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Yesterday's Columbia Sussex contest produced an unprecedented flurry of responses -- and I learned a lot about the bond market, too. Our S&G readership is a veritable V-8 engine of knowledge. As you'll recall, the question concerned the "defeasance" of a $967 million Columbia Sussex bond.
The first reader across the finish line with an answer to this abstruse question is Tom De Martini of Phillipsburg, N.J., who wins hard-copy and e-book versions of Bill Zender's Casino-ology, our newest Huntington Press title. But four other readers submitted correct answers.
What to do? A solomonic solution has been devised by our own Bethany Coffey. To wit: Runners-up will receive e-book copies of Casino-ology, thereby allowing you to enjoy the latest in cutting-edge LVA technology. (I'm reminded of the line in the 1987 Dragnet movie, in which Dan Aykroyd's Sgt. Joe Friday relates, in a hilariously uninflected voice-over, "After losing the two previous vehicles we had been issued, the only car the department was willing to release to us at this point was an unmarked 1987 Yugo, a Yugoslavian import donated to the department as a test vehicle by the government of that country and reflecting the cutting edge of Serbo-Croatian technology."
Whatever happened to the Yugo? (No, you don't get a prize for answering that.)
And now the winner(s):
8:52 P.M. EST, 11/5/08
Defeasance allows an issuer (the company) to collateralize outstanding debt with a portfolio of risk-free government securities (usually U.S. Treasuries) which ostenibly removes the debt from the balance sheet. It can also be accomplished with cash.
So, in this case, the Columbia Sussex bond has already gone through this process, reducing the outstanding value by 90%.
I covered the bond market for eight years ... I knew it would evenutally come in handy.
1:42 A.M. EST, 11/6/08
A defeased bond is a bond that is rendered void by a party by pledging a security or cash in order to pay the tems of the bond. In addition, all covenants and contract provisions are removed from the bond. Simply put, Columbia Sussex pledged cash or some other asset in order to defease (make payments) on the roughly $890 million principal balance and was released from the covenants and provisions which may have triggered a default on Columbia's part.
4:37 A.M. EST, 11/6/08
In simple terms, Fitch, the bond rating agency, is lowering the ratings on certain parts of ColSux debt. The lowering is due to potential litigation costs, which could affect ColSux ability to pay the debt off. The effect of lower ratings is a higher cost for capital for the company in the future.
As for the debt being defeased by 92%, this link will provide a full explanation, but it means the amount defeased is not a liability on the balance sheet when the company places cash or other assets with an escrow agent to cover the amount of defeased debt.
12:53 P.M. EST, 11/6/08
Securities that have been secured by another asset, such as cash or a cash equivalent, by the debt-issuing firm. Firms that have created defeased securities, which are typically bonds, will have sufficient cash set aside for retirement of the debt upon maturity. For example, the U.S. government could place the funds necessary to pay off a series of Treasury bonds in a trust account specifically created to pay the outstanding bonds upon maturity. The government sets aside these funds to ensure that it has enough cash to pay its bonds when they are due. Commonly, defeased securities are retractable.
Securities than can be defeased will often carry a lower yield than comparable securities, as the option to retire the debt early favors the issuer and caps the potential investment return for the bondholder. However, for a risk averse investor, this feature proves beneficial because it lowers the default risk of the security. The document you referenced really has little bearing on Columbia Sussex itself. It's actually pertaining to Asset Securitization Corp. and the bonds they issued to cover mortgages. It seems that on this particular loan, they've paid off 92% of the mortgage. It would sound like a positive sign to me, anyway.
12:54 P.M. EST, 11/6/08
The company "Asset Securitization Corp" has pooled together multiple commerical mortgages. The mortgage payments "pass through" this company. In other words, they collect the payments and send them onto investors. This pool of assets is what is being downgraded. "[O]ne loan remains in the pool" means that all other mortgages have been paid off with the exception of ColSux.
Here's another link with an excellent definition of defeasence. Downgrading the pool of mortgages of which ColSux is the only remaining mortgage doesn't have any direct effect on ColSux.
President-elect Obama is on Line Two, guys. He says he needs you to help him sort out the mess at Treasury. But seriously folks ...
Congratulations to everyone who participated. I think we've started something. And I've learned a lot of somethings. A day without new knowledge is a day wasted, IMO.