Friday, August 21, 2009

Fun with Standard and Poors

On Tuesday (Aug 18) S&P downgraded the debt of homebuilder Beazer Homes (BZH) to “SD” or selective default. Two days later, the homebuilder’s credit (but not its bonds) was upgraded again to CCC, or basically where it was to start the week.

Before you say “whaaa”, lets just say that there is a reason behind the madness. What happened was that Beazer, seeing that its notes were trading below 50%, went out and bought a chunk of them back at those distressed levels. They invested $54 million to buy back $116 million worth of notes due in 2011-2016. Financially it makes a lot of sense, since they’re buying back bonds with yields of 30-50%. They’re not going to make that kind of cash building homes. Not these days, at least.

Well, S&P doesn’t like that very much. They call it a “selective default”. Basically, the company is taking cash on which all creditors have a claim and giving some bondholders (the ones selling) an early payment, while others get nothing. But you can also argue that by retiring debt at such a deep discount, the company puts itself into a better position to pay all creditors down the line. The market tended to agree with the latter assessment and Beazer bonds have rallied from as low as 22% at one time to 60-85% (depending on maturity).

As a (happy) holder of Beazer bonds, I don’t mind this kind of transaction, since it certainly beats other options available to distressed companies. Those usually involve issuing high-yielding secured debt, which basically puts itself in front of the creditor line and pushes us unsecured creditors down. S&P and Friends, on the other hand, don’t mind those as much.

Of course, S&P didn’t find out about these purchases until Beazer published its quarterly report (10-Q) a few days ago, and when they did, they proceeded to downgrade, but only for two days, since the fact is that the bonds outstanding are not really in default (and most probably are in a slightly better position to be paid).

This kind of thing happens in the strange world of debt and not only with obscure names such as Beazer. Earlier this year, Ford saw that its bonds were trading around 20% and instead of trying to purchase them in the market, decided to launch a tender at 30%. It was a total success with $9.9 billion in notes bought up by the carmaker. LINK. There was even a small arbitrage window, as those bonds traded around 20% for a few days AFTER the tender was announced (thank you, Ford!).

S&P weighed in to say “naughty, naughty”, but still had to reverse the downgrade a day later.

As for those bonds? Now trading around 70-75%. “Selective Default” indeed!

Disclaimer: I own Beazer and Ford bonds.

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