Bonds

 

What are bonds?

A bond is a debt security. It is a form of borrowing. Governments and companies issue bonds to raise funds from investors willing to lend them money for a period of time. Investors, including retail investors, buy bonds to earn interest during the life of the bond. Bonds can form part of investors’ investment portfolios.

Most bonds pay a regular stream of interest income throughout their life, also known as coupon. Coupon rates are typically expressed as a percentage of the principal amount, which is also known as the “face” or “par” value. Upon maturity, bonds are redeemed at the face or par value.

Why invest in bonds?

Typically, you can earn returns through:

  • Interest income. Bond issuers pay regular coupon payments to investors throughout the life of the bond.
  • Capital gains. You can earn capital gains if you sell the bonds at a higher price than the price you bought them.

It is important to note that while the coupon rate is generally fixed through the life of the bond, the price of the bond may vary. Hence, in deriving a bond’s return, you will have to consider (i) the coupon that you will receive over the life of the bond and (ii) the potential capital gains or losses if the price of the bond becomes higher or lower than the price you initially paid.

Bond prices

Bond prices are usually quoted as a percentage of the par or face value of the bond, e.g. 101% or 96%.

Comparison Status
 Bond price > Face value Premium
 Bond price < Face value Discount
 Bond price = Face value Par 

Ignoring fees and transaction costs,

If you buy a bond at a premium, your return is lower than the coupon.

If you buy a bond at a discount, your return is higher than the coupon.

If you buy at par, your return is equal to the coupon.

Are bonds suitable for you?

Bonds may be attractive for investors who desire a source of regular income, or are looking to diversify their portfolio of investment assets.

You should consider the suitability of an investment in bonds in light of your own circumstances. In particular, you should consider whether you:

  • understand thoroughly the terms and conditions of the bonds;
  • are able to evaluate the investment in the bonds and how such investment will impact your overall investment portfolio;
  • have sufficient financial resources and liquidity to bear all the risks of investing in the bonds or holding the bonds to maturity, including losing all or a substantial amount of the capital invested;
  • are able to monitor or evaluate (either by yourself or with the help of a financial adviser) changes in economic or other factors that may affect the issuer or the bonds.

How can I buy or sell a bond?

Buying a bond

You can buy a bond at issuance, through a public offer. You will pay the face value of the bond.

You can also buy a bond from the secondary market (after issuance), as long as there is a seller for it. This can be done through a securities exchange, such as the Singapore Exchange (SGX). The price you pay for the bond depends on the prevailing price at the time of your purchase. You will also need to pay transaction fees, such as brokerage fees.

Selling a bond

You can hold the bond to maturity. You can expect to be repaid the principal amount of the bond at maturity provided that the government or entity that issues the bonds (also referred to as the “bond issuer”) does not default.

Before the bond matures, you can sell the bond in the secondary market, as long as there is a buyer for it. The price you receive for selling your bond depends on the prevailing price at the time of sale. If you sell the bond at a price higher than what you paid, you can make a capital gain. However, you could suffer a loss if you sell the bond at a lower price.

Why do bonds have different coupon rates?

1. Credit quality of issuer

The coupon rate offered by an issuer is generally related to its credit quality. Issuers with lower credit quality generally pay higher coupon rates on their bonds. This is because when an issuer has a lower credit quality, there is a greater probability of default. Such issuers typically issue bonds with higher coupon rates in order to compensate investors for the higher risks. This means that bonds that offer high yields usually are of lower credit quality, and are at a higher risk of default. It is thus important for you to carefully study the credit risk of the issuer and whether you have the risk appetite to invest in such bonds.

You can assess the credit issuer of the issuer through its credit ratings or by using credit metrics.

Credit ratings

Some bond issuers and/or bonds have a credit rating. This is one way to get an indication of the issuer’s creditworthiness. Bonds rated BBB and above are typically regarded by the market as having investment grade quality.

However, you should not rely solely on credit ratings when making your investment decision. You must make your own credit assessments, and the following credit metrics can serve as a guide.

Credit metrics

Some useful financial credit metrics that you could look out for are:

  • Debt to equity ratio – it measures how much debt an issuer is using to finance its assets and operations, as compared with the issuer’s equity. A high level of debt suggests higher risk. If debt to equity ratio is more than 2, it means that to finance its operations, the issuer has more than twice the amount of debt compared with equity.
  • Debt to operating income ratio – it indicates the ability of a company to pay its debt using operating income. A higher ratio suggests that the company may have more difficulty servicing its debt. A declining ratio is better than an increasing one because it implies the company is paying off its debt and/or growing earnings.
  • Interest coverage ratio – it reflects how many times the issuer can pay interest on debt obligations, using its operating income (or earnings). A lower interest coverage ratio means a weaker ability to cover interest obligations using its operating income. If the ratio is less than 1, it means that the issuer does not earn enough to cover its interest expense.
  • Operating profit margin – it measures operating profit (or operating income) as a percentage of revenue. This shows the proportion of revenue left, after the issuer pays for operating expenses (such as wages), which can be used to pay for fixed costs (such as interest). The lower the operating profit margin, the higher the risk of the issuer not being able to pay its fixed costs.
  • Free cash flow – it refers to the cash that a company has after spending money to maintain or expand its assets. An issuer with a profitable and well-managed business should exhibit positive free cash flows consistently.

You should compare the credit metrics of an issuer with that of other similar entities, as financial ratios vary across industries.

2. Tenure of the bond

Bonds from the same issuer with longer tenures tend to provide higher coupon rates than bonds with lower tenures. This is to compensate the investors for holding the bonds for a longer period of time as the chance of default rises with the duration of the bond.

Callable bonds have a feature which gives the issuer an option to buy back (redeem) the bond before its maturity date. The issuer may specify a price at which it will call (or redeem) the bonds. If a bond is called when prevailing interest rates are lower than at the time you bought it, you will be exposed to reinvestment risks.

3. Government bonds versus corporate bonds

For any particular country, the safest and highest credit quality bonds are usually its government bonds, followed by quasi-government or government linked entities, banks and then companies. Investors interested in the safety of their bond investments should consider government or investment grade corporate bonds, while investors willing and able to accept a higher level of risk could consider lower credit-quality or non-rated bonds.

It will also be advisable to diversify and avoid concentrated exposures to any one security. Individual investments can go up or down in value. Investing in different products is usually a good strategy to diversify and reduce the risks.

What are the risks of bond investments and what is the maximum I can lose?

As with most forms of investment, you can lose part or even all of your invested amount. Generally, investors are encouraged to invest in a diversified portfolio to reduce the risk caused by a concentration of similar assets.

Here are the risk factors that can impact your investment:

Factor/risk What this means
Default risk or credit risk Bonds are forms of debt owed by the issuer to the bondholder, so bond prices will be affected by the perceived credit quality or probability of default of the bond issuer. Default risk can change due to broader economic changes or changes in the financial situation of the company or country.

When an issuer defaults on its bond, it means that the issuer is unable to provide regular interest payments or return the original investment amount to the bondholder upon maturity. As such, as a bondholder, you may lose all or a substantial part of your investment.
Price risk and interest rate risk A basic relationship that bond investors must keep in mind is that interest rates and bond prices move in opposite directions. This means if prevailing interest rates rise, you will likely see a fall in bond prices, and vice versa.

If bond prices fall, you could experience a capital loss if you sell the bonds before maturity.

Longer term bonds are more sensitive to interest rate changes than bonds with shorter maturity dates.
Liquidity and market risk This will affect you if you want to sell the bond before it matures. A bond’s price will fluctuate with changing market conditions, including the forces of supply and demand of the bond in the secondary market.

For instance, if there are not many interested buyers of the particular bond, it means that the bond is not very liquid and it will be harder for you to sell the bond or you may have to sell the bond at a loss before maturity.
Risks linked to the bond's contractual arrangement A bond is a contractual arrangement between the issuer and you as a bond holder when you invest in the bond. The terms and conditions governing each bond can differ significantly, and you should always read and understand the terms carefully before investing in any bonds. In addition, the terms and conditions of the bonds may change if bondholders agree to changes proposed by the bond issuer.

For example:

Call risks:

Some bonds have a callable feature which gives the issuer an option to buy back (redeem) the bond before its maturity date. These bonds may be redeemed by the issuer when they want to refinance at lower interest rates. This may be unfavourable to you because you may not be able to reinvest in a product with equivalent interest payments.

Early redemption risk:

Bonds may come with terms that allow the issuer or the bondholder to redeem the bonds prior to maturity under certain circumstances. You should take note of which party has the right to exercise the option and the circumstances under which it may be exercised. For example, the issuer may provide for itself to be able to redeem the bonds before maturity for taxation reasons (i.e. if the issuer incurs additional costs for taxation reasons as a result of a change in a law).

What types of bonds/fixed income products are there?

There are different types of bonds to invest in, depending on your investment objectives. Common types of bonds include bonds issued by the government or corporate companies, as well as perpetual securities/perpetual bonds. There are also bond funds or bond ETFs available. Note that some bonds, bond funds or bond ETFs may constitute Specified Investment Products (SIPs). For more information on the requirements in place when transacting SIPs, please refer to the consumer guide on SIPs.

Government bonds

Bonds issued by the government are a form of borrowing by the government to support government spending. Such government bonds are generally considered as having lower risk because the bond is backed by the credit of the government where default is unlikely. Hence, the interest rates on government bonds tend to be lower than those of bonds of other issuers of the same maturity.

In Singapore, both institutional and retail investors can purchase Singapore Government Securities (SGS) that are backed by the Singapore Government. Unlike many other countries, the Singapore Government does not need to finance its expenditures through the issuance of government bonds as it operates a balanced budget policy and often enjoys budget surpluses.

For more information, visit the SGS website.

Singapore Savings Bonds

In recent times, the Singapore Government has introduced a new type of government bond called the Singapore Savings Bonds (SSBs) which are designed specifically for retail investors as a low-cost and low-risk savings product.

Key features of SSBs

  • Safe - Issued and backed by the Singapore Government.
  • Step-up interest rates - The longer you hold your bond, the higher your return. Interest payments are paid every 6 months. Upon maturity, you will get back your full principal amount.
  • Low-cost product – there is no investment fee/charge, apart from the $2 fee charged by banks for application and redemption requests.
  • Flexible redemption option: You don’t have to decide at the start how long you want to hold your Savings Bonds for. You can get your funds back within a month, with no penalty(i.e. no capital losses).

You can apply for each Savings Bond issue with as little as $500, and up to $50,000. In addition, you will be able to hold up to $100,000 of Savings Bonds at any point in time.

How are Savings Bonds different from conventional SGS?

  • Firstly, Savings Bonds are not tradable while conventional SGS can be sold on SGX. However, this means that the prices of conventional SGS can change, depending on market interest rate movements and financial market conditions. So you may receive more or less than your invested capital if you sell your conventional SGS in the secondary market before maturity.
  • Secondly, you can redeem the full principal amount for Savings Bonds in any given month, without any capital losses. However, early redemption for conventional SGS is not available.
  • Finally, Savings Bonds have a lower minimum investment amount and unit size of $500 compared with $1,000 for conventional SGS. Individuals can hold up to $100,000 of Savings Bonds at any point, but there are no investment limits on conventional SGS.

For more information, visit the Singapore Savings Bonds website.

Corporate Bonds

Corporate bonds usually pay out higher interest rates than government bonds because they generally carry more risk.

You can purchase corporate bonds listed on SGX in the same way as you would buy equities, paying the normal brokerage fees. While corporate bonds may offer better returns than savings and fixed deposits, you should note that you will be exposed to credit and other risks. You should therefore consider whether you are able and willing to take a higher risk of default and losing part or all of your investment, in return for higher yields.

Perpetual Securities/ Perpetual Notes/ Perpetual Bonds/ Perpetual Capital Securities

Perpetual securities (also known as perpetual notes, perpetual bonds, or perpetual capital securities) are hybrid securities that combine the features of both debt and equity. You should note that even though perpetual securities have some bond-like features (such as coupon payments), they are not plain vanilla bonds.

Firstly, perpetual securities do not have a maturity date. Secondly, the issuer may, but is not obliged to, redeem the perpetual securities. If the issuer does not exercise the redemption option, you can only exit your investment by selling the perpetual securities in the secondary market. You will therefore be exposed to market price fluctuations and liquidity risks.

In some issues, it is also possible for the issuer to have the right to defer the coupon payments. In the event of a winding up of the issuer, holders of perpetual securities normally rank ahead of ordinary shareholders but behind other senior creditors for the return of the issuer’s assets. If a bond is called or redeemed when prevailing interest rates are lower than at the time you bought it, you will be exposed to reinvestment risks.

Bond Funds

An investor can also gain exposure to bonds by purchasing units in bond funds.

There are different types of bond funds, including global bond funds, regional bond funds, country-specific bond funds, sector or industry specific bond funds, and high yield bond funds. Each has its own investment objective. While many funds regularly pay income (the actual amount paid depends on factors such as market conditions as well as the coupons received from the bonds held), investors of bond funds are generally encouraged to examine total returns when evaluating a bond fund’s performance. Total returns include income generated by bonds held as well as gains or losses of those bonds over a period of time.

Investing in bond funds is usually more practicable than investing directly in the underlying bonds of the funds. Firstly, you do not need as big a capital outlay as if you were to buy all the bonds in the fund. Secondly, the task of actively managing your bond holdings to control your portfolio’s risks and achieve desired returns is passed on to the fund managers. But such activities attract management fees and/or other professional charges, which will reduce the overall returns to you.

Bond ETFSs

Bond ETFs are exchange-traded bonds funds that typically aim to track the performance of bond indices. They may invest in a portfolio of bonds, or replicate that exposure through the use of derivative products like swaps. The Bond ETFs can have different strategies.

Read here for more information on ETFs.

What happens when a bond defaults?

What are defaults?

When a bond issuer fails to make an interest or principal payment by the due date, the bond issuer is generally considered to have “defaulted”. Failure to pay interest or principal usually means an “event of default” has occurred. Failure by the issuer to observe financial covenants, such as ensuring that the net borrowings to total equity does not exceed a certain ratio, could also constitute an “event of default”. The issuer will define the “events of default” in the terms and conditions of the bond which should be disclosed in the offer document given to you.

How can I know when a bond issuer is in trouble?

You, as an investor, must monitor your own investment. If the bond or the issuer is listed on SGX, you should keep a look out for announcements relating to the bond or the issuer.

If the issuer is listed on SGX, its financial statements are required to be announced on a quarterly or half-yearly basis, and its annual report must also be made public. If the issuer is not listed on SGX but its bonds are, its financial statements must nonetheless be disclosed regularly as approved by SGX. Such disclosure arrangements can be found in the offer documents for the bonds. You can look at the periodic financial statements, the annual report, and other documents the issuer may publish to keep up to date on the issuer’s financial situation.

There could also be news reports on the financial position of the issuer, or on the issuer’s industry outlook. You need to assess whether to hold on to the bonds, or to sell part or all of your investment. Seek professional advice if needed.

If you are a bondholder and have some concerns about the company’s compliance with SGX’s listing rules, or about possible market misconduct, you may wish to contact SGX. SGX is the frontline regulator and is required to administer a sound regulatory framework to maintain a fair, orderly and informed market.

What are the possible outcomes when an issuer defaults or is likely to default on its bond payments?

There are three possible outcomes: Debt Restructuring; Winding Up or Judicial Management.

Debt restructuring

When an issuer faces financial distress, it may decide to restructure its debt. The objective of debt restructuring is to renegotiate and modify the terms of the bond to provide relief to the issuer who could otherwise default on payments. Some ways the issuer could conduct debt restructuring include:

  • reducing the amount owed such that the investor will be paid less than what was originally promised;
  • extending the tenure of the bonds such that the issuer can repay the principal at a later date; or
  • exchanging the debt for equity such that the investor will receive shares in the issuer in exchange for the bond, and will no longer be entitled to the principal or the coupons.

To achieve this, the issuer typically engages bondholders in a consent solicitation exercise to seek bondholder approval for the modification of the terms of the bonds. Consent solicitation exercises usually involve the voting for an extraordinary resolution to approve the proposed modifications. Bondholders can choose to vote in favour of the proposal by delivering voting instructions in accordance with procedures outlined by the issuer. You should review the proposed terms and explanations provided by the issuer when deciding whether to approve the proposal.

If a financially distressed issuer is unable to restructure its debt, it may run into problems fulfilling the payment obligations under the bonds and could eventually default on the bonds. When an issuer is unable to pay its debts, it may eventually be wound up.

Winding up

In general, a company can be wound up, or liquidated, in two ways: (i) voluntarily, or (ii) by the court. When a company is wound up, it ceases to operate its business, and the assets are sold off. The proceeds from the sale of assets would be paid to creditors (including bondholders) ahead of shareholders.

An issuer may structure its debt into different classes – senior debt and junior debt. Usually, secured debt is classified as senior debt while unsecured debt is classified as junior debt. Among bondholders, senior debt is paid first, followed by junior debt. Bondholders may not necessarily get all or part of their monies repaid. It depends on the amount of proceeds from the liquidation. Holders of unsecured bonds, for instance, may not be paid at all if the issuer’s assets are not sufficient to pay the holders of secured bonds.

Judicial management

For a company incorporated in Singapore, an alternative to winding up is for the company or its creditors to apply to the Court to put the issuer under judicial management. In general, when a company is under judicial management, the company is protected from claims by creditors. Bondholders are unlikely to receive their coupons or principal payments on their bonds. During this period, the judicial manager takes on the role of the company’s board of directors and runs the business with the aim of its survival or to realise the assets for the benefit of creditors without liquidating the company. The judicial manager will provide creditors with a statement of proposals (e.g. a proposal for achieving the survival of the company), and the creditors will decide at a meeting of creditors whether to approve the judicial manager’s proposals.

Which of the three options – debt restructuring, liquidation or judicial management – should I opt for?

If a debt restructuring proposal has been tabled, some investors prefer to accept the proposal because they take the view that debt restructuring gives them a chance of recovering at least part of their investment sum. Furthermore, liquidation can be a long process and there could be significant legal costs involved.

Some may take the view that there is too much uncertainty and prefer to require the issuer to repay the amounts owed under the bonds, failing which the issuer should be liquidated.

Others may be inclined to give the issuer a chance for its financial position to be improved through judicial management, which could mean eventual repayment of their investment sum.

The Companies Act, administered by the Accounting and Corporate Regulatory Authority (ACRA), applies to the judicial management and winding up of Singapore-incorporated companies. Companies that are incorporated in other jurisdictions are subject to the laws of those jurisdictions.

What is a trustee and what is its role?

A trustee is normally appointed by the issuer to represent the bondholders. Trustees are expected to exercise reasonable care and skill in carrying out their duties.

The duties and obligations of trustees for any bond issue are provided for under the trust deed (between the issuer and trustee) and the law. The trust deed also contains provisions for the protection of the rights and interests of bondholders, such as a limitation on the amount that the company may borrow, as well as the procedures for convening meetings to consider matters that affect bondholders’ rights or interests.

The trustee acts for the bondholders on the terms contained in the trust deed. Bondholders should read the key terms and conditions of the trust deed provided in the offering document. The issuer is obliged to promptly inform the trustee when it is aware of any event of default or when any condition of the trust deed cannot be fulfilled.

How can bondholders enforce their rights when an issuer defaults?

Where the issuer is unable to meet its obligations under the bonds, bondholders would have to enforce their rights under the trust deed. Trust deeds often provide that bondholders who in aggregate hold a certain amount of the bonds (e.g. 25% of the principal amount of the bonds) can instruct the trustee to take action.

For instance, bondholders may request the trustee to give notice to the issuer that the bonds are immediately repayable following the occurrence of an event of default. After the bonds become due and payable, bondholders may request the trustee to institute proceedings against the issuer - for example, to enforce the security (if the bonds are secured) or make a winding-up application.

Particularly where individual bondholder investments are relatively small, collective enforcement of the bondholders’ rights through the trustee allows bondholders to act as a cohesive group. It also serves as a safeguard against situations where individual bondholders, acting on irrational fears or in self-interest, may prematurely call on the repayment of debts against the issuer and cause overall greater losses for all bondholders. In this regard, bondholders may sometimes choose to form an ad hoc committee and retain legal counsel, to consider the course of action and to communicate with the issuer and the trustee.

Indemnity & Pre-Funding

It is common for trust deeds to provide the trustees with the right to seek an indemnity and pre-funding from bondholders before taking the action requested by bondholders as the trustees may incur costs (e.g. legal expenses) and could be exposed to legal liability that may arise from taking such action.

Do note also that before a trustee acts on a request from bondholders, it would have to take steps to verify that the request comes from the beneficial owners of the bonds and that the value of the bonds held by the instructing bondholders meets the relevant threshold under the trust deed. Where the bonds are held through custodians or nominee banks, the trustee would have to work with these parties during the verification process. This process can take some time.