3. The corporate bond’s terms
1. The corporate bond market
2. What is a corporate bond?
3. The corporate bond’s terms
4. Price & yield
5. Credit analysis
Key terms are published when a corporate bond is to be put on the market. They are a summary of the bond’s terms. They are not binding; rather changes can be made during the initial phase of raising capital driven by the response from the investor community. The final terms are specified in the bond indenture. In this section we will go through the most important key terms and their significance, and in some cases we will refer to more detailed information in later sections.
The issuer is the company that is the borrower and the issuer of the bond. It is important to be aware that the operating company is not always the issuer. In cases where the issuer is not the operating company, a parent company guarantee can provide a suitable form of security.
2. Issue volume
Issue volume is the amount to be borrowed. Sometimes the bond indenture can extend to one or more additional issues (known as tap issues). If so, this is specified in the indenture.
Maturity is the lifespan of the bond; i.e. the time until the bond has to be repaid, expressed in years or months. On the maturity date the entire bond is repaid to the bondholders.
Coupon is the interest rate paid out per year. It is paid annually, semi-annually or quarterly. Most corporate bonds are issued with a fixed coupon for the entire maturity of the bond. However, bonds with floating coupons are becoming increasingly common. This means that the coupon is tied to a short-term interbank base rate and changes with that rate.
5. Issue price
Issue price is the price of the bond on the issue date; in most cases it is 100. The bond’s price is expressed as a percentage of the par value. Sometimes bonds are issued at a price less than 100. This is often the case for project companies where cash flows are further in the future. This gives the bond a higher return, even though the coupon (interest rate) is lower.
6. Minimum investment
The minimum investment in corporate bonds is usually SEK or NOK 1 million. In euros the minimum investment is usually 100,000, and in US dollars the corresponding amount is 200,000.
Status refers to a bond’s priority relative to the company’s other financing, such as other bonds, bank loans and share capital. The main priorities are senior and subordinated bonds. Senior bonds have a higher priority than subordinated bonds.
8. Call option
Many corporate bonds, especially high-yield bonds, have a call option. The clause gives the issuer the right to buy back the bond before it matures. Usually the bond is bought back at a higher price than the issue price.
Most major bonds are registered with Euroclear in Sweden, VPS in Norway or a corresponding institute in another country.
A bond can be secured – i.e. has a right to a specific pledge. Pledges are usually real estate, vehicles, equipment or shares in group companies. A secured bond has priority for the specific pledge. Unsecured bonds are entitled to the company’s other assets. Several bonds can be secured against a specific pledge, however. A senior secured bond may have first priority, known as first lien, or second priority, known as second lien, for the pledge.
11. Maintenance covenant
There are two main types of covenants: maintenance and incurrence. Covenants are written into the bond indenture to restrict the company management’s scope and to protect bondholders from excessive risk taking. Maintenance provides the strongest protection and is about the company’s commitment to maintaining certain levels for various key ratios. They often specify a range within which the company can act.
12. Incurrence covenant
An incurrence covenant is a test of a specific event, with dividends, buy-outs or more debt accumulation being the most common. In some cases, the incurrence covenants become more stringent over time, which forces the company to reduce its credit risk during the lifespan of the bond.
13. Change-of-control put
Some bonds have a change-of-control put to protect bondholders against ownership changes that could affect them negatively. The clause entitles bondholders to sell the bond back to the company at a predetermined price, which is usually higher than the price on maturity.
The main task of the agent is to safeguard the bondholders’ interests. The agent ensures that the company fulfils its obligations under the terms of the bond. It also handles communication with the bondholders when changes are to be made to the terms. In the event of restructuring, the agent has the task of convening meetings, making sure that bondholders’ rights are noted and conducting any voting procedures. Agents do not make any commercial decisions; rather they present bondholders’ decisions to the company.
The arranger structures the bond and generally helps the issuer to raise capital. The arranger is usually responsible for maintaining a secondary market for the bond.
16. Legal advisor
An arranger often uses a legal advisor to draw up and ensure the quality of the bond indenture. The legal advisor often also reviews all of the issuer’s business agreements.
Major corporate bonds are usually listed on a stock exchange. The issuer is hereby signalling that it is willing to adopt the stock exchange’s rules on reporting and compliance. However, this does not mean that the corporate bond is traded over the stock exchange. Most bonds are still traded over the telephone via brokerage houses.