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subsidiaries. Those subsidiaries may have had no debt when you bought the holding company’s bond, but if there are no restrictions on the subsidiaries’ ability to issue their own debt, it can undermine the security of Holdco bondholders.
“Opco owns the assets and gets the cash flow. So its debts are paid before it can pay dividends up to Holdco,” explains McOuatt. If Opco has a lot of debt and interest to service, there’s less available to funnel into Holdco, and that can mean Holdco’s bondholders don’t get all their money.
That’s why McOuatt prefers to
buy Opco bonds when possible. But
if she buys Holdco debt, it’s because she’s comfortable with the company’s dividend strategy and Opco’s limits on issuing bonds. She also ensures “there’s adequate compensation for holding a bond that’s a step away from the assets and cash flows.”
Definitions
McOuatt says a covenant’s technical terms can seem familiar, but that doesn’t mean their definitions are standard.
It’s important to understand how the issuer defines “Consolidated EBITDA” because it factors into calculations deter- mining whether a company can issue new debt or distribute dividends. “It can be defined virtually any way a company chooses,” she says. The definitions could appear on first mention, or in an appen- dix. Other terms to watch for:
› Fixed Charge Coverage Ratio › Leverage Ratio
› Consolidated Fixed Charges › Total Consolidated Debt
› Consolidated Interest Expense
These are more likely than Con- solidated EBITDA to be standard, McOuatt notes. Still, check their defin- itions to determine “situations in which incremental debt can be added.” AE
TO FIND OUT WHY MORE CANADIANS ARE CHOOSING GMS
Contact a
Regional Sales Leader in your area
BRITISH COLUMBIA
Laurence Allen
Regional Sales Leader 604.539.1908 • lallen@gms.ca
ALBERTA
David Roberts
Regional Sales Leader 403.532.0667 • droberts@gms.ca
SASKATCHEWAN
Jamie Stangel
Regional Sales Leader & National Accounts Manager 306.790.5763 • jstangel@gms.ca
Kristina Dickie
Regional Sales Leader 306.790.4327 • kdickie@gms.ca
MANITOBA
Michelle Watts
Regional Sales Leader 204.489.9140 • mwatts@gms.ca
ONTARIO
Michael Finucan
Regional Sales Leader 647.244.9462 • mfnucan@gms.ca
Joanna Leng
Regional Sales Leader 416.948.3378 • jleng@gms.ca
ONTARIO & ATLANTIC CANADA
Jim Vaillancourt
Regional Sales Leader 905.987.3288 • jvaillancourt@gms.ca
GROUP MEDICAL SERVICES is the operating name for GMS Insurance Inc. in provinces outside of Saskatchewan.
DEMYSTIFYING COVENANTS
The Canadian Bond Investors Association (CBIA) has proposed a model coven- ant package based on straightforward language and definitions.
If widely adopted, it would streamline the issuance process, says Heather McOuatt, a portfolio manager at Franklin Bissett Investment Management and CBIA board member. It would also reduce the time-consuming detective work fund managers currently have to do when evaluating covenants, and make covenants more accessible to non-specialists.
McOuatt says this wouldn’t penalize managers who are adept at spotting loopholes in a covenant. “I’d rather have my skills go toward analyzing the com- pany, understanding management’s calls and developing my macroeconomic forecast, than figuring out how the placement of a comma in a covenant makes a difference.”
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