BOND, REPURCHASED BOND Repurchased Bonds Held for Resale By Sheldon R. Smith and Marty D. Van Wagoner, CPA
O
n occasion, a company will buy back its own bonds before the maturity date, recognizing a gain or loss on the repurchase. Generally, this buyback is done with the intent to retire the bonds and get the liability off the company’s balance sheet. However, on rare occasions, it is conceivable a company could buy back bonds with the intent to hold those bonds for a time and then reissue them. We look into such a transaction and analyze the related accounting.
Early Retirement of Debt
A company’s economic situation may have changed over the time bonds are outstanding, and early retirement may become advantageous. A company can retire its bonds early either by paying the call price for callable bonds or by purchasing its own bonds in the open market. One reason for retiring bonds early would be to avoid the continued interest payments over time. A company may also want to retire its bonds early if the call price is less than the current market price. If a company has some excess cash, retiring bonds may be a good use of this cash. Additionally, a company may want to retire bonds if it will improve its debt ratios, perhaps to meet or maintain debt covenant requirements. While financial leverage, when deployed successfully, can enhance firm value, sometimes a company’s strategy may include deleveraging if the debt load is too high.
Early Debt Repurchase Without Retirement
What if a company repurchased its own bonds but held them for possible resale prior to maturity, especially if the maturity date is many years in the future? Why might a company choose this option? If economy-wide market interest rates increase, driving down the price of bonds, a company might buy back, but not retire, its bonds at a gain. If the maturity date is still many years in the future, it is possible market interest rates could decrease over the next few years, allowing the company to resell the bonds at a much higher amount than the repurchase price. Alternatively, a company’s bond price could be driven down by a decreased credit rating due to a public lack of confidence of repayment. If the company can raise the cash to buy back all or some of the bonds, contrary to expectation, it could possibly do so at a significantly reduced price. The buyback of those bonds could demonstrate to the public that it is financially stronger than presumed, so its credit rating might increase. It could then reissue those bonds, without the issuance costs associated with a new issuance, at a much higher price. Such scenarios would result in very positive cash flows for an entity. Just as with treasury stock, an entity needs to be cautious with the repurchase of bonds and watch for potential legal pitfalls. Insider trading accusations are of great concern, of course. An entity and its directors, officers, and certain shareholders are subject to Section
the journal entry | january 2021
25
