With the IPO market slowing in Australia, and the global economy experiencing volatility after the international banking chaos regarding Silicon Valley Bank and Credit Suisse, we look at company obligations to convertible noteholders at the Pre-IPO stage.
Credit Suisse wipe out of AT1 capital bonds
Last week, the Swiss financial regulator, FINMA, wiped out approximately AUD$26.1 billion of Credit Suisse bonds as part of the forced merger with UBS.
Additional Tier 1 capital bonds (AT1 bonds) are hybrid debt-equity instruments issued by banks to comply with Basel capital requirements. AT1 bonds usually pay a higher interest rate than other debt instruments due to the higher risk profile. The higher risk profile is due to the potential for the AT1 bonds to be written down or converted to equity. Typically, write down or conversion to equity is triggered by specified levels of losses or capital depletion (causing the bank to be non-compliant with Basel capital requirements).
In the case of Credit Suisse, the AT1 bonds’ terms provided that the instruments could be completely written down or converted into shares in a ‘viability event’, which includes circumstances where extraordinary government support is granted. A statement issued by FINMA said ‘as Credit Suisse was granted extraordinary liquidity assistance loans secured by federal default guarantee on 19 March 2023, these contractual conditions were met for AT1 instruments issued by the bank’.
Writing off AT1 bonds, rather than converting them into shares, means that shareholders, who received 3.25 billion Swiss francs for their shares, had a better outcome than bondholders from the regulator’s intervention.
This decision of FINMA may be subject to legal challenge with a group of AT1 bondholders considering a class action. If Credit Suisse\’s assets had instead been distributed in an insolvency, bondholders\’ claims could expect to rank above those of shareholders. FINMA has yet to explain its decision to write off the bonds rather than converting them to shares as the decision may be the subject of legal proceedings.
While the AT1 bonds are a specific debt instrument issued for bank capital maintenance purposes, they provide a useful reminder for issuers of, and subscribers to, other convertible debt instruments. In volatile times, parties to convertible debt arrangements should be aware of the conversion and redemption triggers of those instruments.
Obligations to convertible noteholders in Australia
The issuance of convertible notes in the pre-IPO stage is a common fundraising mechanism in Australia. Convertible notes are debt securities with the ability to convert to shares. This fundraising approach is popular because it provides the company with an influx of capital (without immediately diluting existing shareholders equity) while the investors gains the opportunity to convert their investment into shares at a discounted price to the IPO price. Alternatively, investors may have their loan repaid plus any interest accrued.
Given the above circumstances surrounding Credit Suisse bondholders, it is crucial to highlight the obligations associated with convertible note instruments when the scheduled dates for an IPO are delayed or cancelled.
Convertible notes facilitate the conversion of notes into shares at predetermined trigger events. The trigger events are usually:
- the maturity date;
- a qualifying finance event (where a subsequent round of equity raise is completed); or
- an exit event (where a company sells its shares or undergoes an IPO).
When considering timeframes for a potential IPO, company directors must consider the impacts of early conversion or the need to pay noteholders their loan amount plus interest due to a trigger event.
The maturity date of debt instruments such as convertible notes must be a consideration for company directors. When the maturity date is reached the notes will be, if not fully redeemable, at least partially redeemable. Directors must consider whether the company’s cashflow would be able to facilitate the redemption of the notes. This poses issues of insolvency if not handled appropriately.
We advise having internal discussions as early as possible to ensure the company has a plan for dealing with these situations as they arise. Approaching noteholders as early and transparently as possible with a view to potentially extending the maturity to provide the company additional time to execute its strategy.
If you would like any further advice in relation to convertible note obligations, contact Glenn Vassallo (Managing Director) or Scott Standen (Director).