“The fundamental law of investing is the uncertainty of the future.” 

Peter Bernstein

As Mr. Bernstein once said, uncertainty is an inherent part of investing. For those financial institutions holding kicker bonds in their investment portfolio, uncertainty can yield above market returns.

So, what are kicker bonds?

Well, the MSRB defines kicker bonds as:

“A callable high coupon bond sold at a premium and priced to a specific call date. The actual yield realized by the investor increases or “kicks up” if that call is not exercised.”

Or simply stated, kicker bonds are unique to other fixed-income securities in that they offer premium coupons as compensation for a short-term call feature.

So, if the potential for greater returns is of interest to you, let’s explore their features in greater detail…

Higher Yield to Maturity:

Kicker bonds generally have shorter call dates than the standard 9-10-year calls typically seen with new issues. In comparing the following two bonds, the kicker bond has a call date five years earlier than the comparable discount security but has a higher yield to maturity of 3.78% compared to the 2.19%.

Comparison of Two Generic AA Rated Tax Exempt Municipal Bonds

Less Price Volatility:

Higher coupon bonds usually have less price volatility as they tend to perform better in rising interest rate environments because the bonds are priced to the call date…as opposed to their maturity date. The shorter call date keeps the dollar price lower. See the following chart comparing the change in price as interest rate increase:

Change in Bond Prices as Interest Rates Increase

Higher Yield to Call:

Kicker bonds provide a higher yield to call relative to a bond with a maturity date close to the kicker bond’s call date. This is where the kicker really comes into play. If the kicker bond is not called, the yield kicks-up over time as the bond approaches its maturity date. Keep in mind that after the first call date most bonds will be callable anytime thereafter with 30 days’ notice, but that can vary by bond. The following table details the yield to call over time:

Yields to Call on (Bond A) Kicker

Summary

Kicker bonds may earn a higher than market return for those financial institutions willing to venture into the uncertainty of short-term call dates. With their unique features, kicker bonds are but one type of fixed income security offered by SB Value Partners. When in need of investment advisory services, please reach out to see what our seventy years of combined fixed income trading experience can offer your financial institution.

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ABOUT THE AUTHOR

Larry Anderson, VP Fixed Income

For over ten years, I have dedicated my free time to competing in pointing breed field trials with Weimaraners. During the spring and fall we participate in competitive field events that evaluate their level of independence, range, and hunting ability. My wife and I also enjoy spending leisure time with our four dogs at my family’s ranch in West Texas.

During market hours, I collaborate with our experienced traders on the fixed income trading desk in support of our Institutional Advisory program. I have over 20 years of experience with fixed income products, including Municipal Bonds, MBS, CMO, Corporate Bonds, and Structured Products. Prior to joining SB Value Partners, I worked for several major broker/dealers in the industry and received a B.S in Agricultural Systems Management from Texas A&M University.