DIY Investor Magazine
/
September 2016
28
As part of its ongoing campaign to see investors better
educated, Retail Bond Expert’s Mr Bond lifts the lid on
some of the markets worst excesses.
The previous article,
mentioned the Prospectus Directive, the basic rule
book governing the issuance of new securities to
investors. Under the PD there are two types of bonds,
Corporate Bonds and Asset Backed Securities
(‘ABS’).
•
A Corporate Bond can be issued by any type
of non-government entity. The issuer will be a
PLC, or the overseas equivalent, and will have two
years audited accounts. In some instance the
issuer will be a new company, likely a holding
company, in which case the two years accounts
will be provided by an operating company beneath it:
ARE SOME BONDS ISSUES EQUITIES
MASQUERADING AS DEBT?
The key points here are:
-
The accounts provide information that allows
investors to judge the risks inherent in an issue, and
provides the numerical raw material for the financial
covenants.
-
Should there be a default investors have access to
the issuer assets, except those specifically excluded by
pledges, e.g. bank guarantees, or mortgages.
•
Asset Backed Securities (‘ABS’), are notes backed
by financial assets. Typically these assets consist
of receivables such as mortgages, credit card
receivables, or auto loans. ABS differ from most
other kinds of notes in that their creditworthiness
derives from sources other than the paying ability of
the originator of the underlying assets
Financial institutions that originate loans—including
banks, credit card providers, auto finance companies
and consumer finance companies—turn their loans
into marketable securities through a process known
as securitisation. The loan originators are commonly
referred to as the issuers of ABS, but in fact they are
the sponsors, not the direct issuers, of these
securities.
These financial institutions sell pools of loans to a
special-purpose vehicle (SPV), whose sole function
is to buy such assets in order to securitise them, the
SPV is the actual issuer of the bonds.
MR BOND SAYS, ‘NO COUPON CAN COMPENSATE FOR
THE RISK YOU ARE BEING ASKED TO TAKE’
The key points are:
•
Bondholders have access only to the SPV’s
assets, i.e. the securitised loans, referred to as
collateral, which are the only assets of the issuer.
You should expect credit enhancement by
over-collateralisation
•
Bondholders are wholly dependent on the cash-
flows from the collateral to service coupons and
the repayment of the loans underlying the collateral
to repay principal.
As a simple summary, a corporate bond has two
years accounts to support it, an ABS has hard assets,
collateral, to provide the cash-flows to service coupons;
the collateral is self-liquidating which provides the
capital to redeem the bonds.
