Net interest cost (NIC) is a type of calculation that is commonly employed by municipalities and companies that offer bond issues to investors. The focus of the calculation is to identify the interest expense or cost that occurs during the life of the bond issue, and which the issuer must absorb as part of the terms and conditions associated with the bond. Accurately assessing the net interest cost will aid in identifying the amount of benefit that is ultimately gained from issuing the bond, even after deducting the interest expense from the funds that are collected from investors.
In order to calculate the net interest cost, it is necessary to take into consideration the number of years that the bond will be in effect, from the date of issue to the final settlement or maturity date. The coupon rate associated with the bond issue is weighted based on that number of years between the issue and settlement dates, and will also allow for the configuration of the interest rate applied to the bond. The rate may be fixed or variable, depending on the terms of the bond contract, with interest payments due at specific points in the life of the bond, or paid in full at the date of maturity.
After allowing for the coupon rate and the number of years the bond will be in force, determining the net interest cost will also require taking into account any premiums or discounts that were also extended to the investor as part of the purchase of the bond issue. Since those are also expenses that would reduce the amount of benefit the issuer receives from the bond over time, they are accounted for in the calculation. When all relevant factors are considered, the final net interest cost will provide an accurate snapshot of whether a proposed bond issue is configured so that the issuer can honor the terms, or if there is a need to rework some aspects of the issue to make the terms more realistic for the issuer.
While issuers look closely at the net interest cost before actually issuing a bond issue, the calculation is also of interest to parties who would buy the bonds. This is because if the net interest cost is relatively high, this could undermine the ability of the issuer to honor those terms, which means that the bond itself may be considered a greater risk. Underwriters who support the bond issue will also look closely at this calculation and compare the net interest cost that will be generated with the ability of the issuer to cover that cost without a great deal of financial hardship. Assuming the cost is within reason and there are no indications that the issuer will have trouble covering the expense, the bond is likely to be a sound investment for everyone concerned.
