The large number of defaults this year by investment-grade companies has called attention to the relative limitations of investment-grade indentures, according to Sherri Andrews, head of high-yield research at BNP Paribas. Andrews says that when there are inherent problems with a credit, tighter indentures cannot protect bondholders from heavy losses on their investment. In certain cases, however, such as that of U.K. telecommunications equipment-maker Marconi, bondholders risk having their claims subordinated to the bank lenders as the bank debt matures and credit lines are renegotiated. While high-yield indentures typically contain protections that prevent banks from stepping ahead of bondholders in the capital structure, investment-grade issues, such as Marconi's, rarely do. Andrews argues that investment-grade bonds should contain protections such as negative pledges, which stipulate that if unsecured bank lenders demand security for a loan, bondholders receive similar security, allowing them to remain pari passu to holders of the bank debt.
However, investment-grade analysts such as Glenn Reynolds, ceo of Creditsights, argue that while such protections may be desirable, bondholders will never unite to obtain them. He notes that arguments for tighter indentures were raised in the late 1980s and early 1990s, but were eventually dropped, as investment bankers who argued for the tighter indentures found themselves losing business. "Whenever a bank asked for stricter covenants, the issuer would just shop the deal to a different investment bank that would say they don't need them just to steal the deal," says Reynolds.
Steve Zamsky, investment-grade strategist at Morgan Stanley, says investors do not think of asking for tougher indentures because default is the last thing on their minds when they step up to buy a new issue. "At the time they're buying the bonds, they think they've got a good credit, otherwise they wouldn't buy them," says Zamsky. He says the only time investment-grade buyers have united for tougher covenants is in the case of European telecoms. Since an issue in the summer of 2000 by Deutsche Telekom, several European telecoms have included "step-up" coupons, which compensate investors for downgrades by adding basis points to the coupon payments. Ironically, says Zamsky, the one European telecom that avoided adding a step-up coupon was Dutch company KPN, the first European carrier to be cut from a single-A to a triple-B rating.