Corporate bonds early prepayment

[zbigi]

So I've been investing some portion of my NW into Polish corporate bonds. The current rates are just too enticing - they pay up to 10% a year, for companies that are unlikely to go bust (mostly large real eastate developers, who are currently in a middle of real estate boom and are raking in obscene profits). However, I've noticed that most of them have a clause for early payment of the principal, at the penalty of paying some trivial fee for that (e.g. 1% of principal). In practice this means, that whenever money becomes cheaper, they'll just pay me off with cheaper money borrowed from somewhere else. Is such clause also the norm for US corporate bonds?

[jacob]

They're not unusual. They're also annoying to deal with since they usually get called when the market is most optimal for the seller and least optimal for you. As such they (should) trade as a discount to make up for that.

[loutfard]

So I've been investing some portion of my NW into Polish corporate bonds. The current rates are just too enticing - they pay up to 10% a year, for companies that are unlikely to go bust (mostly large real eastate developers, who are currently in a middle of real estate boom and are raking in obscene profits).

I was reminded of this post when reading about the financial problems at Ghelamco (sorry, in Dutch), heavily involved in the Warsaw Unit. Liquidity crunch, fire sale of assets seems to keep them going.

Just a reminder that these real estate bond returns are not free money.

[zbigi]

Seems that the company is losing money, but the creditors are fully satisfied so far? That's what I could gather from the translation.

[loutfard]

Seems that the company is losing money, but the creditors are fully satisfied so far? That's what I could gather from the translation.

Indeed. They're forced to get rid of real estate at below book value, but managing so far to do that in a relatively controlled way.

[loutfard]

More info today in De Tijd, the main Belgian business paper, under the header "Real estate giant Ghelamco not out of danger after mega loss".

Remarkably, Ghelamco managed to sell new bonds in Poland for an equivalent of almost 10 million euros in July.

[zbigi]

The stats on Polish bond market so far are that, for non-tiny bond series (over $2.5m), around 95% are paid on time, and the remaining 5% have problems, ranging from delay in interest payments to some loss of capital. I'm not aware of any story of major loss of capital in this segment though, it seems to be limited to these tiny bond series, usually emitted by tiny companies who were either young and very speculative, or straight up scams (cooking the books to gain credibility, borrowing the money and running away with it).

Also, I've read some Polish bond analyst comments on the Ghelamco situation, and his points are that Ghelamco's Polish subsidiary company situation does not look bad - they still have great debt to capital ratio, for example. The tricky part is Polish subsidiary transfering money (via loans) to other parts of the Ghelamco group, which worsens its financial position. They can only do it so much until it starts to look like actions against the company, which could lead to jail time for the Polish subsidiary's execs.

[suomalainen]

The challenge with public bonds for a retail investor is that it's not like stocks where you can easily speculate on daily or even hourly volatility. It's, like, a real investment that trades on fundamentals and not ... hype or whatever (stonks!), i.e., stocks are dumb money and bonds are smart money. While default rates are generally low, they are not non-zero. I don't know anything about the Polish bond market, of course, but I'm risk-averse enough (and not willing to do real underwriting) to buy a bond ETF that removes single-issuer-bankruptcy risk. HYG is the one I generally trade in the US (high-yield aka junk bonds, cuz that's how I roll), but there's also LQD if investment grade is more your style.

To answer the OP question, (cheap) callable public bonds are very common in the US. Non-call (or expensive callable bonds) are more common in the private markets, which are generally only available to institutional investors. Interest rate risk is kind of a theoretical, indirect risk for equities and kind of hazily gets priced into stocks, but it's a very direct risk for bonds and interest rate moves are near-instantly and precisely priced in.

[zbigi]

I'd probably buy a Polish corporate bond ETF, but there just isn't one. So, I've chosen bonds from 8 companies (all either very low or low risk on the risk scale, as per analysts assesments), and stuck 1/3 my NW into it. They mostly maturate in 2028.

[chenda]

I tend to think that for most retail investors corporate bonds aren't worth the trouble. It's easier just to keep your money in cash or government bonds.

[zbigi]

Over here, safe-ish corporate bonds pay roughly 2% more than government bonds, which is a difference between merely catching up with inflation and actually making a nice profit that will cover my living expenses.

[DutchGirl]

Still, I'd want a higher premium than only 2% more of annual interest on them if there's for example a 20% chance of losing money on them when the government bonds for example have only 5% chance of losing money on them.

[zbigi]

It's more like 0.5% (not a real number) vs 0% (the government can always print its own currency to pay off debts denominated in that currency). And, in the case of the "0.5%" scenario, you don't lose it all, or even most - the company you're lending money to should have considerable assets (i.e. don't lend to ones that have bad debt to assets ratio) that will be liquidated in case of bankrupcy, and used to pay off creditors. For example, real estate development companies whose debt I'm holding have plenty of apartment complexes under construction, as well as plots of land in good (read: expensive) locations in top Polish cities. The steel holding has two operating steel mills. The loan collection companies have plenty of purchased debt that can be either eventually be collected, or re-sold wholesale to a competitor. Etc.
The biggest real risk I see is some kind of impossible to imagine for today macro-level black swan event, hitting some sector in a particularly bad way (like say COVID demolished the airlines). For instance, if Russia starts a war in Poland, I imagine sales of apartments will plummet and development companies will face real risk of bankrupcy. Or, if some events cause inflation to go into double digits again, and interest rates follow into double digits as well (right now they're at 5.85%), that could kill apartment sales, and make servicing the debt so expensive that developers could collapse.