A feature of the modern developed economy is the presence of a large number of financial instruments. And in the framework of this article it will be examined what constitute subordinated bonds.
general information
In short, subordinated (secondary) bonds are a high-risk enrichment tool. What attracts investors to it? So, what are subordinated bonds? In fact, this is a company loan, which has a lower priority than other loans in the event of bankruptcy or
liquidation of the company. In other words, their holders will be the last to claim a share in the
company's assets, if something happens to her.
Often subordinated bonds are also called “subordinates” or “junior”. It is clear that this state of affairs creates additional risks for their holders. And they must be offset by increased returns. By nature, these bonds are a rather risky instrument. Therefore, their issuer has lower requirements. As a result, it is easier to secure the issue of securities. High profitability and at the same time a significant turn in the case of payments makes their holders a kind of quasi-shareholders.
Who releases them?
This tool is used by business owners who need liquidity. But at the same time, they do not want to erode their capital by an additional issue of yet another block of shares. Difficult situations with debts or disloyal market conditions, as a rule, interfere with ordinary bonds. Also in practice, the use of this tool is popular in the interaction of the parent and subsidiary companies.
Consider a small example. Suppose the subordinated bonds of Sberbank seem to be something fantastic. But they exist. And the use of this tool to maintain a company in which they own a significant part of the government and even its directors is represented is a common practice. Although, in pursuit of profitability, investors can purchase subordinated bonds of banks that are in a difficult situation.
A small example of work
Let's look at what constitutes a subordinated loan on the example of the relationship of the parent and subsidiary companies. So, the second issues bonds, which are subsequently fully redeemed by the first. This can be done for additional financing in order to increase liquidity, or when a subsidiary is not of interest to investors.
Otherwise, you can do with bonds, which are cheaper. But their main purpose is to serve as lifebuoys for the liquidity of the organization in those cases when no other tool can ensure the full fulfillment of this role.
Who works in this market?
Of greatest interest are subordinated loans / deposits for banks, which account for a significant share of all bonds of this type. Why so? This is due to the specifics of their work. It's all about the so-called credit lag. Consider a small example. The bank attracts a deposit from an individual. He immediately has money. He gives out a loan. But if an individual requires his own funds, then certain problems may arise with their return. To avoid them, a financial leverage tool is used. It lies in the fact that the bank should always have a certain stock of funds for unforeseen situations.
In order to receive it, the issue of subordinated bonds is organized. This is great for organizations that are growing fast. Usually they are issued for a period of five years. Although a specific period may not be indicated. Features of perpetual subordinated bonds in that they pay a certain dividend. Whereas the principal is not repaid. But, alas, these advantages of the tool are adjacent to limitations. So, in case of violation of existing standards, cancellation of issues is provided. In other words, it’s not up to the owners to be at the end of the asset queue, but they will generally lose the chance to get at least something.
Specificity of Securities
Now all of these bonds are serviced in accordance with the Basel III standard. According to him, these securities are regarded as second-level capital. By the way, a particularly important point should be noted: when a deposit insurance agency starts a bankruptcy prevention procedure and bonds fall in price, they turn into ordinary shares. It is legally established that this threshold is 2% of the cost. Therefore, this is an extreme measure.
What is Basel III?
This is the standard for banking supervision. Issued by the Basel Committee, established in 1975. It includes representatives of the Central Banks of countries with the ten largest GDP. It was created in order to develop rules, standards and methodologies that will prevent significant losses of institutional investors.
In total, three documents were issued. Each of them, to one degree or another, normalizes the level of reserve capital, taking into account credit risks. The Russian Federation has ratified all three documents. Although, with certain amendments. And there are a number of reasons for this:
- Lack of necessary staff and funding for the full implementation of the system;
- Lack of statistics on losses due to operational and credit risks;
- A small number of national rating agencies;
- Lack of uniform standards for determining default, credit losses and arrears;
- Shortage of studies on the impact of economic and industry cycles on the level of risks and losses of banking institutions.
But if there are problems, then why are they being implemented? There are several reasons for this:
- Improving the quality of risk management. Ultimately, the stability of the entire banking system is ensured, and the rights of depositors and creditors are protected.
- Normalization of activities at the international level.
Why did you become interested in this topic?
The blame for the situation with FC Otkrytie. The fact is that this structure has created a significant heap of problems that can cost more than one trillion rubles. At first there was a panic and a probability of loss of funds, but then the Central Bank of Russia decided not to introduce a moratorium on payments to depositors of the structure, but accepted obligations to service the institution.
Although some caution still remains. So, subordinated bonds were once traded at 20% of face value. Of course, there was a lot of uncertainty about the future. But those who purchased bonds at the lowest price will be able to claim multiple winnings in 2019. As a result, those investors who gave slack and panicked were the losers. Those who had confidential information or were simply optimistic, now can only smugly rub their hands.
Investment specifics
This tool kit is mainly used by experienced players who want to secure a high level of profitability. Thus, affiliates, large funds and a number of other institutional investors can act as buyers of subordinated bonds. This option is not popular among private investors because of the significant entry threshold. Although steps are gradually being taken to increase the number of people involved.
So, the Moscow Exchange recently began to use the fragmentation of lots, so you can become the owner of the bond with such a "small" amount as a thousand US dollars. Who uses these tools and why? The goals of affiliates are clear from their name. Investment funds want to ensure high returns for themselves. So, bonds of highly reliable issuers, an example of which is Sberbank, provide a good profit. And at the same time - it will be a conservative investment of money.
We put in a word about risks
And again - this toolkit allows you to count on a high level of profitability. But this is only possible thanks to significant risks. Therefore, it is desirable to choose reliable objects. It should be remembered that not only activities are carried out here, when it is possible to lose part of the invested funds, but also all investments. Indeed, during bankruptcy, even holders of ordinary shares often do not fall into anything. And about subordinated bonds and say nothing. Therefore, it is necessary to take seriously the choice of the issuer. The same Sberbank will provide, albeit not very high, but reliable profit over a long period.
Use this tool only if you have high-quality, complete information about the state of the subject and wide knowledge in the field of investment. They are also not advised to start working with large amounts. In the best way, the rule “slower drive, you will continue” can help here. It is necessary to gradually gain experience, to understand the affairs of the company using only public information - and then the probability of failure will be minimized. Of course, you cannot completely protect yourself, and a certain risk will always remain. But it is fully offset by profitability. If you realistically assess the existing risks.
Conclusion
In the world there are a large number of tools that can be used for investing and making money. And the higher the potential profitability, the greater the risk that a person or organization takes on who wants to increase their condition. That is the whole point of subordinated bonds.
Although, the same can be said about any financial instrument that is used for enrichment. Indeed, working with money in our time is an extremely risky occupation, requiring a wide range of knowledge, the ability to effectively use and use it.