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Looking into bonds with Nordkap

Written by Julia Östman | Feb 22, 2024 8:29:42 AM

It has, for natural reasons, been a lot of discussions about the bond market. Bonds have been a popular financing method that has grown strong among Swedish real estate companies in the last ten years, and there are good reasons for that. Thanks to expansive monetary policies with low-interest rates and securities purchases, demand from investors has been high, and the terms favourable. Therefore, it has been an attractive way to diversify the financing base and simultaneously reduce dependence on traditional bank financing.

However, recently it has become more expensive and difficult to finance in this way – primarily due to sharply rising interest rates. As bonds fall in price when interest rates rise, 2022 became one of the worst years ever for bond investors.

As you probably already know, the capital-intensive real estate sector has been particularly vulnerable in this environment. The interest affects both the balance sheet and income statement when property values are pressured from higher yield requirements, while financing costs rise. This results in deteriorated financial ratios, declining creditworthiness, and difficulties in finding borrowed capital at reasonable prices. Bonds are considered especially vulnerable in stressed market situations because they are usually unsecured. The investors' risk of credit loss is therefore higher than for secured bank loans.

Another topic of discussion is the large bond maturities looming around the corner. The sentiment has indeed improved in the early part of the year, in line with hopes for upcoming interest rate cuts. But refinancing will continue to be a challenge for many companies, especially those with low creditworthiness, so-called high-yield companies. Repurchases are also being reported regularly, but why are they done?

In this article, we intend to focus on bonds. Keep reading as we delve into repurchases and high-yield maturities!

 

So, what does it mean when a company decides to repurchase its bonds?

Bonds are essentially a way for companies to borrow money in capital markets instead of from a bank. When investors buy bonds, it can be explained as lending money to the company, and in return, they get back their original invested amount plus interest over a predetermined period. It can, in other words, be part of a robust investment strategy. But at the same time, there's clear credit risk – what happens if the issuer cannot repay the money when due? As mentioned earlier, the real estate industry has been a pressured segment when the interest rates have spiked, which is also the reason for concerns among bondholders.

However, sentiment has improved with increased hopes for upcoming interest rate cuts. Unlike a traditional bank loan, bonds are traded, which means an investor can sell their holdings to another investor. It also means that the company can repurchase – buy back – all or parts of a bond from investors.

We have listed some reasons why companies choose to repurchase bond loans:

  1. Credit rating: By reducing its debt, the company can improve its creditworthiness, which, in turn, can lower its future loan costs.

  2. Capital structure management: Bond repurchases are part of the company's overall plan to manage its capital structure and debt level.

  3. Surplus capital: If the company has extra capital available, it can use it to repurchase bonds and reduce its debt, which can be an advantageous strategy.

  4. Create liquidity for the issuance of new bonds: By repurchasing all or parts of shorter outstanding bonds, capital can be freed up for investors to use in the issuance of new longer-term bonds. This way, companies can extend their capital commitment.

  5. Refinance their debt: Repurchases can be part of a proactive refinancing strategy where shorter-term financing can be replaced with longer-term financing to reduce financing risks.

  6. Repurchase at a low valuation: If the price of a company's bonds is low, and they have access to other more cost-effective financing, repurchases can be beneficial to lower financing costs.

Therefore, repurchasing bonds can be an advantageous strategy for both the company and investors, depending on the circumstances and conditions of the transaction. For investors, it can be positive as it creates liquidity and gives them a better opportunity to sell their holdings and free up capital for other investments. It's especially beneficial for longer-term bond funds that may have limits and investment strategies based on longer holdings. The repurchase price offered by the company can also be considered attractive depending on how it relates to current market pricing. Investors' returns depend on the price and conditions of the transaction.

 

High-yield bonds

High-yield bonds, sometimes referred to as "junk bonds," are bonds issued by companies with low or no credit ratings. Due to the increased risk that the company may be unable to repay the loan at maturity, the largest refinancing risks are also here. A few years ago, companies could act in a favourable interest rate environment and borrow to finance acquisitions, but today the interest rate situation is different, and so is investors' risk appetite.

Arctic Securities states in an article that approximately 20 billion SEK is due in 2024, with the largest volumes in April and October (source: Fastighetsnytt). If a company cannot afford to finance the bond maturity with new loans, there are essentially three paths it can take: a new issuance, sell assets, or negotiate with bondholders. In a market where interest rate conditions and investors' risk appetite are uncertain, companies may need to consider a combination of these strategies.

 

Refinancing of bonds

For long-term debt managers, such as many real estate companies, financing risk is one of the biggest risks the company needs to manage. Therefore, a proactive refinancing strategy and a well-thought-out credit maturity structure are crucial to reduce the risk of not having access to new financing when bonds or other loans mature.

 

Manage bonds smoothly in Nordkap

Nordkap is a TMS focused on risk and debt management, and we are passionate about making the complex financial work of real estate companies a little easier. Equipped with features for bond repurchases, periodization, and reporting, we're your go-to solution for keeping track of finances. In the system you'll get a comprehensive overview and the data can then be easily exported from Nordkap to your company's ERP.

Sounds interesting? Take a step towards smoother risk management today!

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