Attention turns to debt capital as source of finance

Attention turns to debt capital as source of finance

Siddiqi, Moin

A few African countries (excluding S Africa) have taken the first steps to encourage the creation of debt capital markets though the issuing of bonds. Moin Siddiqi explains what these securities are and how the system works.

A small but definite trend has emerged with African corporations listed outside of South Africa, tapping medium-term capital in local currencies from fledgling bond markets.

The development of debt capital markets in some sub-Saharan African (SSA) countries – Botswana, Kenya, Namibia, Tanzania and Zambia – is further proof of Africa’s steady integration into the global financial markets. This bodes well for future increases in foreign portfolio investment.

Before discussing the growth of capital markets in SSA, it is worth looking at the nitty-gritty of debt securities in general – both their advantages and disadvantages.

A debt security is any instrument that is traded more or less freely among investors in the marketplace. Securities are either said to be payable to the bearer or state entitlement with a reference to a register of holders. Bearer securities are usually ‘negotiable instruments’. By contrast, securities in registered form are not themselves documents of title and in the event of loss or theft the register must be produced to establish the identity of the true owner or owners.

There are a wide variety of securities including those that are convertible into stocks and shares, known appropriately as convertibles and those linked to an index or price of a particular commodity. Unlike a conventional bank loan, debt securities are mostly unsecured assets unless forming part of securitisation transactions or structured project financing.

Securities – carrying a fixed or a floating rate of interest, or non-interest bearing termed zero-coupon – may be used for short, medium or long-term financing. Securities with the shortest maturities, under one year, are referred to as commercial paper while securities with maturities of more than a year are called bonds or medium-term notes.

Generally speaking, debt-security markets are only open to blue chip companies whose names are best known to potential investors – unless collateral, such as a bank guarantee, is provided.

Pros and cons

There are many benefits for a company in raising capital by issuing bonds. These can include the favourable pricing terms to be found by tapping the market directly (known as ‘disintermediation’) rather than borrowing from commercial banks. Disintermediation, essentially cutting out the middleman or banker, is especially interesting to larger multinationals whose credit-ratings in global capital markets may be superior to the banks from which they would otherwise seek funding.

Secondly, issuing bonds contributes to raising a company’s profile within the financial community. Offering securities to the market puts a spotlight on the issuing company, its corporate strategy and overall financial situation, as well as its medium-term projections for sales and pre-tax earnings.

In short, debt placements offer the issuers opportunities to enhance their public image and expand future market share.

Thirdly, by diversifying their sources of funding, companies can spread their debt around the market instead of relying upon a relatively small number of banks.

Finally, the terms of the formal agreement of a bond issue is generally more straightforward than that of a loan as prospective investors in debt securities focus specifically on the issuer’s overall financial standing, i.e. the company’s debt service capacity.

But as with nearly all-financial instruments, debt securities have some negative points. Commercial bank lending is based on a prudent assessment of credit-risks. Most bankers have an informed knowledge of a client’s business. In contrast, investors in debt securities do not enjoy similar direct contacts and must rely on information supplied by the issuing company.

There are also substantial costs involved in the issuing of bonds. Interest rates on debt securities are generally lower than a bank’s term loans, but transaction costs are quite expensive.

The issuer hires the services of an investment bank to help document and sell the bond issue. Fees reflect the tasks undertaken by advisers – a simple private placement invokes a single arranging fee but a syndicated, underwritten issue involves management and underwriting commissions. The fees are expressed as a percentage of a security’s face value. Other up-front costs include the additional expense of printing offer circulars, fees levied by legal advisors and accountants and the production of legal documents.

Government support

The development of a local currency bond market in many SSA countries has, until recently, lagged behind other emerging economies – reflecting a lack of institutional support. Among the major constraints were the modest volumes of domestic funds; a lack of medium and longer-term financing; an unavailability of fixed rate funds and poor related infrastructure.

Consequently, most companies have had little choice, if any, but to rely heavily on banks for their primary lending – mostly in short-term loans and overdraft facilities.

The International Finance Corporation (IFC), the private sector arm of the World Bank Group, has helped to highlight the benefits of debt markets to both governments and corporate bodies alike as bond markets can offer cheaper long-term funding channels compared with conventional banks. It also allows companies to better manage the interest rate they pay and, perhaps more importantly, encourages domestic saving by providing mutual and pension funds with longer-dated alternative investment opportunities.

In recent years, some governments have taken the lead in fostering bond markets by establishing long-term benchmarks, which have facilitated issuance by the private sector.

Standard Chartered Bank notes: “If you look at markets such as Kenya and Tanzania in East Africa and Nigeria in West Africa, there is an ongoing desire among governments to see capital markets develop and to encourage savings institutions to start looking at longer-term maturities. Kenya is a good example of a market where that process is developing, with a number of the parastatals looking seriously at accessing the domestic bond market.”

In 2003, diamond-rich Botswana launched its first P500m sovereign bond, led by First National Bank Botswana and Rand Merchant Bank. Its main aim was to set benchmarks for other borrowers.

In addition, the Bank of Botswana extended the yield curve by issuing bonds of two, five and 12 years, creating a secondary liquid pula market in government bonds.

The market received further official support last June when 11 parastatals obtained innovative public securitisation of loans valued at Plbn from the state. The bonds with maturities of three, six, nine, 12,15,18 and 21 years were structured as a collateralised loan obligation, advised by Standard Chartered.

The Bank of Namibia has followed Botswana’s example by issuing five, seven, 12 and 20 year papers. Trading in Namibian bonds is mainly over the counter.

In Zambia, Barclays Bank has helped deepen the debt market through its Zk30bn 12year floating rate note – launched in May 2003 – the largest and longest-dated private placement in the country.

East Africa has also witnessed the growth of corporate paper. Tanzania’s first ever-corporate issue was by Bidco Oil & Soap Ltd, a five-year Tsh10bn fixed rate bond launched in February 2004 with interest and principal guaranteed by Barclays Africa Finance.

Other private issuers include the East African Development Bank (EADB) and the Preferential Trade Area Bank. The former has issued three, four, five and seven-year tenures.

Godfrey Tumusiime, director-general of EADB, said: “Since EADB pioneered the issuing of corporate bonds in 1996, it has had a successful bond issuing and servicing experience, mobilising about $90m, which has been invested in the productive sectors of the three East African economies. The seven-year bond is part of the bank’s intervention to strengthen and deepen the capital markets in the member states.”

Even Sierra Leone has issued its first sovereign bonds, raising over $70m to help rebuild depleted basic infrastructure in country emerging from a decade of civil war.

Encouragingly, initial steps have been taken in some countries towards the creation of viable bond markets in emerging Africa. Fully-fledged capital markets serve as a useful platform for regional economies eager to nurture investor confidence and attract foreign portfolio investment.

However, despite these developments, it will probably take some time for bank lending in Africa to give way to tapping domestic fixed-income markets as in advanced OECD countries. “In many ways it is a question of changing cultures,” says Martin Lopez of Barclays Bank. “Corporates have never had to disclose financial details or pay listing and arranging fees.”

In the final analysis, debt securities are driven by the issuers’ demand for new capital to fund expansion programmes – and this depends largely on the strength of local economy.

Copyright International Communications May 2005

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