By: Wilmington Trust

Issuers of debt securities require an indenture trustee to assume fiduciary duties and handle crucial administrative responsibilities such as monitoring interest payments, monitoring redemptions, and communicating with their investors. Selecting a quality corporate trustee has become an increasingly complex task as a result of ongoing consolidation in the financial services industry.

Industry consolidation affects indenture trustees in one of two ways. A corporate trust department may be sold to another institution, something that is occurring with increasing frequency among money center institutions. Alternatively, the parent company of the company with the trust department may be acquired, resulting in new management for the trustee. At the very least, an issuer may end up with a trustee very different from the one its management team and advisors selected.

Does it matter?
Yes. Mergers and acquisitions can disrupt long-term relationships between corporations and their indenture trustees, which can, in turn, result in decreased service levels. These problems often result from staffing changes and/or system integration problems.

• Staff changes. Layoffs, attrition, and reorganizations are common by-products of mergers and acquisitions. After a sale or merger, corporations and their advisors may find themselves working with new staff members who are unfamiliar with the history of their relationships.
  
  
• Integration problems. Corporate trust departments that expand rapidly through acquisitions frequently encounter system and personnel problems that can result in poor client service. For example, an indenture trustee that is unfamiliar with a client and its transaction document may miss a covenant provision in an indenture. This type of error may harm bondholders and have serious legal repercussions for the issuer.

Some financial firms may have little interest in or commitment to the corporate trust business that they acquire. In such instances, an acquired corporate trust department may be starved of resources or sold to yet another institution, resulting in further upheaval.

Serious indenture trustee errors reflect poorly on the corporate issuer. In addition, these mishaps can tarnish the reputation of the advisor who recommended the trustee. Therefore, attorneys, investment bankers, and other interested parties should scrutinize a trustee before recommending one to a client.

Reducing the risks
In order to avoid merger and acquisition-related disruptions, issuers and their advisors should investigate whether a corporate trust department or its parent company is likely to be acquired by another financial services institution.

• Question the parent company's commitment to the business. Issuers and their advisors should determine whether corporate trust services are an integral part of the firm's business plan. If the trust department is a major revenue source for the parent financial institution, a sale of the trust department is less likely. Meanwhile, reports from analysts and other industry observers will indicate how important the corporate trust business is to the particular parent institution.
  
  
• Evaluate the trustee's acquisition potential. It is difficult to determine if a financial services company will become a takeover candidate, but public statements from the company and analysts' reports may provide insight. A company stating publicly that it has no intention of being acquired may show that it is more committed to remaining independent. Trust companies with a substantial number of municipal clients can be attractive candidates for acquirers.

Though it is impossible to know with certainty whether a trust department or its parent will be sold in the near or distant future, asking strategic questions can help to minimize the likelihood of selecting an acquisition target to serve as trustee.

Questions to ask
Determining the potential for a merger or acquisition involving the corporate trust department or its parent company is only the first part of effective due diligence. If a change of management does not seem likely, it may be appropriate to ask a prospective indenture trustee about issues such as conflicts of interest, personnel tenure, client retention rates, and flexibility.

• Conflicts of Interest. To provide the best possible service to issuers while representing the interests of bondholders, an indenture trustee should be free from conflicts of interest. One common conflict for which issuers and their advisors should be on the lookout involves lending institutions that serve as indenture trustees for the companies to which they loan funds.
  
  The lender's policy may require that the trustee resign if the issuer's credit rating is downgraded, even temporarily. Being forced to engage a successor trustee at this stage may create an unexpected and unwelcome task for the issuer.
  
  Issuers with solid balance sheets may be confident that they will never encounter problems related to a downgrade. History has shown, however, that many investment-grade companies have been downgraded during the life of their long-term bond issues, so it is important for all issuers to be aware of any potential conflicts.
  
  One way to determine whether a corporate trustee is conflict-free is to ask whether its professionals regularly serve on creditors' committees for corporate bankruptcies. Only trustees deemed conflict-free are allowed to participate in such insolvency proceedings.
  
  
• Personnel tenure. A quality indenture trustee will be committed to client service. Low staff turnover is one strong indicator of a provider's client service orientation and something that an issuer or advisor should discuss before selecting a corporate trust provider.
  
  Why is low staff turnover so important? To administer a bond issue, the trustee must keep the financial officers at the issuing corporation fully-informed. The issuer must know well in advance, for example, when to transfer money for coupon payments and when money for calls or redemptions will be needed. Therefore, it is crucial that the trustee have in-depth knowledge of the issue. Indeed, having a new account administrator several times during the life of a debt issue disrupts the continuity of a trustee/issuer relationship.
  
  In addition, an indenture trustee serves as the intermediary between the bondholder and the issuer. Bondholders may contact the trustee as a conduit for information for various reasons over the life of a bond issue. A knowledgeable trustee will be able to address investor inquiries, reducing demands on the issuer.
  
  
• Client retention. In general, indenture trustees that retain issuer clients are the ones that thoroughly perform all services, from reviewing draft documents and cooperating with securities underwriters, to monitoring compliance with the trust indenture. Dedicated, high-quality trustees rarely lose a corporate client. A client retention rate much below 100 percent should be a red flag.
  
  
• Flexibility. Today's capital markets are sophisticated and continually evolving. It is vital that an indenture trustee be familiar with all types of debt issuance, from asset-backed securitizations to zero-coupon notes. Furthermore, the trustee must have the technical ability and experience to assist in restructuring transactions for the benefit of all parties if unforeseen developments should occur.
  
  Because adaptability and creativity are essential for a successful, long-term corporate trustee relationship, issuers and their advisors should ask prospective trustees to describe an innovative solution that the trustee designed to address a complex client problem.

Despite ongoing consolidation within the financial services industry, corporations should be able to rely upon continuity of relationships and excellent personal service from their indenture trustees. Determining whether a trust provider will be involved in a merger and asking about issues such as independence and client retention can help to ensure that they are engaging providers that will be able to meet their needs now and in the future.

Updated: January 1, 2013

This article is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service or as a determination that any investment strategy is suitable for a specific investor. Investors should seek financial advice regarding the suitability of any investment strategy based on their objectives, financial situations, and particular needs. This article is not designed or intended to provide financial, tax, legal, accounting, or other professional advice since such advice always requires consideration of individual circumstances. If professional advice is needed, the services of a professional advisor should be sought.
© 2013 Wilmington Trust Corporation.