This lesson offers insights into how a U.S. corporate bond is typically structured and priced in the primary market, including some of the regulatory rules that govern this process.
The corporate bond primary market is generally where sales of initial offerings takes place.
In this lesson, we’ll outline some of the steps involved in the creation of a corporate bond issuance, as well as some of the regulatory rules that govern this process.
Typically, a company that aims to sell debt enlists an investment bank for guidance on how it may best structure the offering, including the bond’s yield, its size, maturity, and whether it should be split into multiple tranches with varying amounts, expiries and fixed or floating rates of interest.
The investment bank also has several options, such as purchasing the entire issuance as a firm commitment underwriting, selling the notes in a best efforts approach, or forming a syndicate – oftentimes with selling groups – to help it offload the offering onto institutional and retail investors.
When a company issues new bonds, the proposed sale is subject to registration under the Securities Act of 1933, as well as compliance with the Trust Indenture Act of 1939, which generally requires a firm to establish an agreement with a trustee, if its debt issuance exceeds $10 million.
Meanwhile, a corporate bond that is offered to the public must be registered with the Securities and Exchange Commission, or SEC, under the Securities Act of 1933. As part of this registration process, the issuer typically provides a long list of details, including:
- Certified financial statements in compliance with U.S. generally accepted accounting principles, or GAAP, as well as
- Potential risks investors may face,
- A management profile,
- A list of major investors, and
- Certain features of the proposed bond offering.
Investors can also access the company’s prospectus, which is typically submitted by the issuer to the SEC when it registers its bond sale. You can conduct a search in the SEC’s EDGAR system, for example, which houses these prospectuses, as well as other filings required by the regulator.
Here, for example, is a prospectus cover of an offering from Whirlpool:
Prospectuses generally include a description of the proposed notes, the company’s use of proceeds, and other relevant items for investors to consider when deciding to purchase a corporate bond.
Alternatively, companies may sell bonds in a private placement to ‘so-called’ qualified institutional investors, such as an investment company, pension fund, or insurance company.
One of the primary motives for a company to conduct a private placement sale is that the costs involved in the transaction are generally lower than those of public deals. The lower cost is mainly because there are no requirements for its financials to comply with GAAP, or for the securities to be registered with the SEC. Moreover, marketing costs are usually reduced, given that there are not as many investors involved in the transaction.
Once all requirements are satisfied, and an initial structure for the deal is in place, the investment bank or syndicate will open the offering to investors, indicating an initial price or yield for the securities.
Depending largely on the level of orders for the bonds – or the investors’ demand for the issuance – pricing typically undergoes an evolution – meaning, over the course of the sale, a discount, or concession, may be given to increase demand or, if there is significant interest, the bonds may be offered at a higher price than originally announced.
Issuance that receives overwhelming demand from investors may also be ‘upsized,’ meaning the amount of proceeds the company initially aimed to raise may rise in size.
For example, a $500 million corporate bond that is offered at a yield of 6.5% may ultimately be increased to $600 million, with the yield to maturity lowered to 6.0%, if orders for the offering far exceed the original size of the deal.
After this process is complete, the offering is said to launch and sell at a final price, where it will be introduced in the secondary market for trading purposes.
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