Corporate bond crisis: rescuing the business, to rescue the creditors

One of the significant changes in Israel's capital market in recent years was the decrease in the extent of bank credit to corporations along with a dramatic increase in the extent of credit raising through the issue of bonds, especially unsecured ones, to the public. In 2007 the portion of off-bank credit to corporations reached a peak of ~49% of all credits in the market (compared with a less than 23% in 2001). Most of these unsecured corporate bonds were bought by public institutions which saw the bonds mainly as a tool to ensure constant interests in higher rates than government bonds. A substantial part of the amounts raised in this way in Israel was used as "equity" in real-estate projects in other countries, particularly in Eastern Europe.

One of the most noticeable effects of the world financial crisis on Israel's economy is undoubtedly the "crisis of the corporate bonds": the changes in the world's economy, the decrease of corporate activities around the globe and the difficulties in obtaining finance for ongoing operations-especially for real-estate projects (particularly in Eastern Europe)-led many companies to a position where there are heavy concerns about their ability to meet their commitments toward bondholders. This new position requires special and creative deployment by bondholders - usually public institutions - toward companies who are now in the twilight zone of insolvency.

Unlike banks that are used to collection or settlement of problematic debts, debt collection in the capital market is much more complicated: First, players in the capital market usually have no expertise in debt collection or schemes of arrangement. Second, collection of the debts by bondholders requires cooperation of a large number of holders with completely different interests who purchased the bonds at different times, and on the basis of different information. Third, debt collection by corporate bondholders must be undertaken while observing securities laws, in particular the Securities Act of 1968 and regulations enacted there under, as well as observing the antitrust laws in connection to cooperation between institutional bondholders acting as creditors.

The most unique element of the current crisis is the fact that most of the above bonds were purchased by public institutions, including mutual funds, pension funds, study funds, etc., using the monies of their members who assumed that their money was invested in conservative channels and presumably did not take into account the possibility of the dramatic and sharp decrease in the value which actually occurred. As things stand, non-payment of the credit by the borrowing companies means, among other things, a loss of the public's savings which might have a colossal effect on many households and their ability to realise their life savings in the next few years.

The magnitude of the crisis, the overall financial scope of the commitments of the business concerns in bonds of the aforementioned type (which in 2008 stood at an amount of 330 billion NIS) and the number of companies whose ability to meet their commitments is in doubt necessitates taking precautionary and professional steps on the part of the institutional factors managing the public's money - steps essential in order to bring about collection of the largest possible amounts and to decrease as far as possible the losses caused to the investing public. In this sense, the magnitude of the crisis created a sort of "mutual dependency" of the investing public in the borrowing companies, so that from a systematic perspective rescuing the companies' business value or assets means rescuing the public's savings. In fact, the aforementioned "dependency" is even more complicated. In most cases the public institutions who purchased the corporate bonds did so as part of investment of the members' monies (as opposed to nostro investments) so that in the current crisis the institutions must need to "fight the fight" of the investing public without they themselves necessarily having an immediate advantage from the results of such a fight.

In order to reduce the faults in the face of the lacunae in the law, Israel's Securities Authority issued a public statement with regard to the handling of the corporate bonds crisis by public institutions (Decision no. 2009-1(a), November 25th, 2008 as well as Decision no. 2009-1(b), January 21st, 2009 - in the matter of creating an infrastructure for corporate bond arrangements). These instructions form a public statement of the Securities Authority with regards to the correct interpretation of the law pertaining to the entire matter of coping with the bond crisis described above.

The Antitrust Authority also issued guidelines relating to cooperation between institutional bodies and with regard to the treatment and enforcement of rights concerning corporate bonds (Public Statement 1/08, November 25th, 2008 on the matter of cooperation between investment institutions in changing terms of corporate bonds - and the clarification of Public Statement 1/08, March 23rd, 2009 concerning cooperation between investment institutions in changing terms of corporation bonds).

In view of the magnitude of the crisis and its expected effect on the public investing in the various investment tools sold by institutions, the Commissioner for Capital Market in the Ministry of Finance also issued detailed guidelines to public institutions in Israel - guidelines intended to guarantee that investment institutions would take active measures to collect debts, independently or in cooperation with other lenders. These guidelines were also intended to define a framework of deployment of public institutions for the purpose of the ongoing tracking and supervision of the debts they manage. This course of action is needed in order to evaluate and analyse the state of the debts for the handling of problematic debts, and for the purpose of formulating a decision regarding the means that the institutional bodies would take to collect the debt and regarding their participation in the debt settlement procedures - as well as determining the factors responsible for these actions (Circular for Public Institutions 2009-9-7, April 6th, 2009).

Currently there are negotiations between bondholders and a considerable number of companies as part of "the first wave" of payment dates of corporate bonds. It is hoped that companies will be wise enough not to abuse the legal ambiguities relating to the enforcement of the rights of bond owners. Similarly, it is hoped that the public institutions will handle the collection of debts from the companies issuing the corporate bonds determinedly and efficiently on behalf of the investing public.

Ofer Shapira

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