Bonds That Corporations Can Issue

¶ … bonds that corporations can issue to borrow capital. These instruments take various forms depending on who holds the certificate, how the debt is collateralized if at all, the amount and method of paying interest if the debt does in fact pay interest (not all bonds do), and whether the firm can repay the principal in advance of the maturation date. Any corporation that is a legal person sueable for contract violation can issue direct debt, first to large commercial financial underwriters primarily banks, near-banks and the insurance industry, and are then resold in secondary "over the counter" markets to other corporations, brokerages and ultimately individuals. The decision to issue direct debt instead of equity is based on the firms' existing tax and dividend payout ratios, existing leverage and capital positions. Oversight of the issue's management after bond issue is the fiduciary responsibility of the bond trustee, who oversees issuance and distribution of actual certificates or their book registry, the title to any collateral and monitoring indenture violation or default, making sure all regulatory requirements are achieved and the payment of debt interest and principal.

FINRA describes the different types of corporate bonds available to investors, "who have a wide-range of choices with respect to bond structures, coupon rates, maturity dates and credit quality, among other characteristics,"

usually issued in decentralized over the counter markets between individual dealers and brokers. Medium- to long-range "Corporates," corporate bonds with maturities longer than three years in the future, are generally classified against short-term bonds with maturities from 270 days to three years, and "commercial paper," corporate debt with maturity less than 270 days, usually issued in denominations of $1,000. Corporates can pay different fixed or floating "coupon" rates of interest or no interest at all, bear different "sweeteners" or special features like insurance or "survivor options" that usually come at a cost to the investor, can be "called," or repaid to the investor before maturity or not, or can be converted to stock depending on how the firm's choice of capital structure and balance between debt and equity, and dividend payment within choice of equity structure. Some sources consider five years the horizon between short and medium term corporates but this paper adopts the three-year window set by the regulatory institution. The consensus is that "corporations have a lot of flexibility as to how much debt they can issue: the limit is whatever the market will bear."

The firm decides if corporate bonds will pay interest or not. A bond that pays no interest is called a "zero" after this zero coupon rate. Bonds that pay interest usually deliver a semi-annual fixed or variable coupon payment based on an annual rate, and are thus traded at a premium, to reflect the future stream of earnings to the investor. Zeros are traded at a discount, because the investor must receive a higher final return when the bond either matures or is called, and thus is not willing to pay the entire face value in order to let someone else hold their money.

"Floaters" deliver interest at coupon rates that are adjusted periodically within the year based on macroeconomic indexes or exchange rates, more often than "adjustable" or "variable" rate bonds, which deliver coupon rates that remain the same for longer than one year, or until maturity in the case of "fixed-rate" bonds.

Bonds that are "callable" can be paid back by the firm before the stated maturity date. Call provisions set out in the prospectus (proposed agreement before sale) and indenture (contract upon sale) can be restricted beyond a certain date, which for medium- or long-term corporates will be by definition beyond three years or the debt would be called "short-term" or "commercial paper." Convertible bonds can be changed from debt to ownership -- equity; stock -- which significantly alters the firm's leverage ratio and profitability on balance sheets as well as the order in which investors receive payment and are liable to other claimants under bankruptcy provisions.

If the firm intends to call bonds in the future, one way to announce this to lenders is by including a "sinking funds provision" in the debt issue, setting out specific amounts to be repurchased at future dates. Whatever the directors decide, the issued bonds will be designated as "investment grade" or "junk" bonds by the ten Nationally Recognized Statistical Rating Organizations (NRSROs) depending on the firm's balance sheet position at the time of sale. "Corporates are issued by all types of businesses, and are segmented into major industry groups," clarifies FINRA,

but the result may be a hybrid between equity, convertible debt and fixed-rate, non-callable long-term debt depending on the optimum balance between leverage, tax cost and equity for the firm and investors across the firm's divisions in various industries.

Iacobucci and Triantis clarify that any type of corporation with legal personhood qualifies to issue debt as long as it can own property, enter contracts and be sued.