispose of the assets followed by distribution of the proceeds to creditors, or sell the entire business as a going concern.

Even though floating-charge debenture holders can force a liquidation, fixed- charge debenture holders rank above floating-charge debenture holders in the payout after insolvency. Floating-charge holders rank behind preferential creditors who are given priority by statue, such as the tax authorities and employees owed wages.

Similar collateral charges to the floating charge are the floating lien in the US and a few other places, and the commercial pledge in many European countries. The terms bond, debenture and loan stock are often used loosely and inter­changeably, and the dividing line between debentures and loan stock is a fuzzy one. As a general rule debentures are secured with collateral and loan stock is unsecured, but there are examples that do not fit this classification. If liquidation occurs, the unsecured loan stock holders rank beneath the debenture holders.

However, in the US and some other countries the definitions are somewhat different and this can be confusing. Here a debenture is a long-term unsecured bond and so the holders become general creditors who can only claim assets not otherwise pledged.

Trust deeds and covenants

Bond investors may be willing to accept a lower rate of interest if they can be reassured that their money will not be exposed to a high risk. Reassurance is conveyed by placing risk-reducing restrictions on the firm. A trust deed (or bond indenture) sets out the terms of the contract between bond holders and the company. A trustee (if one is appointed) ensures compliance with the contract throughout the life of the bond and has the power to appoint an administrative receiver to liquidate the firm's assets if necessary. If a trustee is not appointed the usual practice is to give each holder an independently exercisable right to take legal action against a delinquent borrower.

The loan agreement will contain a number of affirmative covenants. These usually include the requirements to supply regular financial statements and make interest and principal payments. The deed may also state the fees due to the lenders and details of what procedures should be followed in the event of a technical default, for example non-payment of interest. The issuer may also have the right to ‘call' the bond and/or the lenders to insist on selling back to the issuer. The trust deed also states what, if anything, is ‘backing' the bond in the form of collateral acting as security.

In addition to these basic covenants are the negative (restrictive) covenants. These limit the actions and the rights of the borrower until the debt has been repaid in full. Some examples are:

• Limits on further debt issuance.

• Limits on the dividend level. Lenders are opposed to money brought into the firm by borrowing at one end and then being taken away by shareholders in dividend payments at the other. An excessive withdrawal of shareholders' funds may unbalance the financial structure and weaken future cash flows required to pay bond holders.

• Limits on the disposal of assets. The retention of certain assets, for example property and land, may be essential to reduce the lenders' risk. Disposal of assets covenants often allows a cumulative total of up to, say, 30% of the gross assets of the firms, but no more.

• Financial ratios. A typical covenant here concerns the interest cover, for example: ‘The annual profit should remain four times as great as the overall annual interest charge.' Other restrictions might be placed on working cap­ital ratio levels (the extent to which current assets exceed current liabilities) and the debt to net assets ratio (a gearing ratio covenant) may require that the total borrowing of the firm may not exceed a stated percentage of net worth (share capital and reserves) of, say, 100%.

• Cross default covenant. The trustee has permission to put all loans into default if the borrower defaults on a single loan.

While negative covenants cannot ensure completely risk-free lending they can influence the behaviour of the managerial team so as to reduce the risk of default. They can also provide the management team with an early warning signal to take action. The lender's risk can be further reduced by obtaining guarantees from third parties (for example, guaranteed loan stock). The guar­antor is typically the parent company of the issuer.

The trustee, responsible to bond holders, will inform them if the firm has failed to fulfil its obligation under the trust deed and may initiate legal action against the firm. If the firm has to go through a reorganisation of its finances, admin­istration or liquidation, the trustee will continue to act on behalf of the bond holders.

Other professional help

Once the bond is in issue, the issuer will need administrative support to carry out key tasks throughout its life. A paying agent's main function is to receive money from the issuer to then pay coupons and redemption amounts. When no trustee has been appointed, instead of a paying agent there will be a fiscal agent to undertake the paying agent's role. The fiscal agent is appointed by and is the representative of the issuer, in contrast to the trustee's role as the representative of the lenders. Nevertheless, the fiscal agent must not act in a harmful way toward the bond holders. As well as payments it performs a number of administrative tasks such as sending information on the bond/ issuer to the holders.

A registrar or transfer agent keeps a record of bond ownership and notes all changes of ownership. A listing agent is required only if the bond is listed on a stock exchange such as in London or Luxembourg. The listing agent keeps the stock exchange informed and ensures required documents are delivered to the exchange. In the UK the listing agent must be authorised to act in that capacity by the FCA.

Repayments

The principal on most bonds is paid entirely at maturity. However, some bonds, e.g. callable bonds, can be repaid before the final redemption date. Another alternative is for the company to issue bonds with a range of dates for redemption; so a bond dated 2024-2027 would allow a company the flexibility to repay a part of the principal over the course of four years. This may help prevent ‘a crisis at maturity' by avoiding a large cash outflow at a singular redemption. A range of dates is also useful if machinery subject to deprecia­tion, e.g. a ship, is used as collateral because the amount owed declines as the asset backing declines in value. When there are many maturity dates the bonds are referred to as serial bonds.

Another way of redeeming bonds is for the issuing firm to buy outstanding bonds by offering the holder a sum higher than or equal to the amount ori­ginally paid. A firm is also able to purchase bonds on the open market.

Sinking fund

The most trusted corporates are able to sell bonds without the need to be specific about how the debt will be repaid - the implication is that they will be redeemed using general income flowing from operations or by the issue of more bonds or bank borrowing. Borrowers with lower credit ratings may need to state specific provisions for principal repayment to reduce investor anxiety about the safety of their money.

One way of paying for redemption is to set up a sinking fund, overseen by a trustee, which receives regular sums from the firm that will be sufficient, with added interest, to redeem the bonds at maturity or to periodically retire a pro­portion, thus reducing its debt burden over time. Bonds may be purchased in the market at market prices, at the issue price, at a stated call price in the sinking fund provision or at face value, depending on the original agreement. The indenture/trust deed may allow freedom for the issuer to arbitrarily retire the bonds or to do so only on fixed dates.

Bonds might be selected randomly through a lottery for early redemption. The alternative is the pro rata method with which all bond holders are treated equally, thus they all might be required to retire 10% of their holdings if the issuer decides to reduce the bonds outstanding by 10%.

Because a bond with a sinking fund provision is less risky for the investor, as there is money being set aside, there is a push down on the rate of return offered. However, offsetting this for the investor are the negative effects of not knowing when or how many bonds will be retired.

Some risks for investors

Corporate bond investors are subject to many types of risk.

Default risk (credit risk)

This is the likelihood that the issuer cannot/will not pay one or more coupons in a timely manner or pay the principal sum of the debt at maturity. Bonds are usually higher ranked than equity for payments if a company is in difficulty, but there is always the risk of failure to make agreed payments. This risk depends on creditworthiness, which in turn depends on competitive strength, competence and integrity of the managers, financial structure (e.g. debt levels) and the bond's ranking in the pecking order for repayment in the event of the firm running into difficulty (seniority of the debt).

Event risk

Some adverse event may occur which devalues the bond, e.g. a natural disaster wipes out company profits and damages the ability of the company to pay its obligations. Or an issuer is merged with another firm and the debt burden increases significantly, causing a credit downgrade and lower bond prices.

Sometimes a poison put provision (change of control clause) in the trust deed/indenture protects bond holders because this allows them to sell their bonds back to the borrower when there is a merger/takeover - see Article 4.8. LBO means leveraged buyout, when high levels of debt relative to the equity in the company are used to purchase a business.