Senior Bonds Research Articles

Senior and Subordinated Issues, Debt Ratings and Price Impact

This paper investigates the question of whether bond ratings serve as a basis for market prices of bonds or whether investors use their own research and view the ratings only as rough guidelines. Unlike previous work, which focused on rating changes, this paper uses a new data base to consider bond ratings at issue. Agencies such as Moody's or S&P rate subordinated bonds by notching them down from senior bonds. We consider the pricing of both senior and subordinated issue. If notching policies were done properly, then we should find that all equally rated bonds should be priced equally (same yield). However, we find that the market systematically prices differently bonds of identical ratings but different seniority. Specifically, we find that yields of speculative senior bonds are higher than the yields of similarly rated subordinated bonds. The sign reverses in most cases for investment grade issues. We provide a possible explanation for the direction of the bias. We also control for issue and company characteristics.

The Buyback Boondoggle

ACROSS Latin America today, countries are experimenting with marketbased debt reduction to ease their massive foreign debt burdens. Brazil expects to swap $8 billion of its debt for equity investments during 1988. During the first nine months of 1988, Chile swapped $1.42 billion of its bank debt for equity, and plans to repurchase more debt using reserves. Mexico, which converted roughly $2.5 billion worth of debt during 1986 and 1987, tried unsuccessfully to swap $10 billion in new senior bonds for $20 billion in bank debt in February 1988; a revised plan is said to be in the offing. Many smaller debtor countries are also attempting to restructure their foreign debts. Bolivia repurchased 46 percent of its bank debt last March, and there is now talk of Costa Rica engaging in a buyback.' The danger in the new trend is that when highly indebted countries retire their deeply discounted debt, either through buybacks or debtequity swaps, they may simply be using their scarce resources to subsidize their creditors. Such programs might be valuable as components of efficiency-enhancing larger deals between debtors and creditors. However, highly indebted countries do not benefit if they repurchase debt unilaterally, without receiving concessions. In some instances

Protecting the User Interest in Railroad Reorganization

The typical railroad reorganizations before the enactment of Section 77 in 1933 did not adversely affect the public interest in transportation service. Receivership machinery went into motion as soon as earnings and credit had become insufficient to pay junior fixed charges, but while there was still enough to cover operating expenses, taxes, joint facility rents, senior bond interest and rent for leased roads. By cutting down those fixed charges junior to all these prior charges the receivership eased the pressure on the earnings and thus safeguarded the prior charges and the integrity of operation and service. By deferring or reducing to stock category large junior principal debts incurred by the road to augment facilities, the typical reorganization enabled railroad users to enjoy those facilities without paying for them. For these reasons and because reorganization customarily toned up management and made up for deferred maintenance, receivership usually benefited the public interest automatically. Hence this interest received no special attention in the receivership proceedings which were deemed mere debtor-creditor affairs that would give the public interest due recognition simply by producing a reorganized debt structure sound enough to enable the road to command new capital requirements cheaply.