New investments in secondary bonding

A bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest (so called coupon) and/or to repay the principal at a later date (the maturity of the bond). In other words, a bond is a formal contract to repay borrowed money with interest at fixed intervals.

Thus, a bond is similar to a loan: the issuer is the borrower (debtor), the holder is the lender (creditor), and the coupon is the interest. Bonds are often used to provide the borrower with external funds to finance long-term investments, or, in case of a government bond, to finance current expenditure.

There are two different types of bonds, bonds with fixed interest rates and those with variable interest payments.

The following bonds fall under the first category (fixed-interest):
Zero Bonds – bonds without interest payments/coupon. The issue price must therefore be much lower than the nominal value of the bond
Combined Interest Rate Loan – 2 different interest rates are assigned to the bond, a lower interest in the beginning and a higher interest rate later. That way the bond value will go up.
Straight Bonds – the holder of the bond is entitled to a fixed payment by the issuing institution (in Germany normally on a yearly basis, in the U.S. half-yearly).

The second category (variable) can have the following forms:
Floaters – variable interest rates with a minimum (floor) and a maximum (cap) usually are using a reference interest rate like the one for government bonds.
SURF – Constant Maturity Treasury Step Up Recovery Floating Rate Notes, abbreviated SURF. In contrast to normal floaters they are oriented at short-term interest rates.
Reverse Floater – like normal floaters the interest is oriented at a reference interest rate. However, in a way that the interest is going up when the reference interest rate is declining.
Participation or income bond – besides the redemption – a variable interest is payed based on revenue or dividends of the issuer.

The European market for bonds has changed in 2005 when the government liability for bonds was discontinued. After that no larger unsecured bonds were issued. Until now!
This week, four mayor financial institutions (Deutsche Bank, WestLB, Société Générale, and Lloyds) successfully issued unsecured bonds (senior notes) as well as secondary bonds with a total value of almost € 4.5 bn ($6bn)!

Secondary bonds are a mixture of stockholder’s equity and borrowed capital. In case of bankruptcy the handling of these bonds is of inferior priority, which makes them risky in the current economic circumstances. That is also true for senior notes, which are straight bonds but without the protection of government liability. It makes them interesting for investors because the increased risk is coming with higher interest payments.

According to the analysts, the issuance of unsecured bonds to such an extent, something that was impossible for banks to do in spring of 2009, shows how eager the banks are to prove their financial strength and their independency of government guarantees.

Deutsche Bank had also another reason for issuing their bond; they need money for the takeover of Sal. Oppenheim.

However, it is a sign that the banks are trying to gain trust and overcome the crisis. It has to be seen if they succeed in the long run but at least it looks like it.