Every month, when I receive my credit card bills, I would almost immediately go to the internet and post-date the payment to 1-2 days before date due, and make sure that the bill is paid in full. As far as I am concerned, I am a AAA-customer of the bank. My question is – does the bank like me? Well, not quite. Why? Simple. The bank cannot derive a profit out of me. The bank is there to make a profit, and if it cannot earn a profit out from me, I am quite sure I am not its best customer. In fact, the best customers for the bank are the ones that only pay interest without any default, and not even those that pay up part of the principal sum, let alone those that pay the full principal sum. From my perspective, the bank views me just as a credit-worthy customer and not a profitable customer. Of course, the bank will not deprive me for being a credit card customer because it still needs to maintain a healthy ratio of those who pay on time and those who only pay part of the principal sum. What is my point here? A bank’s perspective can be different from its customer’s perspective.
In a similar way, a bank’s interest in lending to corporate may be different from a retail bond-holder’s interest even though both are lenders to the same company. Banks minimise their risk by securing physical assets as collaterals. That’s why they are in the business of secured lending. Given that banks have already secured the assets, their primary interest would be to achieve profitability when they lend out the funds. However, that cannot be said for an unsecured lender in retail bonds. The primary objective of an unsecured lender should, in my opinion, to focus on the risk to ensure than principal sum is protected and be returned with interest when it is lent out. However, very often, the promise of high returns tends to blind us. If we do not analyse a bit deeper, we may miss the whole picture altogether. In fact, following the default of Swiber, several companies (need not mention them) had met with bondholders or note-holders to re-structure their debts as well as to change the payment conditions that come along with it. To get the bondholders’ support, companies very often have to make higher promises. However, higher promises do not mean safer promises in future. In fact, it could put the company’s financial future at risk due to the higher promise. One pertinent question is – how can we be so sure that the business environment in the future will be better than it is now?
Unfortunately for the bondholders or even shareholders, we do not have much say in the company executive matters except to raise some concerns. By the time, when such a meeting is called upon to discuss the re-structuring of debt payment, the damage is often already done.
For investors, whether we enter an investment as a bondholder or as a shareholder, doing it right first time is of prime importance. The effort needed to back-track is often arduous and painful.
Brennen has been investing in the stock market for 26 years. He trains occasionally and is a managing partner for BP Wealth Learning Centre. He is also the author of the book – “Building Wealth Together Through Stocks” which is available in both soft and hardcopy.