What it means
Most corporate bonds are issued in large blocks that suit pension funds and insurers. A retail note breaks the same idea into small pieces, often priced at $1,000 or less, so a private investor can take part.
The investor receives a coupon, which is the interest payment, and gets the face value back at maturity. Companies issue retail notes to diversify where their funding comes from.
Selling to many individuals reduces reliance on a few big institutions and can build a base of loyal customer-investors. The issuer pays for this in marketing, administration and regulatory work.
For the investor, the key questions are the credit quality of the issuer, the interest rate and how easily the note can be sold. A higher coupon usually signals higher risk, and a note from a weaker issuer can lose value or even default.
Some notes trade on an exchange, but others have little trading, so selling early may be difficult. Retail notes are not the same as bank deposits.
Deposits may be covered by a government protection scheme up to a limit, whereas a note is a loan to the issuer and is usually not covered. If the issuer fails, noteholders rank alongside other creditors and may get back only part of their money.
Some retail notes are structured, meaning the return is linked to an index or a basket of assets rather than a fixed rate. These can be complex and may put the original capital at risk.
It pays to read the term sheet carefully and make sure you understand exactly how the payout is worked out. Tax treatment also deserves attention.
Interest from a note is usually taxable income, and the rules on how it is reported and taxed differ by country, so an investor should compare returns after tax rather than before.
In practice
Real-world examples.
Example
A regional bank offers retail notes in $1,000 units to its customers. A retired customer buys ten notes for $10,000 and receives a fixed interest payment twice a year until the notes mature.
Example
A growing equipment leasing company raises $5,000,000 by selling retail notes with a three-year term. The notes pay a higher rate than a bank deposit, and the company uses the money to buy more equipment to lease out.
Example
An investor reads that a retail note pays 9%, much higher than similar notes from stronger issuers. She looks at the issuer's accounts, sees heavy borrowing and thin profits, and decides the extra yield is not worth the default risk.
Formula
Calculation
Annual coupon = Face value x Coupon rate
Current yield = Annual coupon / Market price
Suppose an investor buys a $1,000 retail note paying a 5% coupon. The annual coupon is $1,000 x 0.05 = $50. If the note is bought on the market at $980, the current yield is $50 / $980 = 0.0510, or 5.10%. Over a five-year life the investor receives 5 x $50 = $250 in coupons plus the $1,000 face value at maturity.Case study
Seen in the real world.
Harlow Equipment Finance is an illustrative, fictional company that wanted to fund its growth without depending on a single bank. Its treasurer designed a retail note programme in $500 units with terms of two, three and five years.
The marketing team promoted the notes to existing customers, and the first issue raised $3,000,000 from more than 2,000 investors. The finance team set up a registry to track payments and sent annual statements, which added cost but also strengthened customer relationships.
In this fictional case the notes were repaid on schedule, and the company found it easier to borrow from banks afterwards because it had shown a wider funding base. The illustrative lesson is that retail notes can broaden funding, provided the issuer is prepared for the administrative burden and the responsibility of lending from small savers.
Watch out
Common mistakes.
- Treating a retail note as if it were a protected bank deposit when it is a loan to the issuer with default risk.
- Chasing the highest coupon without examining the issuer's finances and what the high rate says about risk.
- Assuming a note can be sold quickly at face value, when trading may be thin and the price may be lower.
Questions
People also ask.
What is the difference between a retail note and a bond?
Both are debt securities, but a retail note is designed and sold in small amounts to individuals, while many bonds are sold in large blocks to institutions.
Do retail notes always pay a fixed rate?
No, some pay a floating rate that follows a benchmark and others are structured so that the payout depends on an index or other asset.
What happens if the issuer cannot pay?
Noteholders become creditors and are paid according to their ranking, which may mean receiving only part of their money after secured lenders have been paid.
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