Some of the world's biggest debt investors are demanding betterterms to lend money for corporate takeovers after $42 billion offailed deals left them nursing losses.

The money managers are pressing Wall Street banks to shield themfrom losses that occur when a failed merger prompts a company tobuy back debt at a price below market value, according to peoplewith knowledge of the matter. The discussions heated upafter the failure last month of Lam ResearchCorp.'s $10.6 billion deal to purchase KLA-Tencor Corp., whichcost bondholders $86 million, the people said, asking not to beidentified as the discussions are private.

Investors who have enabled $1.2 trillion of mergers this yearare nervously staring down a growing pipeline of debt that needs tobe sold for deals that may never see the light of day. Among themare AT&T Inc.'s $85 billion merger with Time Warner Inc. andBayer AG's acquisition of Monsanto Co. Those companies have alreadylined up a combined $97 billion in bridge loans from banks, whichtypically offload the debt to investors in the bond market before atransaction is completed.

“The whole M&A wave is being driven on the back ofbondholders providing cheap financing,” said Bill Parry, a managingdirector of capital markets at Seaport Global Securities whoadvises bondholders. “So why not give them fair compensation if adeal falls apart?”

The Credit Roundtable, a group made up of some of the world'sbiggest money managers, is preparing to discuss the matter whenmembers meet in Chicago this month, according to SchroderInvestment Management's David Knutson, a co-head for theorganization. Vanguard Group Inc., Prudential Financial Inc. andLoomis Sayles & Co. are among the members.

What's frustrating bondholders is an obscure clause in creditagreements, known as a special mandatory redemption, that typicallyallows companies to buy back bonds at 101 cents on the dollar ifthe deal goes kaput.

The problem? Many of the bonds have risen much more, in somecases as high as 113 cents, crystallizing losses for investors whendeals are canned and the notes called at 101 cents. The debt hasclimbed in large part because it trades in line with underlyingU.S. government bonds, which have returned 4 percent this year ascentral banks around the world hold interest rates near recordlows.

Call For Change

One option investors are discussing is a change in how thatredemption price is determined, the people said. Instead of gettinga premium to face value of the bond, they want the call price to bemeasured in spread, which is the extra premium over a fixedTreasury rate at the time of sale. Spread is already a commonmeasure investors use to value bonds and fixing it to a benchmarkmeans they don't have to be interest rate forecasters to figure outif they like the deal.

“People are more sensitive to the 101 call than ever before,”said Knutson, who leads credit research at Schroder. “Price-basedcall is an old piece of financial technology that doesn't reflecthow investors trade and manage risk now.”

Sysco Corp.'s failed bid last year for US Foods sent thefirst big jolt to investors, with its longest-dated bonds calledafter trading as high as 113.3 cents on the dollar. The deal wasterminated in June 2015. Investors who bought at the peak lost morethan $309 million.

This year, Halliburton Co. and Lam called back a total of $4.1billion of notes they sold to support busted mergers. Investorswere left with losses of more than $100 million from peak tradingprices for those bonds.

“Investors have been burned by a couple of these specialmandatory redemption bonds,” said Travis King, head ofinvestment-grade credit at Voya Investment Management. “You've hadsuch interest rate volatility this year that that option becomessignificantly less valuable. It can actually constrain theperformance of the bonds.”

Investors are bracing for more pain, with about $10 billion ofAetna Inc. bonds to be called if the insurer fails to close itsdeal to buy Humana Inc. by the end of the year. And there'spotential financing down the road for deals with a lot more fundingon the line, including AT&T, Qualcomm Inc. and Bayer.

“It's definitely a risk you have to consider,” said MarkKiesel, Pacific Investment Management Co.'s chief investmentofficer for global credit. “Some of these deals have a 50, 60 or 70percent chance of going through but there's also a 30, 40 or 50percent chance they don't.”

Bloomberg

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