While everyone is busy arguing over the stimulus bill, without having a clue what its over 1000 pages of "stimuli" include (it is actually split into a 496-page appropriations section and a 577-page tax package), the government is making sure that corporations with public debt trading at a steep discount go out at first opportunity and do open market debt buybacks. We wrote about the recent pick up on secondary debt buybacks here, and now it is likely to become a frenzy due to tax incentives that the bill has in its final form. Fixed income funds are likely to front run companies, resulting in a steep increase in prices of bonds that have the potential to be repurchased.
The specific proposal introduced by Senate Finance Committee Chairman Max Baucus (D, Montana) calls for deferrals of taxes on gains from debt repurchases at discounted levels. Any income realized from debt buybacks in 2009 and 2010 will be deferred to 2011 and then taxed ratably over an eight year period, through 2018.
Let's demonstrate: if an issuer buys $1 billion of its debt at 50 cents on the dollar, the result is a $500 million capital gain and $100 million tax bill at a 20% statutory rate. With the current proposal, assuming a two-year deferral and pro-rata payment over 8 years, the present value of the tax payments becomes $54 million - a $44 million pick up in value! The difference is substantial and could potentially be distributed pro-rata to the company and its bondholders, implying the repurchase price could be increased by 5-6 cents. This could lead to a whole new form of company-bondholder negotiations, especially for large companies whose debt is trading at a large discount.