Income Bonds

1–3Definition / Meaning

An income bond is defined as a debt instrument whereby the issuer agrees to pay the principal but the coupon payments are subject to available earnings. In other words, the issuer is liable to pay the coupon payments only when it has income in its financial statements. From an issuer’s point of view, such bonds are very beneficial as it makes available capital easily without any interest obligations. On the contrary, it is not a preferred instrument for the investor. Because he will have to bear an additional uncertainty of generation of income by the issuer.

Corporate Bonds and Income Bonds

As we know most of the corporates and governments issue bonds regularly and there is a big market available for all such bonds. Moreover, a heavy volume of trade happens in those bonds. All these bonds carry a coupon rate/ interest payment rate. And, the corporates and the governments promise to pay the interest as per the coupon rates regularly at the defined intervals. All these bonds are further guaranteed for payment of principal as per the issue terms. In summary, all these bonds regularly pay the interest and principal on maturity. Depending upon the financial strength and their track record with regard to the timely payment of interest and principal, these bonds carry ratings by the credit rating agencies.

Similarly, in the case of Income Bonds, the bonds also carry the coupon rate and are guaranteed for repayment of the Principal on maturity. However, the issuer has no obligation or compulsion to pay the interest regularly.  Provided the income is not sufficient to take care of the interest obligations during that period. Thus, the interest payment remains uncertain for the investors. Moreover, usually, neither it has a provision to carry over the unpaid interest portion.

Income Bonds vs. Preference Shares

Income bonds look very similar to preference shares with respect to payment of regular dividends. So in both cases, if the income is not sufficient to pay then the interest (for Income Bonds) or dividend (for Preference Shares) payment is not compulsory for the company.

However, in preference shares, if the dividend is not paid in a particular year, then the unpaid dividend for that year will be accumulated and paid in the subsequent year when there is a sufficient income.  This is not the case with income Bond and this is how they are different from each other. Although it is all about structuring an instrument because after all it is similar to an agreement between two parties and it can be structured as per the convenience of the two.

Benefits to Issuer

This type of Bond is very appropriate in times of financial crisis or when the company is undergoing a financial restructuring. It allows the company availability of easy capital in times of uncertainty and crisis without any obligation for regular payment of interest. Of course, investors should be convinced to subscribe.  The direct benefit of this bond is that it can prevent a company from bankruptcy.

Due to this typical nature of the Income Bonds where interest payment certainty is not there and is generally issued by companies having solvency issues, these are a rare occurrence and are not regularly issued and available.

NSI Income Bonds

NSandI is a UK based saving organization working for getting cost-effective funds to the government from the public. Income bonds are one of the many saving products of NSI that are offered to the public.

NSI income bonds are accessible to a person aged 16 or more. The interest rate on the bonds is variable and can increase or decrease depending on the reference rate change by the Bank of England base rate. The investment can range between 500 pounds to 1 million pounds. The best income bond funds offered by NSI can be accessed from their website.

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Sanjay Borad

Sanjay Bulaki Borad

Sanjay Borad is the founder & CEO of eFinanceManagement. He is passionate about keeping and making things simple and easy. Running this blog since 2009 and trying to explain "Financial Management Concepts in Layman's Terms".

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