What Happens When Your Bond or Sukuk has Defaulted?

Introduction

What is bond default?

Why does bond go into default?

What happens when bond default?

1. Debt restructuring
    
   • When an issuer faces financial distress, it may decide to restructure its debt. It is a process that allows a private or public company, or a sovereign entity facing cash flow problems and financial distress to reduce and renegotiate its delinquent debts to improve or restore liquidity so that it can continue its operations.
      
   • Some 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 AND/OR
        
     • Extending the tenure of the bonds such that the issuer can repay the principal at a later date in order to improve the firm’s chances of paying back its loan.
        
   • In addition to the reduction of the total loan amount owed or an extension of the period of repayment, a debt restructure could also include a debt-for-equity swap. What is debt-for-equity swap? It is a process of 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 the principal or the coupons.
      
   • If a financially distressed issuer is unable to restructure its debt, it may run into problems fulfilling the payment obligations under the bonds and could eventually default on the bonds. When an issuer is unable to pay its debts, it may eventually be wound up.
      
2. Winding up
    
   • Winding up or liquidation is the method of ending, or dissolving, a business. The winding up activity includes selling all assets, paying off creditors, and distributing remaining assets to the creditors (including bondholders) ahead of shareholders. Winding up can refer to dissolving either a corporation or a partnership.
      
   • Winding up a business is a legal process regulated by corporate laws as well as a company's articles of association or a partnership agreement. Winding up can be compulsory or voluntary and can apply to both publicly and privately held companies.
      
   • Compulsory winding up happens when laws, or court orders, force a company to appoint a liquidator who sells assets and distributes the proceeds to creditors. A company’s creditors will often trigger the process. In time, creditors will realize that a company is insolvent due to unpaid bills. Winding up, or liquidation, is sometimes part of a bankruptcy proceeding. In some cases, a company may not have sufficient assets to satisfy all its debtors entirely, and then these creditors will face an economic loss.
      
   • Shareholders or partners may trigger a voluntary winding up. Voluntary liquidation is usually brought on through a resolution. The company may or may not be insolvent. If solvent, the reason for winding up may be that the shareholders feel their objectives were met and that it is time to cease operations and distribute company assets.
      
3. Judicial management
    
   • 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 a company is under judicial management, the company 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 company’s board of directors and runs the business with the aim of its survival or to realise the assets for the benefit of creditors without liquidating the company.
      
   • The judicial manager will provide creditors with a statement of proposals (e.g. a proposal for achieving the survival of the company), and the creditors will decide at a meeting of creditors whether to approve the judicial manager’s proposals.

Mitigating the defaults

1. Macro factors analysis
   Investors can put up their own initiatives by doing analysis which should cover the macro factors affecting the issuer i.e. industry, economic environment, geopolitical conditions, etc. 
   
   The constant monitor may provide an early signal to the bond investors on the financial state of the issuer and will give bond investors an inkling on its next step of actions.
    
2. Credit analysis
   Credit analysis by rating agencies could be used as an independent credit views or a second opinion whilst the decision on the credit should eventually still lie with the investors.
    
3. Monitor bond using BIX Malaysia’s tools
   Bond and Sukuk Information Exchange (BIX) is a platform established to provide free public access to information on bonds and sukuk issued in Malaysia. It is created to support SC’s liberalisation in creating a platform for investors to educate themselves regarding the matters related to bond and sukuk.
    
4. Know your right as bond investor
   One of the ways investors can protect their right is to do a thorough study on bond and sukuk covenant.
   
   A bond covenant is a legally binding term of agreement between a bond issuer and a bondholder or investor. The covenant main function is to protect the interest of both the bond holder and issuer. The bond or sukuk Principal Term & Condition (PTC)  and Information Memorandum (IM) document will have the detail on the covenant and issuer’s information
   • Investors can look up any company’s PTC through BIX’s website by using BIX Tools. For more information on bond and sukuk covenant and the importance as well as graphic tutorials, refer to BIX Article here.
      
5. Who to call when your right has been breached?
    
   • Bond Trustee
      
     • In Malaysia for example, institution such as AmanahRaya Trustees Berhad sees that bond interest payments and principal repayments are made as scheduled and protects the interests of the bondholders if the issuer defaults.
        
   • Authority and regulatory body
      
     • Securities Commission Malaysia (SC) could play its roles in ensuring that the restructuring or the recovery process are conducted within the regulations and laws is there to ensure the issuers of these securities as well as the rating agencies to follow the correct regulations to avoid the violation of investors’ rights.

Conclusion