WiseAlpha’s educational series: Teaching you everything you need to know about the bond market and more.
Private industry is characterised by its adherence to the profit motive. Managers must weigh up the profitability of two conceptually different, yet often confused sources of financing – corporate loans and corporate bonds. This article will examine corporate loans and bonds in detail, highlighting their differences and synergies.
Corporate loans are borrowings directly from a bank or group of banks; banks grant an amount to the borrower in exchange for regular payments of interest and return of capital at maturity.
Corporate loans often involve a single borrower and a small number of banks (lenders). Having only a few points of contact facilitates easy communication between borrower and lenders. Hence, corporate loans are flexible, tailored forms of financing which can adapt to company performance over time.
Corporate bonds are debt instruments sold on public markets. Similarly, the issuer borrows an amount from investors in exchange for regular interest payments and the promised return of capital at maturity. Borrowing from a large number of lenders makes bonds less flexible than loans. However, the public markets are often cheaper.
As noted above, corporate loans have greater flexibility – borrowing from a smaller number of lenders facilitates more accessible communication & thus, re-negotiation. Companies in poor financial health find this flexibility provided by corporate loans more valuable, as they are more likely to be unable to meet the terms of the original contract.
Unsurprisingly, banks lend the funds for corporate loans, borrowers include a range of corporates from SMEs up to large, established blue chip companies. Bonds investors are typically financial institutions, namely large asset managers, pension funds, or the ten largest investment banks. Large minimum sizes (£100,000) bar most retail investors. Corporate bond borrowers are typically large corporations. Smaller companies usually lack the economies of scale to cover the costs of publicly listing or lack the minimum credit history/worthiness to be considered by the public debt markets.
Corporate loans are typically shorter term (1-5 years), with corporate bonds typically ranging from 1-30 years. However, there are bonds with maturities greater than 50 years.
Corporate bonds usually pay fixed coupons, while corporate loans typically pay floating rate coupons i,e. LIBOR + X%.
Common corporate bonds pay regular interest payments and one lump principal repayment at maturity. Loans are often ‘amortising’ – principal payments are paid alongside interest payments, just like a mortgage.
Both bonds & corporate loans are less liquid that equities. However, many corporate loans are completely illiquid – they are untradable. Instead, the lending banks must hold to maturity.
Corporate bonds typically have an active secondary market. However, infrastructure remains archaic with deals often done over the phone or via IM chat. Antiquated infrastructure – among other reasons, contributes to creating a relatively illiquid bond market which lags in development behind equities. You can read more about the inner workings of bond markets here.
In practice, bonds & loans are complementary sources of finance. Profit-minded companies create optimised capital structures with layers of funding. Banks loans constitute attractive short term financing, such as revolving credit facilities or bridge financing – you can read more about the different forms of financing here. Meanwhile, corporate bonds can provide productive sources of long term finance for more substantial investments.
Continued innovation is encouraging – a gale of creative destruction has the prospect to place debt markets squarely in line with the public interest. WiseAlpha operates within this broader narrative – removing barriers of entry to provide fair and equal access to the corporate bond market for private investors.
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