Seasoning: What it is, How it Works, Impact

What Is Seasoning?

Seasoning refers to the amount of time that has passed since a debt security has been issued and available to be publicly traded. Seasoning helps determine if a premium or discount should be made for the bond in the secondary market.

A debt security will often be called "unseasoned" if it has been traded for less than a year, or "seasoned" if it has been traded for over a year with a good repayment track record. In the equity markets, a seasoned issue is also known as a seasoned offering or follow-on public offering (FPO), but new issues by blue-chip companies may be considered seasoned immediately.

Understanding Seasoning

Seasoning is a theoretical period of time in which newly issued bonds trade at prices which translate into a higher yields (i.e. at a discount) than those of comparable existing or seasoned bonds. The rationale is that it takes some time for all of the information about an issuer or security to become known. The prices of the new issues eventually adjust, taking a few months or years, to become comparable to the prices seen in more seasoned issues. In effect, the bond will converge to its ideal price after seasoning.

A higher yield on a bond represents a higher cost of borrowing for the issuer. Seasoning, therefore, results in additional costs to the borrower. To put it another way, the seasoning time is when new entrants will experience interest rates on debt that is issued, and thus also have higher debt ratios on average.

On the other hand, since material information pertinent to the pricing of these new securities is not reflected in the issue price, investors have an opportunity to earn excess returns above those justified by the associated risks by investing in these securities.

Seasoning and Issue Reputation

Seasoning is another way of characterizing investments based on reputation, with that reputation built on an investment's history in the market. Investors are typically more skeptical of new investments that do not yet have a proven record and are therefore more likely to pay a premium for securities that are safer. In the case of a seasoned issue, the quality symbolized by having more than 12 months of payments indicates that the likelihood of the note being paid back in full is higher.

In the mortgage sector, seasoning refers to the age of the mortgage. Typically a mortgage is considered to be fully seasoned when it has been held for at least a year. Any holding period less than a year will mean the mortgage is unseasoned, a period during which selling or refinancing the loan may not be approved by lenders, since the risk is higher and the reputation of the borrower is not yet established. In addition, most lenders will not let you cash out your equity or take out home equity lines of credit (HELOC) without full seasoning.