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Bond types

Posted in Bonds

This is how we have classified the various types of bonds in the NZ market. They split into 2 basic types: “bonds” and “preference shares”.

The major difference is that preference shares pay what is termed a 'dividend' but at a fixed rate, rather than 'interest' because 'dividends' can have imputation credits attached to them, and that has some distinct advantages. The other significant difference is that they are subordinate to any debt of the issuer -that is, they rank lower than debt - but rank ahead of ordinary shares.

Bonds (aka notes, securities)

Senior bonds: these sit at the top of the unsecured creditor ranking and are usually described as senior unsecured bonds or notes and are issued by non-banks.

Registered transferable deposits: the same as senior bonds but are issued by NZ banks.  NZ banks do not need to issue a prospectus and RTDs, as they are called (no, they are not alcoholic) are legally the same as ordinary bank term deposits, for all that means regarding potential government support.

Subordinated callable bonds: usually issued by financial institutions as a form of equity in the past, but the rules have changed so don't expect any more of these.  Normally have a call in 5 years and would have been expected to be called then. If not called, they reset at a larger than original margin over the 5 year swap rate. Beware ones issued before the recent financial turmoil as the reset interest rates may be attractive to the issuer.

Capital bonds: also called capital notes, in the NZ market these bonds are normally fixed rate, subordinated bonds with what is known as an 'election date'. At that date bondholders are offered a choice. The exact choice differs from bond to bond, but the bondholder will end up, at the issuer’s choice, either getting fresh capital bonds with a new interest rate and election date, or ordinary shares issued at the then market price (less a small discount) or have them redeemed for cash. The bond holder does not have the power to force redemption for cash at the election date. What that means is that the issuer can make the new terms to rollover terms so unpalatable as to effectively force conversion into ordinary shares.

Convertible bonds: in the NZ market, these are normally fixed rate subordinated bonds that at the conversion date can be converted into ordinary shares of the issuer at the then market prices (less a small discount) or redeemed for cash. In other markets, 'convertibles' are bonds that give the choice to convert to the bond holder, usually at a fixed share price.

Subordinated perpetual bonds: bonds with no maturity date but callable at the issuer’s option. In the NZ market, typically the coupon is reset every year.

Structured credit: these are usually bonds backed by assets (known as asset backed securities – ABS) or by mortgages (known as mortgage backed securities – MBS) and issued out of a trust or special purpose vehicle. However they can be structured in different ways (e.g. benefiting from a guarantee from a third party) so it is especially wise to look closely at the structure, terms and conditions and the assets backing the bonds.

Preference shares

Redeemable preference shares : usually have fixed rate or reset coupons. They are callable - that is, redeemable - by the issuer but are not convertible into ordinary shares and, if not called, are perpetual.

Convertible preference shares: the same as redeemable preference shares but can be converted into ordinary shares of, usually, the issuer at the issuer’s option.

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