Explaining Call Skips for Subordinated Bonds [Customer Question Series ⑨]
Hello.
I am Taisei Fujimura (https://wealth-partner-re.com/) and I work as an IFA for high-net-worth individuals at Wealth Partner (https://twitter.com/wp_fujimura).
Subordinated bonds, perpetual subordinated bonds, and CoCo bonds have call dates (early redemption dates) set, but did you know that these can sometimes be skipped? In this article, I would like to write about call skips for bonds.
(1) What is a call skip?
A call skip refers to a situation where the bond issuer decides not to redeem the bond on the early redemption date. Generally, if a bond has an early redemption clause, it is customary to redeem it at that time, but redemption may be skipped due to various factors.
(2) When does a call skip occur?
Call skips for subordinated bonds, perpetual subordinated bonds, and CoCo bonds can be triggered by factors such as the following:
・When re-issuance is difficult due to economic shocks, etc.
For example, many perpetual subordinated bonds that reached their early redemption dates between 2008 and 2009, during the Lehman Shock, had their redemptions skipped.
In situations where the entire market is in a panic, it is often the case that bonds cannot be issued unless they offer high interest rates. If the issuer determines that it is more economically rational to continue the bond rather than redeem it, they may choose to skip the call.
・When the issuer's financial condition has deteriorated significantly
If the issuer were to redeem the bond while their financial condition is in question, it is likely that they would have to offer high interest rates to raise funds again.
If the issuer determines that it is more economically rational to skip the call rather than redeem, they may choose to skip it.
・When the interest rate after the call skip is cheaper
The decision to skip a call is made by comparing the "interest rate if the call is skipped" with the "interest rate if the bond is redeemed and a new one is issued," and choosing the option with higher economic rationality.
If the issuer's credit risk is temporarily elevated, they may not be able to raise funds unless they offer a high interest rate when trying to issue new bonds.
In such cases, there may be a possibility of a call skip.
The interest rate changes before and after a call skip. Since skipping a call can sometimes result in a significantly lower interest rate compared to redeeming and issuing a new bond, there is a possibility of a call skip in such cases.
(3) Disadvantages for the issuer due to call skips
Investors purchase bonds with the expectation that they will be redeemed on the early redemption date. Therefore, if a call is skipped, the price of the bond may drop significantly.
There are three disadvantages for the issuer when they perform a call skip.
・Risk of reduced capital recognition
Subordinated bonds, perpetual subordinated bonds, and CoCo bonds are special bonds where a portion of the issued bonds can be counted as net assets rather than liabilities.
The remaining term is included in the criteria for determining this capital nature. By skipping a call, the remaining term becomes shorter, which may reduce the amount recognized as capital.
・Risk of rising interest payments
In many cases, the interest rate changes after a call skip, and often the design is such that the interest rate increases compared to before the call skip. The issuer may see an increase in the interest paid to investors. From an investor's perspective, this is not a bad thing as the interest paid annually increases.
・Risk of reputational damage
Basically, investors purchase bonds with the expectation that they will be redeemed on the early redemption date. Since a call skip betrays the expectations of investors, there is a risk that creditworthiness in the market will decline, making it difficult to raise funds, such as being unable to gather funds unless high interest rates are offered when issuing bonds.there is
(4) Disadvantages for investors
・Disruption of plans
Investors generally invest on the assumption that the bond will be redeemed at the time of early redemption. However, if it is skipped, you will continue to hold the bond, so if you had planned to use the investment funds for something else at that time, you will not be able to use those funds unless you sell the bond.
When investing in bonds with early redemption clauses, you should invest with long-term funds for which you have not yet determined a specific use.
(5) Specific examples of call skips
Please also see the following article, which summarizes examples of call skips.
(6) Summary
This time, we discussed call skips on subordinated bonds. The possibility that a bond may not be redeemed at the expected time can be very unsettling, but it is nothing to fear if you manage your risks.When investing in bonds with early redemption clauses, please invest with funds that you do not need to use at that time, rather than funds for which you have already determined a specific use.
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