14: Long-Term Debt and Leasingfunds in long-term (more than one year) debt security issues. Sinking funds work in such a way that the
typical bond issue with, say, a $100 million principal amount and a 15-year maturity will probably have
only a few million dollars’ worth of bonds still outstanding when the last bonds are redeemed 15 years
after issuance. Depending on the terms of the sinking fund, the actual average maturity of this issue (the
weighted average years outstanding) will probably be less than 10 years, not the 15 years originally stated.
Because sinking funds force corporations to redeem some bonds early, they reduce the risk of default
for two reasons. First, sinking funds increase the likelihood that investors will become aware of any
financial difficulties encountered by the issuing company early (when it misses a sinking fund payment)
rather than late. This will trigger the demand for effective corrective action, up to and including the
removal of the issuing company’s incumbent management team. Second, because at maturity only a
fraction of a given bond issue will remain outstanding, the issuing company’s managers will have less
incentive to default on the issue or attempt to expropriate bondholder wealth by filing for bankruptcy
protection.
Security Interest
The bond indenture is similar to a loan agreement, in that any collateral pledged against the bond, the
lenders’ security interest, is specifically identified in the document. Usually, the title to the collateral is
attached to the indenture, which also describes the collateral’s disposition under various circumstances.
The protection of bond collateral is crucial to increasing the safety – and thus to enhancing the
marketability – of a bond issue.
Trustee
A trustee is a third party to a bond indenture, and can be an individual, a corporation or, most often,
a commercial bank trust department. The trustee, whose services are paid for by the issuer, acts as a
watchdog on behalf of the bondholders, making sure that the issuer does not default on its contractual
responsibilities. The trustee is empowered to take specified actions on behalf of bondholders if the
borrower violates any indenture terms.
14 -3c METHODS OF ISSUING CORPORATE BONDS
The Australian corporate bond market is small relative to the size of the markets for Australian government
and state government bonds. Nonetheless, there has been increasing encouragement from regulators
such as the ASX, and the Australian Federal Treasurer to make it easier for companies to issue bonds in
the country. In Australia, offers of corporate bonds to retail investors generally require full prospectus
disclosure. In May 2010, the Australian Securities and Investments Commission (ASIC) provided
conditional relief from many of the more onerous prospectus requirements for issuers of vanilla (plain)
corporate bonds. The ASIC initiatives simplified the disclosure requirements for certain offers of listed
vanilla bonds by allowing such offers to be made with reduced disclosure under a short-form prospectus.
The measures also allowed vanilla bonds to be offered under a two-part prospectus, comprising a base
prospectus (which may be used for a number of different offers) and a second part prospectus (which
can relate to a particular offer).
Large offerings of corporate bonds are generally underwritten by an investment banking syndicate,
because no single bank is willing and able to support the risk inherent in the full funding. However,
there is tremendous variation in actual offering procedures, and these differences have increased over
time as new debt securities have developed. There is clearly international competition among capital
trustee (bond)
A third party to a bond
indenture that acts as a
watchdog on behalf of the
bondholders, making sure that
the issuer does not default on
its contractual responsibilities