In light of the new Peet Bond issue announced last week, we thought it would be an opportunity to discuss what are ‘Simple Corporate Bonds’ (SCB). In 2014 in Australian Parliament passed the Corporations Amendment (Simple Corporate Bonds and Other Measures) Act. This amendment aimed to make it easier for both companies seeking finance and retail investors to access the corporate bond market. While the Australian corporate bond market has been predominantly utilised for wholesale investors, this amendment is intended to bridge the gap between retail investors and institutional debt markets. Given the persistently low interest rate environment, this will help investors access a more diverse range of interest rate securities. The key changes include:
- Simpler disclosure requirements that are more debt-oriented rather than attempting to apply equity disclosure standards.
- Adjustments to directors’ liability that softens the possibility of prospectus issues while still maintaining strong accountability
- Streamlined due diligence processes due to the changes above. This reduces costs and time while decreasing direct involvement of Board.
- Laying down the foundations for the listing of existing wholesale bonds in the form of CHESS Depository Interests (CDI), similar to that of listed Commonwealth Government Securities (CGS) currently.
Simple Corporate Bond criteria:
- Ranked senior unsecured
- Unsubordinated except to secured debt (i.e. bank loans)
- Australian dollar denominated
- Pay fixed or floating rate of interest (No deferred interest and no step-downs)
- Minimum offer size of $50 million
- Listed on recognised exchange (i.e. ASX)
- No longer than 15 years to maturity
- No early redemption at the issuer’s discretion and other limitations on early redemption such as taxation and accounting changes
- Conversion not permitted
So how do they compare with a typical listed hybrid? To demonstrate this comparison, we will outline the differences between SCBs and Capital Notes. Let’s begin with the Capital Notes. Capital notes are classified as Tier 1 regulatory capital and distribute discretionary floating rate quarterly payments. Tier 1 securities lie below senior & subordinated debt and above equity in the capital structure. This means that capital notes rank behind senior and subordinated debt in the priority of payments and classified as junior subordinated. From a structural perspective, the capital notes convert into ordinary shares if not redeemed on a prior optional call date. As capital notes meet the new capital instrument eligibility criteria under current bank regulation they also contain the loss absorbing terms and conditions known as Capital and Non-Viability Trigger Events. Upon the occurrence of these events this security will be converted into ordinary shares without the protection of conversion condition. This means that the holder does not have the right to recover any unpaid principal and interest subject to issuer solvency. Now let’s look at Simple Corporate Bonds. Simple Corporate Bonds are classified at senior unsecured debt obligations of the issuer and can pay either a fixed or floating rate of interest. The bonds are structured as simple so they have no optionality, mandatory interest payments and have a final maturity date whereby the bondholder will receive principal repayment. SCBs must meet specific legal eligibility requirements regarding the issuer and the security. The bonds are protected by event of default conditions which give the holder the right to recover any unpaid principal or interest subject to issuer solvency. This makes SCBs more ‘debt-like’ by nature. The key difference between SCBs and Capital Notes (Hybrids) is the event of default terminology. SCB holders are generally protected by a series of covenants such as a negative pledge, restrictions of indebtedness and gearing covenants and in a period of insolvency are entitled to recover unpaid principal and interest. On the other hand, Capital Note holders are protected by capital requirements but if the issuer becomes non-viable, the securities convert to equity and investors are entitled to no repayment on par with shareholders. Additionally, payments for hybrids are not mandatory and subject to more conditions in comparison to the mandatory interest payments of SCBs. Hybrids therefore are more complex than SCBs and reflect more ‘equity-like’ characteristics resulting in price volatility similar to shares in periods of stress. However, investors are generally compensated for this additional risk in the form of a higher interest margin. So what is the market saying? Prior to the upcoming Peet issue there has only been one SCB issued in the last 12 months on the ASX – Australian Unity Bonds (ASX Code: AYUHB). Clearly the market has been attracted to the more secure characteristics of this bond. Seniority of SCBs in the capital structure of a company is more clear cut and enables a broader range of investors to participate. As the hybrid market has displayed sharp volatility over the last 6 months, demand for relatively safer fixed income securities remains high. This is evident in trading margin performance, illustrated below. Figure 1. Trading Margin Performance (Indexed) Source: BondAdviser As a result, the new SCB legislation allows retail investors to diversify risk in their fixed income portfolio by gaining exposure to different sections of the capital structure traditionally only available to wholesale investors. Due to various incentives outlined in the amendment coupled with sufficient investor demand for senior debt, investors need more corporations to come to the market and issue SCBs.