Sinking Funds - Corporate Bonds and Credit Agreement

Sinking Funds

Model Simplified Indenture, Section 3.01-3.06, Exhibit A, Section 6

Northwest Note Agreement, Section 8.1, 8.3, 8.5

• Sinking Fund = a fund formed by periodically setting aside money for the gradual repayment of a debt or replacement of a wasting asset

• 3 elements in public bonds

  • Requirement to redeem certain amounts prior to maturity

    • Principal repayment is distributed throughout the year overtime the principal amount declines, by the time the principal is due, less is owed

  • Right to redeem that amount at par

    • Usually redemption is at a premium

  • Right to use bonds purchased in market/ previously redeemed or converted to satisfy requirement

    • Use other bonds to repay, those bonds might be unconvertible

• Economics of choice between options for satisfying requirements

  • You get money back earlier shorter loan usually carries less risk

  • But the option to redeem is more valuable to the company than the bondholder

  • Company have option (not requirement) to redeem in par/ repurchase company would

    1. redeem at par when purchase price is higher than par

    2. repurchase when the purchase price is lower than par

  • Company would only exercise option when it is beneficial to the company

• Procedure (notice etc.) same as for optional redemption

Problem Set 4

Consider the Model Simplified Indenture - Section 3.01-3.06, Exhibit A, Section 6

Assume that $100 million of Debentures have been issued by MSI under the MSI Indenture and that the first sentence of §6 of the Debentures reads "The Company will redeem $10 million principal amount of the Securities on June 1, 1995 and on each June 1 thereafter through June 1, 2004…”

On April 20, 1994, the Company repurchases $15 million of Securities. On May 20, 1994, the Company redeems $25 million of Securities pursuant to §5 of the Securities. No securities have been converted or delivered to the Trustee for cancellation.

1. What are the Company's options with respect to the mandatory redemption requirement on June 1, 1995? How would you advise the Company?

• Kahan: It could redeem bonds at par or use bonds repurchased or previously redeemed to satisfy the sinking fund requirement. The company should redeem bonds at par if the value of these bonds (if unredeemed) is above par.

• Exhibit A, section 6: Mandatory Redemption “The Company will redeem $_____ principal amount of the Securities’ on ____ and on each ___ thereafter through ______ at a redemption price of 100% of principal amount, plus accrued interest to the redemption date… The Company may reduce the principal amount of Securities to be redeemed pursuant to this paragraph by subtracting 100% of the principal amount (excluding premium) of any Securities’ that have been previously cancelled, that Securityholders have converted (other than Securities converted after being called for mandatory redemption), that the Company has delivered to the trustee for cancellation or that the Company has redeemed other than pursuant to this paragraph. The Company may so subtract the same Security only once”

2. Assume that, on June 1, 1995, you hold $1 million in Securities, that the Company decides to redeem $10 million of Securities on June 1, 1995, and the redemption is to be made pro rata. What portion of your securities will be redeemed?

• Kahan: The answer to this question depends on out of what pool of bonds the redemption is made. Bonds repurchased by the Company are in that pool, but bonds that were previously redeemed are not. So 10/75 is the pro rata share of bonds redeemed.

• 100M issued outstanding;

  • 15M repurchased;

  • 25M redeemed previously

• Company wants to redeem 10M out of the 60M held by holders, what portion is being redeemed? What is denominator? 10M out of what? 75M

  1. All issued bonds originally = $100m (10/100 = 10%)

  2. All excerpt for previously $25M redeemed bonds = $75m (10/75 = 13.3%)

     • 15M repurchased; outstanding under 2.08, still counts

     • 25M redeemed previously; if cancelled not outstanding doesn’t count

  3. All except for 25M redeemed and 15M repurchased bonds = $60m (10/60 = 16.7%)

     • If 25M is not cancelled outstanding counts

• Company redeem 10M out of 75M because:

  • Section 3.02 Selection of Securities to be redeemed “If less than all the Securities are to be redeemed, the trustee shall select the Securities to be redeemed…Trustee shall make the selection from Securities outstanding not previously called for redemption. The Trustee may select for redemption portions of the Principal of Securities that have denominations larger than $1000…”

    • Securities must be (1) outstanding; and (2) not previously called for redemption

    • Redeemed securities are not outstanding nor previously called for redemption

    • In general, stocks that company purchased are not considered as outstanding 15M should not count but 2.08

• Section 2.08 Outstanding Securities

  • “Securities outstanding at any time are all Securities authenticated by the Trustee except for those canceled by the Registrar, those delivered to it for cancellation and those described in this Section as not outstanding.

    • “delivered to it for cancellation” refers to when the security is supposed to be cancelled but trustee didn’t do its job

  • A security does not cease to be outstanding because the Company or an Affiliate holds the Security.” $15M securities company repurchase still counts as outstanding

  • If a Security is considered paid under Section 4.01, they cease to be outstanding and interest on them ceases to accrue”

    • Section 4.01 “The Company shall pay the Principal of and interest on the Securities on the dates and in the manner provided in the Securities and this Indenture. Principal and interest shall be considered paid on the date due it the Paying Agent holds in accordance with this Indenture on that date money sufficient to pay all Principal and interest then due and the Paying Agent is not prohibited from paying such money to the Holders…”

    • If company gives money to paying agent, that’s enough for securities to be considered paid what agent do with the money is not considered important. But this only applies if paying agent is not prohibited from paying the money + payment made on due date (cannot use this rule for late payment) Not relevant as no money is paid to the paying agent when the securities are repurchased

  • Section 2.12 Cancellation “Company may at any time deliver Securities to trustee for cancellation. Paying agent shall forward to the trustee any Securitas surrounded to them for payment or conversion. The Trustee shall cancel all securities surrendered to them for payment or conversion. The Trustee shall cancel all Securities surrendered for registration of transfer, exchange, payment, conversion or cancellation and shall dispose of canceled Securities according to its standard procedures or as the Company otherwise direct. The Company may not issue new securities to replace securities that it has paid or which have been delivered to the Trustee for cancellation”

  • Two types of Securities

    • 1) Company redeemed the securities securities are cancelled (whether or not) surrendered for payment on redemption date paid/ Paying Agent hold the money not outstanding under 4.01 (cancelled)

    • 2) When Company repurchase bonds, it has to pay principal + premium on maturity date not “transfer, exchange, payment conversion or cancellation” but if the company wants the repurchased bonds to be cancelled Company can deliver it to Trustee for cancellation

  • When Company wants to redeem 10M,...