What is Bond Issuance?

Bond issuance is a method used by governments, corporations, and municipalities to raise capital by borrowing money from investors. When an investor buys a bond, they are essentially lending money to the issuer in exchange for periodic interest payments and the return of the principal amount at maturity.

Companies may choose to issue bonds instead of taking out bank loans or selling equity because bonds can provide a way to raise capital without diluting ownership. The interest rate, or coupon, that a bond pays depends on factors such as market conditions, credit ratings, and maturity length. Longer-term bonds typically carry higher interest rates to compensate investors for increased risk over time.

What are the types of bonds?

Bonds can be categorized into government bonds, corporate bonds, and asset-backed securities.

Government bonds

Governments issue bonds to finance public spending and economic initiatives. The most common types of government bonds are:

• Sovereign bonds: These are issued by national governments, such as U.S. Treasury bonds or Japanese Government Bonds (JGBs). Some governments issue inflation-linked bonds, such as Treasury Inflation-Protected Securities (TIPS) in the U.S.
• Municipal bond: These are issued by local and regional governments to fund infrastructure projects.
• Agency and ‘quasi-government’ bonds: These are issued by government-backed agencies, such as the World Bank or European Investment Bank, to fund specific programs.

Corporate bonds

Corporate bonds are issued by businesses to raise capital for expansion, acquisitions, or other growth initiatives. They can be divided into two broad categories:

• Investment-grade bonds are issued by companies with strong credit ratings
• Speculative-grade bonds, also known as high-yield or ‘junk’ bonds, are issued by companies with a higher credit risk (e.g. newer companies or businesses in volatile industries).

Securitized bonds

These bonds are created by bundling various types of loans and selling them as investment products. They include:

• Mortgage-backed securities (MBS): These are bonds backed by pools of home mortgages. Banks and finance companies sell mortgage loans to third parties, which then bundle them into securities. Investors are paid based on mortgage interest rates and principal payments.
• Asset-backed securities (ABS): These are bonds backed by consumer loans, such as credit card debt, car loans, or student loans.

Convertible and callable bonds

Two other types of bonds are convertible and callable bonds:

• Convertible bonds give investors the option to convert their bond holdings into stock shares at a predetermined price.
• Callable bonds allow the bond issuer to repay the bond before its official maturity date, usually when interest rates decline. This allows companies to refinance at a lower cost and reduce borrowing expenses.

What is the bond issuance process?

The bond issuance process involves multiple steps, which we outline below.

1. Initial planning and structuring

First, the bond issuer (e.g. a company or government) decides how much capital needs to be raised and assesses whether issuing bonds is the best option for their needs. The issuer then chooses the appropriate bond structure, such as:

• Fixed-rate bonds: Steady interest payments
• Floating-rate bonds: Interest tied to market conditions
• Zero-coupon bonds: Issued at a discount with no periodic interest
• Convertible bonds: Can be exchanged for company stock.

At this stage, the issuer also establishes the maturity period and sets an interest rate (coupon) competitive with market conditions and risk levels.

2. Engaging banks and underwriters

Next, the issuer partners with an investment bank or underwriters to structure the bond, determine pricing, ensure legal compliance, and market the bond to investors. The underwriter helps the bond issuer draft the bond prospectus, which is a legal document outlining the bond’s terms, the issuer’s financial health, and any potential risks for investors.

3. Credit rating and regulatory approval

If the bond issuer doesn't yet have a rating, they will seek one from a credit rating agency such as Moody’s, S&P, or Fitch. Bond ratings provide investors with an independent assessment of the issuer’s creditworthiness.

Before issuing bonds, it’s also essential to register with the appropriate regulatory bodies. In the U.S. this is the Securities and Exchange Commission (SEC).

4. Marketing and investor engagement (the roadshow)

Once the issuer has received a rating and regulatory approval, a roadshow is conducted to present the bond offering to institutional investors. This involves holding meetings in major financial hubs to assess investor interest and determine pricing expectations.

If investor demand is not strong enough, the bond issuer may choose to postpone the offering or adjust the terms of the bond. 

5. Issuing the bond and pricing

With investor interest confirmed, the issuer and underwriters set a launch date based on market conditions. On the day of issuance:

• A ‘Go/No-Go’ call is held to decide whether to proceed
• The bond is announced to the bond market, and the order book (a record of investor interest) is opened
• Throughout the day, pricing adjustments may be made based on investor demand and prevailing market conditions, which can impact final yields and allocations.

After finalizing orders, the issuer and banks close the book and confirm the final price and allocation to investors.

6. Allocation and secondary market trading

Investors receive their allocations based on order size and quality. The final coupon and yield are set, and the bond is listed on the secondary markets where it can be traded by investors. The issuer begins making regular interest payments until the bond matures.

Why do companies issue bonds instead of borrowing from a bank?

For companies, issuing bonds may provide lower interest rates, access to more capital, and greater flexibility compared to taking out bank loans. However, bond issuance also comes with risks, including interest rate risk, credit risk, and liquidity risk.

Below are some reasons why companies may issue bonds as an alternative to bank loans.

Lower interest

Interest rates on corporate bonds are often lower than bank loan rates, but this depends heavily on the creditworthiness of the issuer. Companies with strong credit ratings can typically issue bonds at lower costs, while those with weaker credit profiles may face higher rates than they would from banks.

When a company issues bonds, however, it can secure funding at a more competitive interest rate – especially if it has a strong credit rating. This allows companies to minimize borrowing costs.

Access larger amounts of capital

Bank loans often come with borrowing limits that may not be sufficient for large-scale projects. With bond issuance, corporations can raise significant amounts of capital by attracting multiple investors instead of relying on a single lender.

Greater flexibility

Bonds also provide greater financial flexibility compared to banks. For example, banks may require businesses to limit additional borrowing until the loan is repaid or maintain certain financial ratios to reduce default risk. Issuing bonds often allows companies to bypass these restrictions, which can provide greater control over finances.

Longer repayment periods

Bank loans often have shorter repayment terms, which can put pressure on companies to repay their debts quickly. Bonds, however, can be structured with longer maturity periods of 10, 20, or even 30 years.

Issuing bonds vs equity financing

Companies wanting to raise money can choose between issuing bonds and equity financing (selling shares), each of which has its own advantages and drawbacks.

When a company issues stocks, it grants proportional ownership to investors in exchange for capital. One of the biggest advantages of issuing stock is that the company doesn’t have to repay the money it raises. However, issuing new shares has certain drawbacks that may make bonds a more attractive option.

Firstly, issuing new shares increases the total number of shares in circulation. This means that future earnings must be shared amongst a larger group of investors, which can result in lower earnings per share (EPS). EPS is a key metric used by investors when evaluating a company’s profitability, and so a declining EPS may make a company less attractive to investors.

Secondly, issuing more shares can also dilute ownership by spreading control amongst a larger number of shareholders. For existing investors, this often means a reduction in the value of their shares, which can make stock issuance a less appealing option for companies wanting to protect shareholder value.

Bond issuance, on the other hand, allows companies to raise capital without giving up ownership or control. If a company can find willing investors, it can continue issuing bonds without affecting how the business operates. Although companies must eventually repay the bond principal and make interest payments, they retain full control over decision-making and don’t have to divide future profits with a larger shareholder base.

Essentially:

• Issuing bonds allows businesses to access funding while maintaining independence
• Issuing stocks eliminates debt obligations but spreads ownership across a wider group of investors.

Example of bond issuance

The below example shows how companies use bond issuance as a financing tool, allowing them to secure funding for expansion while providing investors with a fixed-income investment opportunity.

Imagine a renewable energy company wants to construct a new solar farm at a cost of $5 million. To finance the project, the company decides to issue bonds to investors. The company – or bond issuer – chooses to sell 5,000 bonds at $1,000 each, setting the face value for each bond at $1,000.

Before issuing the bonds, the company proposes an annual interest rate, or coupon, and a repayment schedule. However, the final terms are set during the bookbuilding process.  To make sure the bond is attractive to investors, the bond issuer considers current market interest rates and sets a six-year maturity period with a 4.5% annual coupon rate.

Each year, bondholders receive 4.5% of $1,000 ($45) in interest payments. At the end of six years, when the bond matures, the company (bond issuer) repays the $1,000 face value to each bondholder.

The time to maturity affects both the risk and return for investors. A six-year bond is considered less risky than a 20-year bond because there’s a shorter timeframe for potential economic changes that could impact the company’s ability to repay. However, longer-term bonds usually offer higher interest rates to compensate for the increased risk.

This material is for informational purposes only and should not be considered as an investment recommendation or a personal recommendation.