subordinated either to designated notes payable (usually bank loans) or to all other
debt. In the event of liquidation or reorganization, holders of subordinated
debentures cannot be paid until all senior debt, as named in the debentures’
indenture, has been paid.14.12 Some companies may be in a position to benefit from the sale of either
development bonds or pollution control bonds. State and local governments
may se t up both industrial development agencies and pollution control agencies.
These agencies are allowed, under certain circumstances, to sell tax-exempt
bonds, then to make the proceeds available to corporations for specific uses
deemed to be in the public interest.
14.13 Municipal Bond Insurance, Municipalities can have their bonds insured, in
which an insurance company guarantees to pay the coupon and principal
payments should the issuer default. This reduces risk to investors, who will thus
accept a lower coupon rate for an insured bond vis-à-vis an uninsured one. Even
though the municipality must pay a fee to get its bonds insured, its savings due to
the lower coupon rate often makes insurance cost-effective.
- Basis for bond ratings:
Bond ratings are based on both qualitative and quantitative factors, some of which are
listed below:
- Ratios: How strong are the debt ratio, the times-interest-earned ratio, the fixed
charge coverage ratio, the current ratio, and other ratios? The better the ratios, the
higher the bond’s rating. - Mortgage provisions: Is the bond secured by a mortgage? If it is, and if the
property has a high value in relation to the amount of bonded debt, the bond’s rating
is enhanced. - Subordination provisions: Is the bond subordinated to other debt? If so, it will be
rated at least one notch below the rating to the amount of bonded debt, the bond’s
rating is enhanced. - Guarantee provisions: Some bonds are guaranteed by other firms. If a week
company’s debt is guaranteed by a strong company (usually the weak company’s
parent), the bond will be given the strong company’s rating. - Sinking fund: Does the bond have a sinking fund to ensure systematic repayment?
This feature is a plus factor to the rating agencies. - Maturity: Other things the same, a bond with a shorter maturity will be judged less
risky than a longer-term bond, and this will be reflected in the ratings. - Stability: Are the issuer’s sales and earnings stable?
- Regulation: Is the issuer regulated, and could an adverse regulatory climate cause
the company’s economic position to decline? Regulation is especially important for
utilities, railroads, and telephone companies. - Antitrust: Are any antitrust actions pending against the firm that could erode its
position?