Hodak Committee Partially Giving in to to Banks' Demands

In the face of pressure from banks and corporations, the Hodak Commission has taken a step backward: It will will modify its recommendations on corporate fund raising. One change is that the committee will not recommend that bondholders be able to immediately recall their bonds should a company change hands.

The commission, which was set up by the Finance Ministry to establish criteria for institutional lenders to purchase corporate bonds, is expected to issue its final recommendations soon.

The ministry established the commission due to criticism that the institutionals had been lending money without requiring sufficient security from bond issuers.

The commission's interim recommendations raised the ire of banks and corporate bond issuers, including IDB, who would be adversely affected by the results.

The primary objections involve the provision that credit be conditioned on a negative lien, in which further funds may not be raised with permission of existing bondholders, and that bondholders be able to demand immediate repayment should the issuing company change hands. Corporations also questioned whether the commission had the authority to set basic credit rules for institutional lenders.

Other detractors argued that instead of addressing the bonds, the state should address institutions' risk management, and that implementing the commission's recommendations would reduce credit and stunt economic growth.

Others said that issuing companies lack an address to manage communications with all of their institutional investors.

Capital market sources said over the weekend that the commission is not expected to back down from the two recommendations that unleashed the most controversy - the negative lien requirement, and redemption if the company changes hand. The commission is expected, however, to propose some alternatives and concessions.

The negative lien provision would mean that a corporation issuing bonds to institutional investors could not later encumber its assets in favor of banks that did not have a security interest prior to the bond issue. For the institutional investors, this would not be a true lien on assets, because an asset left unencumbered is also not encumbered to them. For them, the unencumbered assets are part of their risk calculation, should the borrower encounter difficulties. From the moment that it is encumbered, their debt is left with an inferior redemption position.

The banking system is especially opposed to this provision, fearing that the banks will not be able to continue to increasing their credit for companies in exchange for guarantees linked to the companies' assets. The companies are concerned that they will have trouble raising capital, and by how the banks may respond.

However, the Hodak Commission noted that major corporations around the world, including Coca-Cola and DuPont, have raised capital through bonds with a negative pledge provision, to no adverse effects.

The commission states that this provision is necessary to maintain the quality of the institutional lenders' credit.

Plus, the investment committee of each institution would be able to diverge from the recommendation for a specific investment or credit line.

In addition, in its final recommendations, the commission will note the exceptions in its interim report. The commission agreed to exempt a specific lien on a new asset that a company acquires with its own equity capital. In addition, it was noted that if bondholders receive second and third liens following a first lien in favor of the banks, there would be no need for a negative pledge.

If the corporations make specific financial commitments to institutional lenders, such as limiting certain debt ratios, the negative pledge requirement may be waived.

With regard to the commission's requirement that a change in corporate control enable immediate redemption for bondholders, corporate bond issuers say this would be a poison pill, making it impossible to corporations to change hands.

The commission is ready to show flexibility and change the requirement so that it requires a majority vote, instead of being automatic. The commission may exempt companies that get approval from government regulatory authorities.