Issuing Bonds is just another way a company can access cash for their business. Documentation and pricing is key to structuring a new issue.
The process for new bond issuing begins when a company, or issuer, decides it wants to access the Canadian debt market.
Why would a company want to access debt markets? There are a multitude of reasons, but one of the most common is that a company needs to replace an issue that is maturing. It might also need cash to pay for a purchase or new project, want to add leverage to its balance sheet, or perhaps repay short-term debt and issue longer-term debt because it likes where the longer-term coupons are.
A company’s decision to issue debt is based on its belief that there’s an available market for that debt. It’s the job of investment dealers to advise companies as to whether that debt could be salable (although as an aside, that advice is not always right!).
The investors who would be interested in purchasing that debt would typically be institutional investors like pension funds, investment councilors, fund managers and hedge funds. These are the largest and most sophisticated debt buyers.
One of the ﬁrst things the issuer needs to do is get credit ratings from an accredited rating agency. Market convention in Canada recommends using two or more ratings for frequent issuers and at least one for less frequent ones. Most institutional investors have their own credit research teams and make decisions about credit worthiness on their own. No matter how you choose to go about it, ratings are a necessary box most investors must check.
Corporate issuers also need to document the transaction with both the regulators and investors. These documents are prepared by external lawyers and can take five to seven days.
Issuers can choose to document and access the public markets in two possible ways:
1) Short Form Base Shelf
If the issuer plans to access the public market frequently (more than once a year), he would likely choose to document the issue using a short term base shelf. The short-term base shelf (SFBS) has a term of 25 months and provides a general description of the debt securities. The SFBS allows the issuer quick access to the market, taking advantage of good market conditions. Once the SFBS is approved by the regulator, the issuer can complete the entire issuance process within 24 hours. All he needs to do is provide the market with a preliminary term sheet that details the terms of the prospective issue. Once the issue is priced, the issuer is required to ﬁle a ﬁnal pricing supplement with the ﬁnal pricing terms of that speciﬁc transaction. In order to ﬁle a SFBS, the issuer has to be a public company in Canada and a reporting issuer in Canada.
2) Long Form Prospectus
If the company is an infrequent issuer (once every three to five years), it will likely choose to access the market through a long form prospectus. If the ratings for the issuer are current, the issuer can have this process turned around in five to seven days. The issuer would ﬁle a preliminary prospectus with the regulator, detailing a lot of the same information in the short from base shelf. Once the preliminary prospectus is approved, the new issue can be introduced into the market. After the issue is priced, the issuer will ﬁle the ﬁnal prospectus with all the ﬁnal pricing terms of the transaction.
For those looking to access the private placement market, there is a third option:
3) Private Placement Sold to Accredited Investors Only
Public and private companies can issue to accredited investors without regulatory approval. In this situation, the issuer must provide an offering memorandum with all the same details that would be found in the two methods above. Investors would be required to provide their name and address to the regulator, as well as an acknowledgement that they understand they’re buying a private placement. This route is commonplace among Canadian subsidiaries of foreign multinationals who are reporting issuers in their home market, but whose Canadian subsidiaries are not in Canada.
There is also a pure private placement market that is very bespoke in nature and not marketed to the broader market. Issue sizes are small, generally lower rated (crossovers between investment grade and non-investment grade) and purchased by investors that buy and hold to maturity. This is a distinct market from the one described above.
Agented vs. Underwritten Transactions
Another decision issuers have to make is whether they want to access the market with an agented or underwritten transaction.
The large majority of high-grade corporate issuance in Canada is completed on an agented basis. There are a number of reasons for this. For one, the short term base shelf process described above is largely used by frequent issuers, who by deﬁnition have previously issued issues (secondary bonds) in the market. Having more secondary bonds in the market provides more clarity for issuers and investors as to where new issue bonds should be introduced into the market. More clarity leads to more certainty, which means issuers are more willing to introduce agented issues into the market.
Why would issuers be willing to launch a deal into the market on an agented basis? Lower fees. Agented deal fees are lower than underwritten fees.
The large majority of high-yield issuance in Canada, on the other hand, is completed on an underwritten basis. High-yield transactions tend to, by deﬁnition, be higher risk credits issuers and more infrequent issuers. There’s not as much clarity in the secondary market as to whether a new issue could be launched, or when. As a result, high-yield issuers are willing to pay higher fees for certainty of execution.
The large majority of equity issues in Canada are also launched into the market as underwritten deals. Equities are a higher-risk asset class, and as such, equity issuers are also willing to pay for certainty when it comes to execution.
Going To Market
Issuers will generally hire one or multiple dealers to provide structuring and documentation guidance as they work on accessing the market.
Once all of this groundwork has been laid, the real fun begins.
First, the issuer must get internal approvals to execute the transaction. He would then decide on a syndicate of investment dealers who will execute a deal based on agreed documents and terms. Within that syndicate, he would also pick one or more lead dealers for the transaction. Typically, the dealers who worked on the documents become a least one of the execution leads.
In an agented investment-grade transaction, the key terms of the proposed transaction are agreed upon by the issuer and lead dealers. With the issuer’s approval, the leads then go out to the market (investors) to determine if the proposed terms are salable.
The proposed terms would include ranking of the debt, term, amount, price (in the corporate market this would be a spread expressed in basis points over the government curve) and covenants.
For an investment-grade issuer, the issue is launched with a price (spread) expressed as a number with a spread range of plus or minus (+/-) something usually inside of 5 basis points. An example of this would be +98 (+/- 3 bps). Investors would put in orders with a face amount of bonds either at market (which would be at whatever the clearing spread is) or at a speciﬁed spread.
For an underwritten investment-grade transaction to get priced in Canada, the issuer would agree on all the terms with the underwriters (dealers) and then the deal would get priced between the issuer and the underwriters. The details of the underwritten deal would be sent out in a press release by the issuer, and shortly after that, the issue would be launched to the market.
Most underwritten transactions are launched at a speciﬁc spread with no range attached to it. Once the issue is subscribed for by investors, the issue gets re-priced between the underwriters and the investors at the agreed upon spread.
The last and most interesting part of the process is the pricing of the transaction. After the investment dealers launch the issue, investors put orders into “the book” with amounts and sizes attached to them.
When the issuance market is strong, most investors put in market orders; when the market conditions are weak, many investors might put in orders with conditions attached. Examples of these “conditions” could be different spreads or different parts of the capital structure (senior debt versus subordinated debt), different maturity dates, minimum issuance size and suggested covenant changes.
Once the intended issue size is fully subscribed for at the agreed-upon terms and all the allocations to investors have been made, the issuer gets on a call with the investment dealers to put the pin in the price.
Finding Common Ground
In the end, what issuers are seeking to accomplish when they are issuing bonds is terms they’re comfortable with, pricing that’s acceptable to them, distribution to investors that’s broad, smooth execution from their syndicate and good support from that syndicate in the secondary market.
What investors are seeking when they participate in a new issue is terms they’re comfortable with, pricing that’s acceptable to them and a balance of an allocation and performance/support of the bond in the secondary market.
Despite the potential conﬂicting objectives of issuers and investors, many of their objectives overlap.
The real role of the investment dealers is to get these two groups together to agree for their – and the market’s – mutual beneﬁt.
From time to time the pendulum swings from one side to the other, but the beauty of the market is that eventually, it will swing the other way – usually when everyone least expects it.