In the process of a Bond Issue, it is often recommended by Bond Counsel to have a Credit Enhancement to the Bond offering. This has several favourable benefits for the Issuer;
- Credit enhancement will guarantee the Bonds, offering a degree of relief for debt obligations of the Issuer
- It will often hold the underlying rating of the Credit Enhancer (a bank or insurer) and will therefore make the Bonds more attractive to purchasers
- It can make the Bonds of an ‘investment grade’ and can benefit smaller, less well-known Issuers.
Credit Enhancement to a Bond Issue may be the final piece of the complex jigsaw that is the bond issue process and may be the culprit of the highest portion of cost.
Credit Enhancement can take many different forms. Typically, it may be an insurance policy or a type of financial guarantee that is underwritten by an insurer who specialises in financial risk. It may often be a bank who may issue a Letter of Credit or other form of Demand Guarantee to underpin the Bond. It may also be the assignment of other forms of assets, creating an asset backed Bond. The Trustee being the holder of such assets.
The structure of the Credit Enhancement could ultimately be the deciding factor of whether a potential investor accepts to purchase the bonds or not. Ultimately, how safe is the end credit? Of course, if the Bond is backed by a rated and known insurer or bank, then the investment risk in purchasing the bonds is smaller than having no credit enhancement at all and relying on the strength of the Issuer alone.
It is of extreme importance to find the correct Credit Enhancement for the Bond and ensure that it is suited to the structure of the Bond. Above all, there are two factors that will influence the method utilised. Firstly, the costs: Insurance Guarantee’s or Financial Guarantees may be more expensive for young companies as the Issuer compared to perhaps bank undertakings. Secondly, the rating required for the Bond: To achieve an investment grade rating and become attractive to purchasers, it is important to ensure that the Credit Enhancement carrier is of suitable size, ranking and stature. Of course, the more complex the enhancement, the more costly it could be.
If you are contemplating a Bond Issue, or indeed any other type of debt obligation issue and are seeking the correct Credit Enhancement partner to underpin the obligations and of course to minimise enhancement costs, please contact us where our experienced partners will be pleased to assist you and provide the best options for necessary facilities.