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About Corporate Bonds

Distinctive Features of Fixed-Rate Capital Securities

Pricing

While a retail-targeted fixed-rate capital security typically has a liquidation value or principal amount of $25, the actual price paid by the investor may be more or less than $25, particularly when the security is purchased in the secondary market. These fixed-rate capital securities trade at a single, “flat” price, which includes—without separately identifying—the amount of income accrued since the last payment date, in addition to any premium to or discount from par value. The premium or discount is revealed by subtracting the amount of accrued income from the purchase price to determine the adjusted price, which is then compared to the security’s liquidation value.

 

To illustrate:

  Premium Discount
Purchase price $25.25 $25.25
Accrued income (0.15) (0.30)
Adjusted price $25.10 [>$25.00] $24.95 [<$25.00]

On securities purchased in the secondary market, the amount of premium or discount will depend on the securities’ stated coupon rates in relation to prevailing market rates and to the market’s perception of the issuer’s current credit quality. (See “Factors That Affect the Price of Fixed-Income Securities,”) Daily flat-price quotes for the listed, retail-targeted securities are published in the financial pages of most newspapers under the relevant exchange listings. The institutionally targeted offerings are not listed and trade like traditional corporate bonds.

Maturity

Most fixed-rate capital securities have defined maturities ranging between 20 and 49 years from the date of issuance. Some have been issued as perpetual fixed-rate capital securities, which have no maturity date.

Most fixed-rate capital securities also have a “call” provision that entitles the issuer to redeem the shares prior to maturity. An issuer would most likely “call” the securities during a period when falling interest rates were lowering the cost of capital. For the investor, however, this possibility creates the risk that the returned principal would have to be reinvested at lower rates. In most issues, the “call” provision cannot be exercised by the issuer for at least five or 10 years from the original issue date, giving the investor a measure of “call” protection. The yields on fixed-rate capital securities will usually be higher than the yields of noncallable alternatives to compensate for this reinvestment risk.

Because the structures described on pages 4-5 were created to provide the issuer with tax-deductible payments, they also include a “special event” redemption option. This would allow the issuer to redeem the securities at their liquidation value — for retail offerings, and with a “make-whole” for most institutional offerings — in the event of a tax law change that disallows the deductibility of payments by the issuer’s parent company or subjects the issuer to taxation separate from the parent. Many securities also allow for a “call” in the event that the issuing partnership or trust is ever deemed to be an investment company.3 Moreover, the bank issues incorporate a “call” provision if capital treatment is eliminated.

In partnership and trust securities, the issuer may also have an option to extend the maturity of the securities, although this option could not be exercised during a payment deferral period, nor can the payment deferral option be used to extend maturity.

Credit Quality

Credit Ratings on Cumulative Issuance of Fixed-Rate Capital Securities (1993-2003)

In most cases, fixed-rate capital securities carry investment-grade ratings from two or more rating agencies such as Standard & Poor’s, Moody’s Investors Service and Fitch Ratings. These ratings indicate the agencies’ views of the issuer’s relative ability to meet its principal and income payment obligations on the securities. Securities from lower-rated issuers generally offer higher yields to compensate for higher credit risk.

Liquidity

Because retail-targeted fixed-rate capital securities are listed on major stock exchanges, investors in these securities can usually depend on an orderly, public market for their securities should they wish to sell them prior to maturity. The exchange listing does not guarantee liquidity, however.

As with all fixed-income securities, the price received in a sale prior to maturity may be more or less than the liquidation value or principal amount, and more or less than the investor originally paid. On any day, a fixed-income security’s value will depend on market interest rates and the issuer’s current or prospective credit quality, as well as the market balance between supply and demand. (See Factors That Affect the Price of Fixed-Income Securities.)

3 Investment companies are regulated under the terms of the Investment Company Act of 1940. Partnership and trust fixed-rate capital securities benefit from an exemption to this legislation.

 

All information and opinions contained in this publication were produced by the Securities Industry and Financial Markets Association from our membership and other sources believed by the Association to be accurate and reliable. By providing this general information, the Securities Industry and Financial Markets Association makes neither a recommendation as to the appropriateness of investing in fixed-income securities nor is it providing any specific investment advice for any particular investor. Due to rapidly changing market conditions and the complexity of investment decisions, supplemental information and sources may be required to make informed investment decisions.