Exchange-traded notes, or “baby bonds” are a retail-friendly debt instrument which trades like a stock, with a typical par value of $25.00. These vehicles have historically been a great way for companies to raise some additional funds via unsecured debt while it also allows retail investors to participate with safer income alternatives to common stock or preferred equity. Over the past decade I’ve covered shipping equities and income opportunities, these baby bonds have offered strong returns and the default rates have been essentially nonexistent from the bigger names. This contrasts with the similar-yields we’ve seen from the energy sector and REITs, where defaults and averse restructurings have been much more prevalent.
Unfortunately, both for companies looking to raise funds and for investors looking for income opportunities, we’ve had a dearth of baby bond offerings recently. During 2018, we only had one instrument: $25M in 8.5% notes from International Seaways (INSW-A). Again in 2019, only one offering: $27.5M in 8.0% notes from Global Ship Lease (GSLD). This was a significant drop from what had previously been a far busier market.
2020 has started out very rough due to the COVID-19 pandemic; however, we have seen some green shoots in the form of the latest Scorpio Tankers offering: $25M in 7.0% notes due 2025 (SBBA). This instrument offers retail investors the chance to participate in a lower risk instrument. Although the offering itself was positive, the trend of a shrinking bond market continues as Scorpio Tankers has just finished repaying $54M of their legacy 6.75% notes, which were due in May 2020. Investors can now receive an additional 25bps even as global interest rates are far lower and Scorpio’s asset base has significantly expanded. This reflects the continuing challenging markets. In this brief update, I’ll cover the broad details of the Scorpio Tankers 7.0% Senior Unsecured Notes due 2025 (SBBA). I have hosted a more thorough review of these bonds as well as all other income opportunities in shipping via our Value Investor’s Edge research platform, and I’ve also added some income commentary via our ShipBrief newsletter. I encourage folks to review our premium research if they are interested in more income opportunities and in-depth risk reviews. Prior to reading this update and certainly prior to making any allocation decisions, I highly recommend a full review of the official bond prospectus posted with the SEC.
Baby Bond Overview & Relevant Covenants
Exchange-traded debt (often referred to as “baby bonds”) are a more retail-friendly debt instrument. These bonds trade on the NYSE and typically cost the same to buy/sell as traditional stocks and ETFs. The majority of these instruments are denominated with an original par value of $25, similar to their preferred equity cousins. Unlike preferred equity, these are bona fide debt instruments, and are included on each company’s balance sheets. Additionally, these instruments have maturity dates and most include some form of restrictive covenants. However, unlike with bank debt, there are very little ‘teeth’ behind these covenants, most are simply restrictive (i.e. cannot issue more debt or repurchase equity) and covenant violations are unlikely to lead to court actions since the debt itself is unsecured (not tied to any hard assets). For the SBBA notes in particular, the relevant covenant highlights are:
- 70% cap on debt to assets (STNG net D/A is approx. 67%)
- $650M minimum net worth (STNG has a NAV of just over $1.5B)
These covenants don’t have significant teeth, but they should restrict STNG from issuing more senior debt if asset values decline. STNG has a NAV (real-time residual equity value) of over $1.5B, so the bonds have a significant safety buffer.
SBBA Details and Structure
I covered the broad structure of baby bonds above and we should expect the bonds to continue to trade just like a regular stock (or preferred equity) until the bonds are either called or they mature. As I’m writing this update, SBBA has been trading since 5 June and currently sits at a slight discount to par (just under $24.00).
These bonds have a par value of $25.00 and will mature on 30 June 2025. The interest rate is 7.0% and interest is paid quarterly (30th of March, June, September, and December). The first payment will be effective on 30 June and it will be a small amount since interest just began accruing on 29 May. Note that the “record date” is the 15th of each month (i.e. 15 June just recently passed), which is important if considering trading around the interest payments. Also keep in mind that these payments are taxed as income (particularly relevant for US investors), so it might make more sense to own these in a tax-free vehicle like a 401K or IRA, all-else-equal. As always, please consult your personal tax professional.
Scorpio has the option to call the bonds starting on 30 June 2022 at $25.50, then $25.25 after 30 June 2023, then at $25.00 after 30 June 2024. This gives Scorpio the opportunity to redeem the bonds if interest rates would decrease substantially and they could find more attractive financing opportunities. In the grand scheme, 7.0% for shipping unsecured debt is pretty low and Scorpio is fairly highly levered, so I doubt the call options will be utilized.
Attractive Pricing? Better for Scorpio or Investors?
Normally, I would suggest that Scorpio got the ‘better deal’ in this issuance considering the light covenants; however, baby bonds have historically been very retail friendly (200-300bps premium to other high yield unsecured bonds in the energy or REIT sectors without any major defaults in the past 10 years), LIBOR is close to zero (0.31%), the 10y Treasury yield (“risk-free rate”) is just 0.7%, and Scorpio has a massive NAV cushion of over $1.5B, so I find these attractive compared to the benchmarks. Baby bonds are generally quite retail friendly and the historical track record of returns has been strong, so I am hoping we’ll continue to see more of these in the markets at reasonable interest rates.