Investment bankers have found a hot new product to sell to their corporate clients: defeasance.
Defeasance, while not exactly a term on the tip of everyone's tongue, is quickly being added to the vocabulary of many corporate treasurers. And within six months, shareholders and bondholders likewise may start mouthing the unwieldy word.
Exxon Corporation, the first company to do a deal involving defeasance, says it has received numerous inquiries from other corporate treasurers interested in finding out how the giant company did its recent deal. And investment bankers confirm that defeasance is a hot topic in the cold climate they're having.
Economic defeasance, as it is currently being construed, is a method that allows a company to restructure its long-term debt without voiding the covenants surrounding that debt. One example of a covenant may be that when a company issues a bond, it promises its lenders that certain revenues or income from properties will ensure payment of the principal of that debt.
A company may want to get around such promises without breaking them. It does this through defeasance by placing the debt in a nonrevocable trust. Then it covers its guarantees with the interest and principal of a pool, say, of US government securities or corporate securities of matching quality.
The advantages for the corporation are twofold. First, it can improve the balance in its books by taking note of the decline in market value of the old, low-interest-rate bonds it has issued. These old bonds can be covered by buying at a discount a smaller amount of old, low-interest securities of equal or better safety rating. Second, it will make a capital gain on the discounted securities if interest rates decline and the bonds' value increases, or as they mature.