A BRIEF GUIDE ON THE PROCESS OF A BOND ISSUANCE
A bond in very simple terms, is essentially a loan given to a company by an investor. Just like with the operation of any loan, the investor gives the company a specified amount of money for a defined period of time, and in return gets periodic payments (interest) and is repaid the original sum at the end of the period. It is a tradeable security issued by a bond issuer which represents a covenant by the issuer to not only repay the investors the full amount, but also make periodic interest payments during the tenor of the bonds. Bonds are typically issued by companies and governments in order to raise money for a particular purpose. In today’s newsletter, I will be talking about bonds as issued by companies and corporations, and also examining the process of a bond issuance.
WHY
As I stated earlier, bonds are typically used by companies to raise money. It is an aspect of debt financing which is often an attractive option in raising capital. Given that a bond shares certain similarities with a loan, you might be wondering why companies would rather go the bond issuance route. Well, there are quite a number of reasons that drive this decision. First, it is important to note that loans usually come with a higher interest rate and will generally restrict the company`s ability to raise additional capital. A Bond issuance typically seeks to raise capital which runs into billions (of Naira), and bonds allow the company to raise capital from different investors, at lower interest rates and with a bit more freedom than a loan gives. Bonds generally have less fees, less debt service expenses than outright loans from banks. The company issuing the bond will typically only incur expenses one time when they are issuing the said bonds on the market. Bonds also provide financing for a longer-term, for example, many corporate bonds have a maturity of up to seven years, while government bonds typically mature within a period of 10 years and above.
TYPES OF BONDS
A bond is a debt security issued by a company to raise money from investors. These bonds are issued upon and backed by the company’s ability to repay them, depending on the company’s future profitability. This future profitability and ability to repay is why bonds are often issued quality ratings to give investors an idea of the associated risk with the bonds. Certain bonds may also be secured by the company’s physical assets, in which case, where the company fails to repay the sum, investors can go after the company’s assets. Bonds may also be convertible where they give investors the opportunity to potentially convert their bonds to shares of the company. Companies also sometimes issue callable bonds which simply means that the company can elect to pay them off before their official maturity date.
PARTIES IN A BOND ISSUANCE
Now that we have established what a bond is, we can turn our attention to the parties to a bond issuance. Like any corporate or commercial transaction there are certain parties whose presence is a constant feature, in pulling off the transaction. In a bond issuance, some of those parties represent commercial interests, while other parties are required by regulation to ensure that the process of the issuance conforms with the existing laws, and also to safeguard the interest of potential investors.
The most important party, of course, is the Issuer without whom there will not be a transaction in the first place. In many cases, companies that intend to issue bonds incorporate a special purpose vehicle (SPV) as a public company to be the issuer of the bonds. The Securities and Exchange Commission (SEC) rules allows the issuance of bonds through special purpose vehicles. This way the company is able to isolate financial risk, and instead act as the sponsor or guarantor to the associated SPV, which is the issuer. Another party to a bond issuance is the investor. The Investor is the party that simply provides the funding or buys the bonds which are offered by the company, and upon allotment of the bonds, they are known as bondholders. The Trustee is a neutral party that is designated as the official representative of the bondholders, to ensure compliance with the terms of the various contracts between the issuer and the bondholders, and safeguard the interest of the Bondholders. The Issuing House, acts as an intermediary of sorts between the issuer and potential investors. It is a financial institution that under takes the process of registration, distribution, and sale of the bonds on the market on behalf of the issuer. Depending on the size of the issue, there may be more than one issuing house; in which case one of them will be the lead issuing house coordinating the activities of all the issuing houses. The Registrar to the issue is charged with maintaining the property register of bondholders, effecting any changes to the register, issuing bonds certificates, and the general administration of the issue.
On the financial end, the Reporting Accountant reports on the financial information to be provided in the prospectus, while the Auditors review and report the accuracy of the issuer's financial records, and ensure compliance with relevant accounting standards and tax regulations. The Rating Agency analyses the financial strength of the company, their ability to make repayments under the bond issue, and the likelihood of default. Other parties include the underwriters (if applicable), the receiving bank and the Solicitors to the issue, the issuer and the trustees, who are charged with preparing the legal documents in the transaction.
PROCESS OF THE ISSUE
As expected, every bond issue in Nigeria, is subject to registration and approval by the SEC. It must be mentioned that the SEC’s regulations only allow public companies to issue bonds in the Nigerian market (private companies cannot).
i. Resolutions and Appointments: A company must first authorise the issue by passing a board resolution to that effect. Where the amount to be raised through the issue goes beyond the company's borrowing limits as set by its memorandum and articles of association, or the bonds to be issued are convertible bonds the resolution has to be passed at a General Meeting of the company (Rule 568(C) SEC Rules). The company then appoints the professional parties (as listed above) to the transaction. Subsequently, the company discusses the process, strategy and terms of the bond issuance, such as provisions for coupon pricing, tenor of the bond, par value, redemption and conversion provisions.
ii. Documentation: The next stage involves the preparation of the transaction and marketing documents of the issue. These include the Vending Agreement setting out the obligations of the issuing house and the issuer; the Programme Trust Deed or a series trust deed (where the bond is issued in tranches) which vests assets on the trustees where the bond is secured by assets, and creates a trust in favour of the beneficiaries which are the bondholders; the Pricing Supplement which sets out the summary of the offer, the transaction timeline, and the use of proceeds among other things. Legal and financial due diligence is also conducted. The Rating Agency also conducts a rating process. Rule 568 (A) stipulates that all corporate bonds shall be rated by a rating agency, and where it is issued through a public offering, the credit rating must not be below an investment-grade. The SEC rules also stipulate that an issuer who defaults in payment of interest or repayment of principal in respect of a previous debt issuance for a period of more than six months shall not be allowed to offer bonds.
iii. Regulatory Review and Approval: The transaction documents are collated, alongside the application for registration (Form SEC 6), memorandum and articles of association, reporting accountant’s report, ratings report, draft prospectus, and other legal documents and submitted to the SEC for review and approval. An application for securities exchange listing is also submitted if it is decided that the bonds be listed on the floor of the securities exchange. The issuing house also obtains approval for the open date of the offer.
iv. Sale and Allotment: Upon obtaining the necessary approvals, the process of offer, sale and allotments to the public begins. The bonds may be issued by way of an offer for subscription, a rights issue or private placement (Rule 568 (B). The issuer may decide to underwrite the issue, and the issuing house undertakes a road show to key institutions and other investors to build demand for the bonds. The underwriter guarantees that a minimum amount of capital will be raised, and undertakes to take part of the shortfall bonds that are not demanded by investors. The bonds may also be issued through a book-building process (Rule 321) in which case, the issuing house takes no risk in the shortfall of the bonds, but sources demand from the market to determine the best price for the offer. Another option is shelf registration (Rule 40c) where the issuer intends to access the market in the near future (typically within 2 years).
Upon subscription to the issue by investors, allotment certificates are issued and the issuing house updates the pricing supplement with the price of the issue, the coupon price (interest rate to be paid to the investors), the number of securities to be issued, files this with the SEC, and obtains the SEC’s approval. The proceeds of the issue are then deposited in a separate interest yielding account with the receiving bank as required by Rule 305 of the SEC Rules.