Corporate Debt Market

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Abstract

Companies have raised more debt in the bond market this year than ever before, as a dash for cash during the coronavirus crisis took issuance.

Many companies hardest hit by the pandemic have been pushed to secure bond deals against their assets.

However, to raise capital a corporate can use different forms, those debt obligations include six financial instruments: 

1. Commercial paper 
2. Bank loans market
3. Bonds
4. Medium term notes
5.  Asset-backed securities
6.  Equipment leases

In this paper we will analyse the Bonds for better understand their function, their interaction into the balance sheet of a company, and how this financial instrument can be used.

1. introduction

There is no uniform system for classifying the sectors of the global corporate bond market.

However, any country found a distinction between an internal market and the foreign financial market, one where are negotiated bond issue from national companies and the other where are negotiated bonds issued by a non-domiciliated company.

Curious to observed that Bonds negotiated in foreign market are nicknamed: 

• “Yankee bonds” (USA)
• “Samurai bonds” (Japan)
• “Bulldog Bonds” (United Kingdom)
•  “Rembrandt Bonds” (Netherlands)
•  “Matador Bond” (Spain)

Bonds are regulated financial product, and any country that allowed the product to be negotiate regulate it, the most common regulatory requirements are:

• Restrictions on the bond structures that may be issued 
• Restrictions on the minimum or maximum size of an issue and/or the frequency with which an issuer may come to market
• A waiting period before an issuer may bring the issue to market 
• A minimum quality standard (credit rating) for the issue or issuer
• Disclosure and periodic reporting requirements 
• Restrictions on the types of financial institutions permitted to underwrite issues 

The external corporate bond market, also called the international corporate bond market, they display generally those features:

• They are underwritten by an international syndicate
• At issuance, they are offered simultaneously to investors in more than one country
• They are issued outside the jurisdiction on any single country 
• They are in unregistered form

Basic Feature of a Corporate Bond Issue

The issuer of a corporate bond promises to pay a specific percentage of pare value on designated dates and to repay par or principal value of the bond at maturity.

In some countries, such as United States, interest payments are made semi-annually, in other countries, the interest payment are made annually. 

Both the promises of corporate bond issuer and the rights if investors who buy their bonds are set forth in detail in contract called bond indentures. 

The covenants or restrictions on management are important in the analysis of the credit risk of a corporate bond issue.

A bond’s indenture clearly outlines three important aspects: 

• its maturity 
• its security 
• its provisions for retirement

2. The flexibility and its features

The bond is a financial instrument that shows a high grade of flexibility, most corporate issue bond that contain a provision allowing the issuer the option to buy back all or part of the issue prior to maturity. 

Some have what is call sinking fund, a provision which specifies that the issuer must retire a predetermined amount of the issue periodically. 

For those reason is always fundamental understand the negotiated terms of the bond issued. 

The issuer has the right to redeem the entire amount of bonds outstanding on a date before the maturity within a contraction of the interest payable at its conclusion. 

To manage those options most of the negotiation use what is call the refunding, a provision that denies the issuer the right to redeem bonds during the first 5 to 10 years following the date of issue. 

However, the risk that the issuer can retire all or part of the bonds issue prior to maturity is well known and is a factor referred as risk or timing risk. 

The most common structure negotiating a bond are: 

• Maturity 
• Security
• Convertible and exchangeable bonds
• Warrants 
• Putable Bonds
• Zero-Coupon bonds 
• Floating-rate securities 
• Inflation-indexed bonds 
• Dual-currency bonds
• High- Yield Sector
• Green Bond

3. Maturity of bonds 

Most corporate bonds are term bonds, they run for a term of years and then become due and payable, often referred as bullets bonds.

Generally, obligations are due less than 10 years from the date of issue are called notes. 

However, term bonds can also stand for 20 or 30 years or even retired by payment prior to maturity is reach, if provided in the indenture.

4. Security bonds

Security bond could be form by pledged either real property or personal property, to offer security beyond the general credit standing of the issuer. 

A mortgage bond grants the bondholders with a legal right to sell the mortgage property to satisfy unpaid obligations to bondholders.

The mortgage lien is important because it gives the mortgage bondholders a strong bargaining position relative to other creditors when determining the terms of a reorganization in bankruptcy. 

Some companies do not own fixed assets or other real property, and so they have nothing on which they can give a mortgage line to secure the bondholders.

In those case, if the company hold securities of other companies as holding companies, they pledge stocks, notes, bonds, or whatever other kind of financial instruments they own.

These assets are termed “collateral” and bonds secure those assets are called “collateral trust bonds”.

The general idea of the equipment trust arrangement is also used by companies engaged in providing other kinds of transportation, in the same manner Airlines use this kind of financing to purchase planes, and international oil companies use it to buy huge tankers.

However, there are different way to raise capital by debenture bond, those for example are not secured by a specific pledge of property which does not mean that this type of bonds has no claim on the property. 

Even further the market recognises, also, the subordinated debenture bond is an issue that ranks after secured debt, after debenture bond, and often after some general creditors in its claim on assets and earnings. 

5. Convertible and exchangeable bonds

The differences between those two types of convertible bond are on the right to exchange the value contracted within share raise from the issuer or from recognised third party. 

Clarifying the concept, a convertible bond is a corporate bond with a call option to buy the common stock of the issuer.

Instead, an exchangeable bond grants the bond holder the right to exchange the bond for the common stock of a firm other than the issuer of the bond.

As example the corporate bond of an X corporate is exchangeable for the common stock of its parent company.

6. Warrants

A warrants bond is simply a call option, that permit the holder to purchase the common stock of the issuer of the debt or the common stock of a firm other than the issuers.

Generally, warrants can be detached from the bond and sold separately. 

Typically, when exercising the warrant, the investor may choose to pay cash or to offer the debt that was part of the offering. 

7. Putable Bonds  

A putable bond grants the bondholder within the right to sell the issue back to the issuer at a par value on designated dates.

The advantage of the bond holder is that if interest rates rise after the issue date, the market value of the bond remain stable. 

The bond holder can sell the bond back to the issuer for a par value. 

8. Zero-Coupon bonds

Those are bonds without coupon payments or a stated interest rate, but the instrument remain attractive because the investor who holds the bond to the maturity date will realize a predetermined amount of money as return.

10. Floating-rate securities 

Floating rate securities allow the purchase of an asset to obtain an interest rate that follow changes in the level of some predetermined benchmark rate. 

They maybe be resettled over six-months, and for those characteristics are attractive to some institutional investors to limit the liability when the securities is benchmarked on some of the macroeconomic value determined from the police of that institution, ad example inflation for central bank. 

Talking about inflation, a floating rate security may have a lower interest cost than a fix-rate or a long-term security, because inflation with inflation the long term maybe incorporates a substantial premium against uncertainty of future of inflation and interest rate.

Outside the USA, bond coupon rates are generally linked to the rate of inflation and are called “Linkers”.

 10. Dual-Currency bonds 

Dual currency bonds have the characteristics to split the payment in different currencies, for example the pay coupon interest in dollars and the principal repayment in Euro. 

Generally, the exchange rate that is used to convert the principal and coupon payments into a specific currency is specified:

• at the time is issued
• at the time a cash flow is made
• The choice is up to the investor or the issuer.

The frequency of corporate bond interest payments can be semi-annual or annual, different countries have different practice:

• United States
• Canada
• United kingdom 
• Japan
• Australia 

In those country the practice is to make coupon interest payments is semi-annually. 

Instead in the European market (26 Countries) it is often made annually, to compare the two options there is a standard formula.

11. High- Yield Sector

The high Yeld bond is a highly risky product, are generally not attractive for the public market, but their structure is highly interest for moving the risk from the issuer a commercial bank to the market of professional investors, for this very reason the interest in return is often competitive. 

In fact, if the commercial banks lend to high credit risk borrower that risk is accepted directly by all citizens, also if they wish not to accept the risk, and the reason is that the commercial bank liability are backed by the Central Bank and so carried the guarantee of the governments. 

Instead, by issuing a high Yield Sector Bond, the risk of this investing is taken by this specific and professional investor group that willing to accept them, within the advantage that the bonds give Corporation the opportunity to issue long term fixed rate debts and may overcame a bad credit rating.

Generally, they have followed common structure: the agreement paid a fixed coupon were term the bonds, but today more complex bond structures occupy the bond space and bonds are issued also for leveraged buyout (LBO), and so financing a recapitalization producing higher debts.  

12. Green Bond

Green bonds are different from conventional bonds in their use, they are to be exclusively used towards financing or re-financing ‘green’ projects, such as to develop renewable energy technologies.

In 2021, financial markets began its response to climate changes with the European Central Bank pushing with favour the adoption of this model on vast scale. 

The World Bank Group has since followed and provided a steady stream of investable green bonds to speed up the funding supply.

It is highly recommended that green bond issuers comply with the core components of the International Capital Market Association’s Green Bond Principles (“GBP”). 

Those include being responsible for making clear to investors which objects are environmentally sustainable and separating the net proceeds of the green bonds from the issuers’ ordinary investment accounts.

The products have been very popular since 2018 with issuance reaching USD 167.6 billion for a total of over USD 500 billion green bonds outstanding, according to Climate Bonds Initiative. 

Finally, with the 2021 initiative, issuers are no longer limited to governments but also banks or corporates. 

Then a regional basis total cumulative green issuance for Europe has reached USD362.7bn, with France leading on USD102.0 bn followed by Germany on USD57.8bn and Netherlands on USD44.3. Sweden on USD33.4bn and Spain on USD31.4bn round out the top 5. 

In Asia-Pacific, regional total cumulative sits at USD194.1bn with China well in front at USD111.7bn then a gap to Japan on USD19.3bn, Australia on $12.7bn with India at USD11.4bn and South Korea at USD8.3bn comprising the remaining top 5 nations. 

Total cumulative issuance for LATAM is USD17.9bn on the 30 June. 

Chile leads at USD7.0bn followed by Brazil usd5.7bn, Mexico USD2.1bn and Peru on USD886mn and Argentina on USD 637mn filling 4th and 5th spots, respectively.

State Bank of India issued a USD denominated green bond last year. Here is the bond, as seen on the Bond Evalue Mobile App, along with an extract of its offering circular, which clearly lays out the use of proceeds.

February 2021

by Daniele Lupi