Wednesday, 5 May 2010

No David Gill, the bond issue is NOT "like remortgaging your house"

As David Gill hasn’t made many public statements about the club’s financial position since the bond issue, I always look out for his comments with interest.  On Sunday the News of the World and various other media outlets reported David’s comments in the latest edition of the Manchester United Disabled Supporters Association magazine “Rollin’ Reds”.  This is what he was quoted as saying about the debt:

"In essence, it changed third-party bank debt with various maturities into new debt, so it was like remortgaging your house with what we feel is a better instrument.
"There are no covenants if you meet interest payments every quarter - you are very much left to your own devices.
"So while debt is obviously on the minds of the supporters the simple answer is while we didn't reduce overall debt we now have more flexibility with what we believe is a better instrument and the bond issue attracted roughly double the target, so in that sense it was a success."

Doesn’t that sound reassuring?  It’s just like switching your mortgage to get a better deal....  Well here’s a question, how many people move their mortgage to a lender who charges them more interest than they were paying before?  Because that’s what Red Football has done by switching the bank debt for the bonds.

Let me explain....

The cheap bank debt
This is how the old bank loans were described in note 17 of Red Footballs accounts for the year to June 2009:

£501,707,000 of senior facilities drawn down by Red Football Limited, by way of four term loans that attract interest based on LlBOR plus a margin which ranges between 2.125% and 5.00%.
The senior facilities have terms between 7 and 10 years from the 16 August 2006, and the term loans have an average life of 5.6 years at the balance sheet date. Term loan A accrues interest at LIBOR + 2.125% and amortises over its term with a final re-payment in June 2013. Term loan B accrues interest at LIBOR + 2.5% and is repayable in two equal instalments in February 2014 and August 2014. Term loan C accrues interest at LIBOR + 2.75% and is repayable in two equal instalments in February 2015 and August 2015. Term loan D accrues interest at LIBOR + 5.0% and is repayable in one instalment in August 2016. The above loans are redeemable at par.
What’s missing from that description is how much each term loan was.  This document (the “term sheet” for the loans from 2006) tells us how much they each were in 2006, since when Term Loan A has been gradually paid down to bring the total to £501m:

Term loan
“Margin” over LIBOR

The “margin”, is the extra interest charged above “LIBOR” which is the “London Interbank Offered Rate”, a benchmark wholesale interest rate.  Because LIBOR goes up and down with market interest rates, the actual rates charged on these loans will fluctuate over time.  LIBOR today (6 month LIBOR) is 0.94%.  So the interest rate on these facilities if they were in place today would be 3.482% + 0.94% = 4.422%.  On £501.7m of debt, that would cost £22m a year in interest.

The expensive swap
At this point, regular followers of United’s financial affairs are probably thinking something like: “What the hell are you talking about Anders?  The interest charge shown in last year’s accounts was over £40m....” and they’d be right too.  The interest payable on bank loans and overdrafts in the Red Football accounts was £42.1m.  So what’s going on?  The answer is “the swap”.  An interest rate swap is a derivative contract that “swaps” one rate for another.  In the case of Red Football, the company entered into a contract to swap the variable LIBOR element of the bank interest rate for a fixed rate of 5.0775% on £450m of the bank loans.  So instead of paying 3.992% on this £450m, Red Football was paying 3.4282% + 5.0775% = 8.56%.  On the rest of the loans, Red Football paid the lower floating rate.  So half of the interest paid by the club last year was because of the losses on the swap contract.

With the bond in place, Red Football has ditched the swap at a very significant cost.  The swap ran until the end of 2013, and to close it and get rid of it now (as it is losing money) is going to cost £38.6m.  The cost represents the difference between current swap rates (around 2.2%) and the old swap rate of 5.0775% multiplied by the £450m value for three years.  The club is paying £11m of this up front and then around £5m each year for five years.

If the bank debt was still in place, Red Football could still close off the swap at the same cost, and could even lock in the 2.2% available now.  This would fix the annual interest cost at £28.5m per annum.
The very expensive bonds
Unlike the bank debt, the bonds pay a fixed interest rate (or “coupon”).  The coupon on the 425m US$ bonds is 8.375% and the coupon on the 250m £ bonds is 8.5%.  At the current exchange rate, the interest cost of the bonds is £44.8m.  That’s more than twice the interest cost of the bank debt at today’s interest rates.
The real reason for the bond issue
So what on earth is David Gill talking about when he says the bond is “a better instrument” than the bank debt?  United could have exited from the swap (at the same cost), entered into a new swap to lock in current low interest rates, and only have to pay £28.5m in interest a  year vs. £45m on the bonds. The club would also have saved the £15m cost of the bond issue and would only have £500m of bank loans outstanding rather than £534m of bonds outstanding.

So why could the Glazers possibly want to swap cheaper bank debt for more expensive bond debt?  David Gill gives us clues when he says “There are no covenants if you meet interest payments every quarter - you are very much left to your own devices........while we didn't reduce overall debt we now have more flexibility”.

Under the bank debt covenants, 40% of any cash over £1m had to be used to pay down debt and there were strict targets to meet to reduce the ratio of debt to profits each year.  It was very hard for the Glazers to pay themselves dividends under the bank covenants.  You can see all the details in the term sheet.

The bond sweeps away all these restrictions, and brings in all the rights to dividends that I have described elsewhere.  The bond unlocks the Ronaldo money and the early Aon payments.  This cash can now be paid to the Glazers.

So no David, the bond issue isn’t “like remortgaging your house”.  Unless when David Gill remortgages his house he signs up for a higher mortgage rate than he’s already paying and agrees to let a gang of burglars in to steal his silver......



monsta said...

First thing I would like to say is I am no financial expert! So if anything I say in the next few paragraphs is wrong I apologise!

I know this isn't going to happen so what I am going to say is largely academic. But let us just imagine - for arguments sake - that the Glazers did want to take a more active role in reducing the debt.

Whilst it is true that the acquisition of bonds has lead to a increased level of interest, the lack of covenants in the bonds means the Glazers could take a more aggressive stance in reducing the overall debt by actually tackling the principle on the loan as opposed to just the interest. If this principle could be reduced by a sufficient amount then it could be possible that the amount of interest paid is less even though the interest rate has increased thereby leading to a more favourable financial position.

Obviously for that to happen they would need to reduce the principle by a significant amount but this could be achieved by selling the clubs main assets, namely Old Trafford and Carrington. If the right price was agreed before the issuing of the bonds it is possible that the money raised by these sales could pay off the principle by a sufficient amount to see a reduction in the annual interest payments. So the bond could actually be more favourable despite the increased level of interest.

Now I am not familiar with the repayment structure and am unaware if the the club will incur penalty charges if they pay the principle too quickly but in this post I am assuming that is not case.

My main point in this comment is to figure out if it is possible for the bond to be more advantageous than the bank loan assuming the main objective is to pay of the debt ASAP even if it means sacrificing some club assets.

metalfactor said...

AndersRed, are you suggesting that David Gill is lying to keep fans happy? a little white lie..
That's a very stupid thing to do, or maybe he is just a bit stupid?
what do you suggest?

Anonymous said...

with the story running in today's newspaper.that last year they reject 1.5 billion pound bid from middle-east(Qatar).
it's indication for red knight that glazers want 1.5billion pound.

otherwise y this come now when red knight announce their plan make bid before world cup.this story come just after 1 or 2 day after red knight announcement.

i don't see any truth in those story about glazers rejected a over 1 billion pound bid.

i m sure when red knight made a bid glazer will accepted quick as possible.

Anonymous said...

If the Glazers really rejected a bid of £1.5bn as reported in the Guardian today then this means that either 1) reports of their financial problems are completely wrong or 2) they have a plan to sort out their finances (e.g. selling their US football club). Either way we can expect them to clear the PIK debts soon. They would have to be totally loopy to have that debt sucking up their profits for the forseeable future when they can cash in and take a huge profit now.

steven said...

The Glazers have rejected an offer of £1.5 billion for United.

Yeah, sure. They would have danced naked in the streets if they had received an offer on that scale.
Are you sure that wasn't 1.5 billion of your US dollars, Malc. Jokers.

Rocco said...

response to Monsta.

You need to think about what you are saying my friend / Glazer conspirer. Fair enough you have said you're not a fin. expert (no-one is if you follow the markets...) but your idea of reducing the debt by selling the stadium and training ground has one tincy flaw: you then pay rent on both to whomever you sell to i.e. create more expense which will NEVER be removed and offsets what you save in principal reduction whilst also reducing cash flows if securitize the match day revenues - offer a slice of what you make each home match to outside investor for upfront payment of "X").

Why would you want these assets to be removed from the club's ownership and control in the first place? So that we can be associated with and discussed in the same sentance as, that bunch up the road that play in white and went bankrupt.

Think about it, why on earth would the Glazers wish to use "their" money from "their" club when, at maturity, the debt can be repaid via refinanced with a new bond issuance (i.e. you issue more bonds to repay those expiring). The HOPE is that they sell the club at a value of "PIKs + whatever their payoff would be", take their free money having invested zero and foxtrot oscar back to bourbon country.


BD said...

Hi Andersred

You make a lot of sense in financial terms viz the bond issue, but you forget that apart from the very realistic possibility of the Glazers taking increased dividends out for their own pockets, doesn't the bond issue help conform the club to the new UEFA guidelines for debt consolidation by 2012 season?
I assume that was probably the major issue that forced the club executives to consider the bond deal. The price to pay is the additional 20 million or so increased interest.

If the motive was solely to take more money out of the club for their own purposes, aren't they doing it a very stupid way by issuing the bond?

andersred said...

Hi metalfactor,

Is David Gill lying? Who used the phrase "being economical with the truth"?

To everyone looking sceptically at the "rejected bids" stories, I totally agree. As a wise man on the Red Issue Sanctuary said better than I could:

"Apart from anything else, if there had been a bid, and if the Glazers genuinely had no interest in selling at any price, why would they bother (as it's reasonable to presume they have) feeding that information to the press? To save the Red Knights some trouble? How thoughtful."



UEFA haven't published the details of their new Financial Fair Play rules yet (coming in the summer). From what I can see, they hope to tackle debt through the rules barring consecutive losses for three years - too much debt = too much interest = losses. United can pay the interest at the cost of low investment in the squad and needlessly high ticket prices. Sadly, the new rules look unlikely to catch the Glazers.

I can't see any difference between the bank loans and the bonds that are relevant for the new rules.

Incidentally, this is best description of what is currently planned that I have read so far:


Anonymous said...

If they had rejected a bid of £1.5bn the Glazers may want to publicise this for at least two reasons. Firstly it demonstrates that they don't have financial problems and hence reassures fans that the club don't need "rescuing" from them. Secondly it backs up their statements about being long-term owners. If it is true (and we don't know that it is) then the Glazers are here for a long time to come and the Red Knights may as well pack up and go home.

Personally I'm fed up of all this financial talk and all this wild speculation about the Glazers' intentions. Let's see if we get the spending we need this summer. I'll judge the Glazers on that. How they come up with the money is their business.

andersred said...

hi there,

They do have financial problems. There'll be some revelations about them later this month....

Could I suggest that if you're fed up with all this financial talk then you may be reading the wrong blog?

I'd like to pick you up on one point though. You say "How they come up with the money is their business." Don't you think that's what Pompey fans used to say?


Diem said...

Rocco: monsta is actually worryingly on target - the Glazers could sell of the stadium and Carrington - by the time anyone would have to worry about it we'd all be dead. At some point it does become a question of re-leasing, re-purchasing or re-building, however the contract would probably be for 100 years, and the Glazers would have had their cash long since.

Anders - far be it for me to question the technicalities, however is the swap really 3.4282 + 5.0775? My understanding was that the 3.4282 would be offset by the spread paid by the other party in the swap arrangement?

Otherwise the club have swapped LIBOR + X for FIXED + X?

Rocco said...

I think you misunderstood my point / I wasn't clear enough.

My point is not that it is not possible / unlikely but that it was suggested by monsta as being a viable / "good" idea.

Of course they may sell off these assets as specifically mentioned in the bond docs but it would be a disaster.

Anyway, let's hope this never comes around.

monsta said...

In response to Rocco

Just so to clear up a misunderstanding, I am NOT saying the Glazer's will do what I described. The Glazer's do not have the clubs interest at heart and this is quite evident from day one when they decided to saddle the club with enormous debts. Add the excessive "management fees" paid to the Glazers and it is obvious they are only interested in making a profit out of Manchester United. So like I said, my argument was purely academic.

I just wanted to know if it is possible to make the bonds work in Manchester United's favour. In all honesty though, the only viable long-term solution for Manchester United is a successful takeover bid that is not financed by excessive borrowing. The Glazers are immoral but they are not stupid and I suspect this was their plan all along; they are simply holding out until the right price is offered and will make a massive profit from the resulting sale. Until then they are just propping the club by restructuring the various loans. Timing is everything though because if the clubs performance begin to diminish then the value will drop and any profits from a sale will decrease.

Then again greed could be blinding the Glazers from the obvious much like it did with Gillette and Hicks for Liverpool. But their main profit must surely come from the sale of the club especially if you consider the high interest rates of the PIK loans.

Anonymous said...


This recent video on the Glazers says everything we need to know about those sh**s attitude to fan and ownership.

Jack said...

From the para,
"...the company entered into a contract to swap the variable LIBOR element of the bank interest rate for a fixed rate of 5.0775% on £450m of the bank loans.

the swap is Libor for 5.0775%, otherwise refinancing wouldn't make sense

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