Bond Indentures Definition
Bond Indenture, also known as bond resolution, is is a core legal document that acts as a contract between the bond issuer and bondholder and contains all the details related to the bond, like details of the issue, purpose of issue, obligations of the issuer of bond & rights of bondholders.
As per The Trust Indenture Act of 1939, any bond issued that is regulated by U.S. Security and Exchange Commission (SEC) must have a trustee; the issuer appoints a trustee or fiscal agent that can be a financial institution or bank which acts as a representative of all the bondholders.
Component of Bond Indenture
Bond IndentureIndentureIndenture is a legal agreement between two or more parties to meet their respective obligations. It is a common term used in the bond market to provide the lender and borrower with the necessary comfort in the transaction in the event of one defaulting party. is the legal contract document between the Bond Issuer and the bondholders. Bond Indenture includes many clauses. Few important ones are listed below:
- Purpose: Bond Indenture must include the agenda behind the issue of this bond.
- Face Value: Face value is the price at which this bond is going to be issued
- Interest Rate: This is the interest rate given to each bondholder on the face value.
- Payment Dates: The date or tenure when the interest will be paid to bondholders.
- Maturity Date: The date on which the bond will expire and all invested amount will be refunded to the bondholders.
- Interest Calculation: Methodology related to the calculation of interest like interest paid is simple interest or compounded interest.
- Call features: Issued Bond is a callable bondCallable BondA callable bond is a fixed-rate bond in which the issuing company has the right to repay the face value of the security at a pre-agreed-upon value prior to the bond's maturity. This right is exercised when the market interest rate falls. or non-callable bond.
- Call Protection Period: Minimum period within which the bond cannot be replaced or redeemed.
- Non-Payment actions: This clause includes details related to possible action to be taken in case of default from the issuer in payment of interest or refund of the invested amount at the maturity of the bond. Possible action can be like increasing the interest rate, penalty related details, reduction in tenure of maturity.
- Collaterals: Some bonds are backed by the collaterals. Such bonds are known as a Secured bondA Secured BondA secured bond is when the bond's issuer provides a specific asset as collateral and offers a reduced interest rate compared to unsecured bonds. In case of default, the issuer is obligated to transfer the title of the collateralized asset to the bondholder.. Bonds can be of different types on the basis of collaterals. Some are listed below:
- A collaterals trust bond is a bond against which the securities owned by the issuer, but held by the trustee appointed by the issuer.
- Mortgage bonds are bonds where real estates, equipment, and other tangible assets are kept as collateral.
- Covered bonds are bonds that are issued by the bank, or some mortgage institution, and pool of assets are kept as collateral against such bonds.
- In case of default, the collateral is sold, and the amount is used to repay the collateralized bondholders.
- Covenant: In order to protect the interest of the bond issuer and holder, there are certain obligations put on the issuer of the bond. The CovenantCovenantDebt covenants are formal agreements between different parties like creditors, suppliers, vendors, shareholders, investors, and a company, establishing limits for financial ratios such as leverage ratios, working capital ratios, and dividend payout ratios, which a debtor must refrain from breaching. can be a Restrictive Covenant that restricts issuer to do certain activities that make them less creditworthy and increase the chance of default, like pay the dividend, restriction on the purchase of property, etc. Similarly, Covenant can be an Affirmative Covenant that forces the issuer to meet certain requirements like maintain a certain level of reserved cash, deliver audited financial statements, etc.
Bond Indenture Example
Example of Bond Indenture: There is a company XYZ that need capital to expand his business for that he sought advice from his financial advisor. The company’s Financial Advisor suggested raising funds from the people who are seeking to invest their money in such a business.
After a discussion with the advisor, the company decided to approach various investors, and rather than negotiating them individually company decided to create a Bond Indenture or deed of trust, which will act as a contract between XYZ and all investors (Bondholders).
Stakeholders in Bond Indenture
The following are the stakeholders in the bond indenture.
#1 – Issuer
The issuer generates the Bond Indenture. The indenture contains all the legal details of the issuer of the bond to give a clear picture to the investors.
- Like in the case of a Sovereign bond, which government body will be responsible as an issuer. Such as HM Treasury in the United Kingdom, RBI in India.
- For corporate bondsCorporate BondsCorporate Bonds are fixed-income securities issued by companies that promise periodic fixed payments. These fixed payments are broken down into two parts: the coupon and the notional or face value., details of corporate legal entity will be mentioned.
- In the case of the securitized bond, details of the sponsor that will be a financial institution and is the in-charge of the securitization process.
#2 – Trustee/ Fiscal Agent
The trustee is a bank or financial institution that holds the bond indenture. Trustee roles are primarily providing financial and legal assistance to bondholders. The main role of the trustee is holding the funds until payments are done to bondholders, invoicing the issuer for interest and principal paymentsPrincipal PaymentsThe principle amount is a significant portion of the total loan amount. Aside from monthly installments, when a borrower pays a part of the principal amount, the loan's original amount is directly reduced., calling meetings of bondholders, ensuring all the terms and conditions mentioned in Indenture are properly adhered by the issuer.
#3 – Bondholders
The bondholder is the investor that puts his money in this debt security to receive some periodic income from interest and receive the principal amount at the time of maturity of the bond.
- Bond Indenture is the legal document; all the clauses mentioned in the document are applicable to all the stakeholders involved in the transaction.
- Bond Indenture protect the interest of all the stakeholders and reduce the chance of default.
- Indenture clearly defines all the information related to the bond.
- The rights and Duties of all the stakeholders are clearly defined in the Indentures that helps in avoiding any confusion.
- This document ensures all the stakeholders must be aware of the covenantsCovenantsCovenant refers to the borrower's promise to the lender, quoted on a formal debt agreement stating the former's obligations and limitations. It is a standard clause of the bond contracts and loan agreements. for proper transparency.
- Indenture is the only legal document that is referred in case of any dispute regarding the bond.
- Indentures are non-transferable; hence there are very limited options available to exit these contracts.
- These contracts, once signed, are not renegotiable, so any change in the interest rate due to policy change may have financial repercussions.
Bond Indenture is a core legal document that safeguards the right of both investors and issuers. It contains all information related to the bond, along with the Rights and responsibility of both issuer and bondholders. Indenture has the legal binding on all the stakeholders, and in case of any dispute or default, the indenture will be considered for any resolution.
This has been a guide to Bond Indenture and its definition. Here we discuss the components and stakeholders of bond indenture along with the examples. You can learn more about fixed income from the following articles –