Capital Note
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{{Unreferenced, date=June 2019, bot=noref (GreenC bot) Capital notes are several types of
securities A security is a tradable financial asset. The term commonly refers to any form of financial instrument, but its legal definition varies by jurisdiction. In some countries and languages people commonly use the term "security" to refer to any for ...
. "Capital note" has a number of meanings, as it can be either an
equity Equity may refer to: Finance, accounting and ownership * Equity (finance), ownership of assets that have liabilities attached to them ** Stock, equity based on original contributions of cash or other value to a business ** Home equity, the dif ...
security, a
debt Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to another party, the creditor. Debt is a deferred payment, or series of payments, which differentiates it from an immediate purchase. The ...
security or a form of security used in
structured finance Structured finance is a sector of finance - specifically financial law - that manages leverage and risk. Strategies may involve legal and corporate restructuring, off balance sheet accounting, or the use of financial instruments. Securitization ...
. In all cases, the use of the term "capital" is to denote that the security is relatively
junior Junior or Juniors may refer to: Arts and entertainment Music * ''Junior'' (Junior Mance album), 1959 * ''Junior'' (Röyksopp album), 2009 * ''Junior'' (Kaki King album), 2010 * ''Junior'' (LaFontaines album), 2019 Films * ''Junior'' (1994 ...
in the issuing corporation's order of priorities in claims for its assets.


Convertibles

Capital notes are a form of
convertible security A convertible security is a financial instrument whose holder has the right to convert it into another security of the same issuer. Most convertible securities are convertible bonds or preferred stocks that pay regular interest and can be converted ...
exercisable into shares. They are
equity Equity may refer to: Finance, accounting and ownership * Equity (finance), ownership of assets that have liabilities attached to them ** Stock, equity based on original contributions of cash or other value to a business ** Home equity, the dif ...
vehicles. Capital notes are similar to warrants, except that they often do not have an expiration date or an exercise price (hence, the entire consideration the
company A company, abbreviated as co., is a Legal personality, legal entity representing an association of people, whether Natural person, natural, Legal person, legal or a mixture of both, with a specific objective. Company members share a common p ...
expects to receive, for its future
issue Issue or issues may refer to: Publishing * ''Issue'' (company), a mobile publishing company * ''Issue'' (magazine), a monthly Korean comics anthology magazine * Issue (postal service), a stamp or a series of stamps released to the public * '' ...
of shares, is paid when the capital note is issued). Capital notes may be issued in connection with a debt-for-equity swap restructuring: instead of promptly issuing the debt-replacing shares, the company issues convertible securities, in order to postpone the event of
share dilution Stock dilution, also known as equity dilution, is the decrease in existing shareholders' ownership percentage of a company as a result of the company issuing new equity. New equity increases the total shares outstanding which has a dilutive eff ...
.


Bonds

Alternately, a capital note is a
bond Bond or bonds may refer to: Common meanings * Bond (finance), a type of debt security * Bail bond, a commercial third-party guarantor of surety bonds in the United States * Chemical bond, the attraction of atoms, ions or molecules to form chemica ...
with a very long maturity horizon, reaching several decades (sometimes as much as 50 or 100 years). Unlike equity securities, these capital notes ''do'' mature at some point; therefore, they form part of the company's liabilities and not part of
equity Equity may refer to: Finance, accounting and ownership * Equity (finance), ownership of assets that have liabilities attached to them ** Stock, equity based on original contributions of cash or other value to a business ** Home equity, the dif ...
. However, since their maturity is so far in the future, they are treated as equity for practical purposes; the company keeps the money raised through them inside its balance sheet for a very long time.
Bank A bank is a financial institution that accepts deposits from the public and creates a demand deposit while simultaneously making loans. Lending activities can be directly performed by the bank or indirectly through capital markets. Because ...
s and other financial institutions issue these bonds to satisfy regulatory demands regarding
capital requirement A capital requirement (also known as regulatory capital, capital adequacy or capital base) is the amount of capital a bank or other financial institution has to have as required by its financial regulator. This is usually expressed as a capital ad ...
s, specifically under the
Basel Accords The Basel Accords refer to the banking supervision accords (recommendations on banking regulations) issued by the Basel Committee on Banking Supervision (BCBS). Basel I was developed through deliberations among central bankers from major countries ...
. In the Basel "tiers" system, capital notes are treated as close to equity, as both reinforce the bank's "capital". Additionally, bank capital notes are usually not collateralized and are contractually subordinated, forming a junior class of debt. Similar terms might be found in redeemable
preferred shares Preferred stock (also called preferred shares, preference shares, or simply preferreds) is a component of share capital that may have any combination of features not possessed by common stock, including properties of both an equity and a debt ins ...
. Contrary to the warrant-like capital notes described above, these capital notes are usually not convertible, so they represent no current or future stake in the corporation's equity (
share capital A corporation's share capital, commonly referred to as capital stock in the United States, is the portion of a corporation's equity that has been derived by the issue of shares in the corporation to a shareholder, usually for cash. "Share capita ...
).


Structured finance

In
structured finance Structured finance is a sector of finance - specifically financial law - that manages leverage and risk. Strategies may involve legal and corporate restructuring, off balance sheet accounting, or the use of financial instruments. Securitization ...
, the capital note is the most junior security issued by a
structured investment vehicle A structured investment vehicle (SIV) is a non-bank financial institution established to earn a credit spread between the longer-term assets held in its portfolio and the shorter-term liabilities it issues. They are simple credit spread lenders, ...
. It is comparable to the equity
tranche In structured finance, a tranche is one of a number of related securities offered as part of the same transaction. In the financial sense of the word, each bond is a different slice of the deal's risk. Transaction documentation (see indenture) ...
of a CDO. Investors who buy the capital notes are the first in line to bear risk if the cash flows from the SIV's assets are insufficient to cover promised payments to all investors. See
securitization transaction Securitization is the financial practice of pooling various types of contractual debt such as residential mortgages, commercial mortgages, auto loans or credit card debt obligations (or other non-debt assets which generate receivables) and selling ...
for more details on how the process of slicing up risk (or "tranching") works. Credit Equity securities Interest-bearing instruments Embedded options