Bond Indenture

Updated July 12, 2023

Introduction to Bond Indenture

A bond indenture is a long & complex legal document entered into between the bond issuer and investors (i.e. bond holders) managed through a trustee or fiscal agent which can be a bank or any financial institution, and such document includes the details of the issue; the objective of the issue, rights of the bondholders to receive the income and obligation of the issuer towards payment of coupon and repayment of payment on respective due dates.

Explanation

• We can simply say that a bond indenture is a legal contract. It specifies everything about the issue, the issuer, and the obligations of the issuer. It also clearly lays down the rights of the bondholders. The US SEC (Securities and Exchange Commission) mandates the issue to handle through a trustee or a fiscal agent.
• The trustee’s job would be to prepare the indenture document and ensure that the issue takes place only as per provisions contained in the document.
• Thus, we can say three persons are involved in the bond indenture: the issuer, the bondholder, and the fiscal agent/trustee.
• The document is lengthy and complex. The bond indenture document contains specific important provisions in the whole document. Some important provisions include definitions, issues, execution, and authentication of notes, redemption, defaults and remedies, and trustee.
• The end part of the document includes the signatures of the relevant parties.

Example of Bond Indenture

We can consider the example of the bond indenture document of “Utility Debt Securitization Authority” and the bondholders, issued on April 07, 2016, through bond trustee “The Bank of New York Mellon”. This document highlights details of a bond issue for $ 636,770,000.

Full details of the indenture document can become accessible below:

https://www.lipower.org/wp-content/uploads/2016/11/2.-Bond-Indenture.pdf

Crux Information of the document is as follows:

• Principal Amount: $ 636,770,000
• Staggered repayment of principal after 2023 in 15 tranches
• Term of bond repayment
• Restriction on an optional redemption
• Coupon payment: semi-annual
• Interest calculations: 360 days basis
• Coupon rate: 5%

What Parties Are Usually Associated with Bond Indenture?

Parties	Explanation
Bond Issuer	This is the person who issues the bonds. The document clearly states the obligations of the issuer. The issuer is responsible for paying the coupons on respective due dates and repaying the principal amount. The issuer uses the funds for the purpose specified in the indenture document. This issuer is a company in the case of corporate bonds. However, the securitization process must mention in the case of securitized bonds.
Bond Holders	The bondholder is the investor in the issue. It received interest periodically. The principal is repaid to the bondholder at the maturity date. The rights of the bondholders are specified in the indenture document.
Fiscal Agent	It is a banker or a financial institution that manages the issue. This involves protecting the funds for repayment. It ensures the payment of interest and compliance with the provisions contained in the indenture document.

Clauses of Bond Indenture

• Purpose of The Issue: This clause specifies the issue’s main purpose and clarifies the proposed use of the funds.
• Face Value of Each Bond: This is the face value of the bond. All interest rates apply on the face to arrive at the coupon amount.
• Coupon Payment Dates: The indenture document specifies the dates of coupon payments. It can be monthly, quarterly, semi-annually, or yearly.
• Maturity Date: The late date by which principal repayment is made.
• Coupon rate: This is the cost of holding funds for the issuer. This rate specifies separately in the indenture document.
• Features of The Bond: The bond may be callable or non-callable. This feature is specified in the document.
• Collaterals: A bond issue becomes secured when backed by security or an asset. If tangible assets such as property, real estate, machinery, etc., secure the bonds, they are called mortgage bonds. When a pool of assets or fund-based assets secures the bonds, they are covered bonds.
  
• Covenants: This ensures that the interest of the bond issuer and holders is protected. It may restrict the issuer on some activities, including chances of defaults by the issuer.

Bond Indenture Provisions

The entire indenture document brake into different paragraphs. Each paragraph has certain information to communicate to the reader. We will discuss some of the important contents of the document.

Article	Explanation
Definitions	This area specifies the definition of various words or terms used in the document. This helps a reader understand the term’s meaning and removes ambiguity. It further specifies the rules of construction which apply to the contract.
Bonds/Notes	This is the most important in the entire document. It lists down the bond terms such as interest rate, payment cycle, repayment dates, method of repayment, etc. It also throws light in case of cancellation of the bond, tax withholding, limitation of liability of the payment, extra rights of the bondholder in case of defaults, etc.
Covenants	It lists down the concerns of each party, such as a certificate of compliance, the business activities to be carried out, the limitation of a certain set of transactions that may degrade the creditworthiness of the issuer, the audit of the issuer regularly, insurance to avoid the risk, etc. It ensures the interest of both parties is taken into consideration.
Remedies	This area provides remedial solutions in case of default by the corporate issuer. It specifies a few terms, such as the events of default, cumulative rights and responsibilities, control by the bondholders, limitation of suits, and optional possession.
Redemption of the bonds	This area specifies the redemption terms, pricing, and methodology. It may also grant the holder to redeem before the redemption date, up to a certain percentage. The redemption amount should include the coupon from the last payment date to the current payment date, along with the principal amount.

Advantages

Below are some advantages :

• The document specifies the rights of the investors and the issuer’s obligations, thereby removing ambiguity in the process.
• All information related to the bonds clearly state in the agreement, giving the stakeholders a complete picture.
• On the basis of this document, the investor can decide on the reliability and creditworthiness of the issuer.
• Through such a document, the chance of default is minimized.
• Since the indenture document is legally valid, disputes can be managed by taking this document as evidence.

Disadvantages

Below are some disadvantages:

• The document issued to each person specifically; thus, it can transfer.
• The chances to exit the contracts are limited.
• The document does not contain summary information for quick reading.
• Once the document is signed, it cannot negotiate.
• The indenture document normally covers changes in interest rates. So, the investor may lose the opportunity in case of an increase in interest in the future.

Conclusion

A bond indenture is a legally valid document protecting the interest of the issuer and the holder through a fiscal agent. The document is primarily issued to specify the particulars or minute information of the issue. It clearly states the rights of the issuer, which helps the investor to understand the terms easily. Due to legal validity, the document can be invoked in court in case of any dispute observed in the actual execution of the contract.

Recommended Articles

This is a guide to Bond Indenture. Here we also discuss the introduction and clauses of bond indenture, advantages, and disadvantages. You may also have a look at the following articles to learn more –

1. Dimsum Bond
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