Investing in bonds - some facts
During last month's Midi plc bond issue, the online blog of the Times of Malta website, contained comments that since these bonds were unsecured, the investment proposition was not worth considering. Unfortunately over recent years, investors have been led to believe that "capital guaranteed" investments cannot fail, and many prospective investors therefore ask: "Are these bonds guaranteed?"
In reality, many bonds are "guaranteed or secured" but even these do not necessarily mean that your capital is 100 per cent guaranteed, or secured. In fact, there can never be a 100 per cent guarantee and prospective investors should read the fine print when faced with such a proposition. Guarantors can fail and their guarantee, therefore, may not be honoured in full.
Bonds can be categorised as:
Senior (unsubordinated) - A senior or unsubordinated bond has priority on interest payments by the company over other unsecured debt. If such a company defaults, holders of senior bonds have a prior claim in receiving whatever money is available before other creditors receive payment. Senior bonds normally offer slightly lower interest rates compared to junior or subordinated bonds since they are considered less risky.
Junior (subordinated) - Subordinated bonds offer a lower protection to investors and the main issuers of such bonds are usually banks. The concept of subordination implies that in the event of the winding up of the issuer, bondholders will rank after depositors (in the case of banks) and other unsubordinated creditors.
A further classification can be made within the senior category. Some bonds are secured while others are unsecured. Senior secured bonds are often secured by collateral, usually real estate or physical equipment that may be liquidated in favour of bondholders if the issuer defaults on interest or principal when it is due. On the other hand, senior unsecured bonds are backed only by the creditworthiness and reputation of the issuer, and do not have a pledge over any asset in favour of bondholders. Unsecured bonds normally offer a higher interest rate since they carry higher risk.
While investors purchasing international bonds can also verify the issuer's credit rating published by any of the three large international credit rating agencies, the only local bonds that have an international rating are those of BoV (rated A-) and the European Investment Bank (rated AAA). The Government of Malta also has an investment-grade rating (A). Meanwhile all other corporate bond issuers have not sought an international rating since this is not a requirement under current Listing Rules.
Many corporate bonds in Malta had been issued through special purpose finance companies, set up specifically as a public company for the bond offering. Since these companies merely act as a finance company, many such issues offer a guarantee from the parent company. For example the Tumas Investments plc bond is guaranteed by Spinola Development Company Ltd. the company that owns the Portomaso complex and itself, 100 per cent subsidiary of the Tumas Group.
Among the 33 bonds on the Official List and second tier market of the Malta Stock Exchange, only four bonds are secured. These are the ones issued by Dolmen Properties plc, Big Bon Finance plc, Gap Developments plc and Pavi Shopping Complex plc. All other bonds are unsecured, although some of these unsecured bonds are guaranteed by the parent company. The lowest ranked bonds are the ones issued by BoV and HSBC which are all subordinated bonds.
Although secured bonds are thought to be safe investments due to the collateral attached, investors should assess the financial strength of the issuer or underlying guarantor.
In the case where the bonds issued by finance companies are guaranteed, financial statements of the finance company and the guarantor must be published by way of a Malta Stock Exchange announcement within four months from their year-end.
On the other hand, where the bonds issued by finance companies are not guaranteed, consolidated accounts of the group, of which the finance vehicle forms part, would normally be published within the standard 10-month time frame. Therefore those group companies having a December financial year-end normally publish their results by October.
Furthermore some issuers are also the trading companies or parent companies themselves (such as Simonds Farsons Cisk, IHI, and Midi) and in such circumstances, the news flow is more regular since accounts are published even at the half-year stage.
Regular communications from bond issuers and timely publication of financial results will help the market gauge the level of risk applicable to the various bonds listed on the market. Prospective investors may prefer holding unsecured bonds of established companies with a strong track record and a healthy balance sheet, rather than secured bonds issued by companies with a limited trading record.
A section of the press recently carried an article stating that Maltese investors have also ventured into foreign perpetual or annuity bonds, possibly in view of their attractive rate of interest. As the name implies, perpetual bonds have no fixed maturity date, and as such can be considered as permanent capital by issuers to fulfill regulatory capital requirements. Many perpetual bonds which, in reality, are deeply subordinated bonds have been issued by banks and financial institutions over recent years.
Unfortunately, as a result of the current international financial crises, many well-known international banks are close to insolvency and being saved by governments who are acquiring controlling stakes in these banks. As such, fear of a complete takeover or nationalisation of these financial institutions possibly rendering the ordinary equity and perpetual bonds worthless, has driven these perpetual prices to very low levels.
Prospective bond investors should therefore understand the type of bond being acquired, although this may seem attractive from an interest rate perspective.
http://www.rfstockbrokers.com
Rizzo, Farrugia & Co. (Stockbrokers) Ltd. RFC, are members of the Malta Stock Exchange and licensed by the Malta Financial Services Authority. This report has been prepared in accordance with legal requirements. It has not been disclosed to the issuer/s herein mentioned before its publication. It is based on public information only and is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. The author and other relevant persons may not trade in the securities to which this report relates (other than executing unsolicited client orders) until such time as the recipients of this report have had a reasonable opportunity to act thereon. RFC, its directors, the author of this report, other employees or RFC on behalf of its clients have holdings in the securities herein mentioned and may at any time make purchases and/or sales in them as principal or agent. Stock markets are volatile and subject to fluctuations which cannot be reasonably foreseen. Past performance is not necessarily indicative of future results. Neither RFC nor any of its directors or employees accept any liability for any loss or damage arising out of the use of all or any part thereof and no representation or warranty is provided in respect of the reliability of the information contained in this report.
© 2008 Rizzo, Farrugia & Co. (Stockbrokers) Ltd. All rights reserved.
Mr Rizzo is director of Rizzo, Farrugia & Co. (Stockbrokers) Ltd.
In reality, many bonds are "guaranteed or secured" but even these do not necessarily mean that your capital is 100 per cent guaranteed, or secured. In fact, there can never be a 100 per cent guarantee and prospective investors should read the fine print when faced with such a proposition. Guarantors can fail and their guarantee, therefore, may not be honoured in full.
Bonds can be categorised as:
Senior (unsubordinated) - A senior or unsubordinated bond has priority on interest payments by the company over other unsecured debt. If such a company defaults, holders of senior bonds have a prior claim in receiving whatever money is available before other creditors receive payment. Senior bonds normally offer slightly lower interest rates compared to junior or subordinated bonds since they are considered less risky.
Junior (subordinated) - Subordinated bonds offer a lower protection to investors and the main issuers of such bonds are usually banks. The concept of subordination implies that in the event of the winding up of the issuer, bondholders will rank after depositors (in the case of banks) and other unsubordinated creditors.
A further classification can be made within the senior category. Some bonds are secured while others are unsecured. Senior secured bonds are often secured by collateral, usually real estate or physical equipment that may be liquidated in favour of bondholders if the issuer defaults on interest or principal when it is due. On the other hand, senior unsecured bonds are backed only by the creditworthiness and reputation of the issuer, and do not have a pledge over any asset in favour of bondholders. Unsecured bonds normally offer a higher interest rate since they carry higher risk.
While investors purchasing international bonds can also verify the issuer's credit rating published by any of the three large international credit rating agencies, the only local bonds that have an international rating are those of BoV (rated A-) and the European Investment Bank (rated AAA). The Government of Malta also has an investment-grade rating (A). Meanwhile all other corporate bond issuers have not sought an international rating since this is not a requirement under current Listing Rules.
Many corporate bonds in Malta had been issued through special purpose finance companies, set up specifically as a public company for the bond offering. Since these companies merely act as a finance company, many such issues offer a guarantee from the parent company. For example the Tumas Investments plc bond is guaranteed by Spinola Development Company Ltd. the company that owns the Portomaso complex and itself, 100 per cent subsidiary of the Tumas Group.
Among the 33 bonds on the Official List and second tier market of the Malta Stock Exchange, only four bonds are secured. These are the ones issued by Dolmen Properties plc, Big Bon Finance plc, Gap Developments plc and Pavi Shopping Complex plc. All other bonds are unsecured, although some of these unsecured bonds are guaranteed by the parent company. The lowest ranked bonds are the ones issued by BoV and HSBC which are all subordinated bonds.
Although secured bonds are thought to be safe investments due to the collateral attached, investors should assess the financial strength of the issuer or underlying guarantor.
In the case where the bonds issued by finance companies are guaranteed, financial statements of the finance company and the guarantor must be published by way of a Malta Stock Exchange announcement within four months from their year-end.
On the other hand, where the bonds issued by finance companies are not guaranteed, consolidated accounts of the group, of which the finance vehicle forms part, would normally be published within the standard 10-month time frame. Therefore those group companies having a December financial year-end normally publish their results by October.
Furthermore some issuers are also the trading companies or parent companies themselves (such as Simonds Farsons Cisk, IHI, and Midi) and in such circumstances, the news flow is more regular since accounts are published even at the half-year stage.
Regular communications from bond issuers and timely publication of financial results will help the market gauge the level of risk applicable to the various bonds listed on the market. Prospective investors may prefer holding unsecured bonds of established companies with a strong track record and a healthy balance sheet, rather than secured bonds issued by companies with a limited trading record.
A section of the press recently carried an article stating that Maltese investors have also ventured into foreign perpetual or annuity bonds, possibly in view of their attractive rate of interest. As the name implies, perpetual bonds have no fixed maturity date, and as such can be considered as permanent capital by issuers to fulfill regulatory capital requirements. Many perpetual bonds which, in reality, are deeply subordinated bonds have been issued by banks and financial institutions over recent years.
Unfortunately, as a result of the current international financial crises, many well-known international banks are close to insolvency and being saved by governments who are acquiring controlling stakes in these banks. As such, fear of a complete takeover or nationalisation of these financial institutions possibly rendering the ordinary equity and perpetual bonds worthless, has driven these perpetual prices to very low levels.
Prospective bond investors should therefore understand the type of bond being acquired, although this may seem attractive from an interest rate perspective.
http://www.rfstockbrokers.com
Rizzo, Farrugia & Co. (Stockbrokers) Ltd. RFC, are members of the Malta Stock Exchange and licensed by the Malta Financial Services Authority. This report has been prepared in accordance with legal requirements. It has not been disclosed to the issuer/s herein mentioned before its publication. It is based on public information only and is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. The author and other relevant persons may not trade in the securities to which this report relates (other than executing unsolicited client orders) until such time as the recipients of this report have had a reasonable opportunity to act thereon. RFC, its directors, the author of this report, other employees or RFC on behalf of its clients have holdings in the securities herein mentioned and may at any time make purchases and/or sales in them as principal or agent. Stock markets are volatile and subject to fluctuations which cannot be reasonably foreseen. Past performance is not necessarily indicative of future results. Neither RFC nor any of its directors or employees accept any liability for any loss or damage arising out of the use of all or any part thereof and no representation or warranty is provided in respect of the reliability of the information contained in this report.
© 2008 Rizzo, Farrugia & Co. (Stockbrokers) Ltd. All rights reserved.
Mr Rizzo is director of Rizzo, Farrugia & Co. (Stockbrokers) Ltd.
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