Bond Indenture

Introduction to Bond Indenture

Bond indenture is a long & complex legal document entered into between bond issuer and investors (i.e. bond holders) managed through a trustee or fiscal agent which can be a bank or any financial institution and such document includes the details of the issue, the objective of the issue, rights of the bond holders to receive the income and obligation of the issuer towards payment of coupon and repayment of payment on respective due dates.

Explanation

• We can simply say that a bond indenture is a legal contract. It specifies everything about the issue, the issuer, and the obligations of the issuer. It also clearly lays down the rights of the bond holders. The US SEC (Securities and Exchange Commission) mandates the issue to be handled through a trustee or a fiscal agent.
• The job of the trustee would be the preparation of the indenture document and ensure that the issue takes place only as per provisions contained in the document.
• Thus, we can say there are three persons involved in the bond indenture, namely the issuer, the bondholder, and the fiscal agent/trustee.
• The document is lengthy and complex. The bond indenture document contains specific provisions that are important in the whole document. Some of the important provisions include definitions, issue, execution, and authentication of notes, redemption, defaults and remedies, and trustee.
• The end part of the document includes the signatures of relevant parties.

Example of Bond Indenture

We can consider the example of bond indenture document of “Utility Debt Securitization Authority” and the bond holders, issued on April 07, 2016, through bond trustee “The Bank of New York Mellon”. This document highlights details of a bond issue for $ 636,770,000.

Full details of the indenture document can be accessed as below:

https://www.lipower.org/wp-content/uploads/2016/11/2.-Bond-Indenture.pdf

Crux Information of the document is as follows:

• Principal Amount: $ 636,770,000
• Staggered repayment of principal after 2023 in 15 tranches
• Term of bond repayment
• Restriction on an optional redemption
• Coupon payment: semi-annual
• Interest calculations: 360 days basis
• Coupon rate: 5%

What Parties Are Usually Associated with Bond Indenture?

Parties	Explanation
Bond Issuer	This is the person who issues the bonds. The document clearly states the obligations of the issuer. Issuer undertakes the responsibility to pay the coupons on respective due dates and to repay the principal amount. Issuer uses the funds for the purpose specified in the indenture document. The issuer is a company in the case of corporate bonds. However, in the case of securitized bonds, the details of the securitization process are required to be mentioned.
Bond Holders	The bondholder is the investor in the issue. It received interest on a periodic basis. The principal is repaid to the bondholder at the maturity date. The rights of the bondholders are clearly specified in the indenture document.
Fiscal Agent	It is a banker or a financial institution that manages the issue. It is involved in protecting the funds for the purpose of repayment. It ensures the payment of interest and compliances of the provisions contained in the indenture document.

Clauses of Bond Indenture

• Purpose of The Issue: This clause specifies the main purpose of the issue and also clarifies the proposed use of the funds.
• Face Value of Each Bond: This is the face value of the bond. All interest rates are applied on the face to arrive at the coupon amount.
• Coupon Payment Dates: The indenture document specifies the dates of coupon payments. It can be monthly, quarterly, semi-annually, or yearly.
• Maturity Date: This is the late date by which repayment of principal is to be done.
• Coupon rate: This is the cost of holding funds for the issuer. This rate is specified separately in the indenture document.
• Features of The Bond: The bond may be callable or non-callable. This feature is specified in the document.
• Collaterals: In case the bond issue is backed by security or an asset, it is called a secured bond. In case the bonds are secured by some tangible assets such as property, real estate, machinery, etc. such bonds are called as mortgage bonds. In case the bonds are secured by a pool of assets or some fund-based assets, it is called covered bonds.
• Covenants: This ensures that the interest of both the bond issuer and holders is protected. It may restrict the issuer on some activities which may include chances of defaults by the issuer.

Bond Indenture Provisions

The entire indenture document is broken into different paragraphs. Each paragraph has certain information to be communicated to the reader. We will discuss some of the important contents of the document.

Article	Explanation
Definitions	This area specifies the definition of various words or terms used in the document. This helps a reader to get a clear meaning of the term and removes ambiguity. It further specifies the rules of construction which apply to the contract.
Bonds/Notes	This is the most important in the entire document. It lists down the terms of the bond such as interest rate, payment cycle, repayment dates, method of repayment, etc. It also throws light in case cancellation of the bond, tax withholding, limitation of liability of the payment, extra rights of the bondholder in case of defaults, etc.
Covenants	It lists down the concerns of each party such as a certificate of compliance, the business activities to be carried out, limitation of a certain set of transactions which may degrade the creditworthiness of the issuer, audit of the issuer on regular basis, insurance to avoid the risk, etc. It ensures interest of both parties is taken into consideration.
Remedies	This area provides remedial solutions in case of default by the corporate issuer. It specifies a few terms such as the events of default, cumulative rights, and responsibilities, control by the bondholders, limitation of suits, optional possession
Redemption of the bonds	This area specifies the terms of redemption, its pricing, a methodology to be adopted. It may also grant the holder to redeem before the redemption date, up to a certain percentage. The redemption amount should include the coupon from the last date of payment to the current date of payment along with the principal amount.

Advantages

Some of the advantages are given below:

• The document clearly specifies the rights of the investors and the obligations of the issuer, thereby removing ambiguity in the process.
• All information related to the bonds is clearly stated in the agreement which gives a complete picture to the stakeholders.
• On the basis of this document, the investor can decide on the reliability and creditworthiness of the issuer.
• Through such a document, the chance of default is minimized.
• Since the indenture document is legally valid, disputes can be managed by taking this document as evidence.

Disadvantages

Some of the advantages are given below:

• The document is issued to each person specifically and thus it cannot be transferred.
• The chances to exit the contracts are limited.
• The document does not contain summary information for quick reading.
• Once the document is signed, it cannot be negotiated.
• Change in interest rate is normally covered by the indenture document. So, the investor may lose the opportunity in case of an increase in interest in the future.

Conclusion

Bond indenture is a legal valid document protecting the interest of both the issuer and the holder, through a fiscal agent. The document is primarily issued to specify the particulars or minute information of the issue. It clearly states the rights of the issuer, which helps the investor to understand the terms easily. Due to legal validity, the document can be invoked in court in case of any dispute observed in the actual execution of the contract.

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This is a guide to Bond Indenture. Here we also discuss the introduction and clauses of bond indenture along with advantages and disadvantages. You may also have a look at the following articles to learn more –

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