€172 million in new corporate bonds expected in H1

Financial Article 369 by Edward Rizzo - Feb 05, 2015

Following a very buoyant primary market for corporate bonds last year, this trend is expected to continue also in the coming months as indicated by the listing calendar published by the Malta Stock Exchange last week showing a possible €172 million in new corporate bond issuance until June 2015. Although this may seem to be a high figure, it is worth remembering that during 2014, total corporate bond issuance amounted to €288.5 million across 12 issuers.

This calendar is purely a tentative one and some of the bonds included in this list may be delayed for various reasons including the length of time required to compile the prospectus and obtain approval from the regulator. Meanwhile, other companies who intend to tap the market may not as yet have selected a sponsor to assist them in the approval process and the Malta Stock Exchange would therefore not be aware of such possible offerings.

Some investors continue to question why some companies opt for bond financing as opposed to bank borrowings. Across international financial markets, it is the norm for companies to diversify their funding base and obtain financing from both the banks as well as from institutional and retail investors via the financial market. Some local companies have also adopted this strategy in recent years and this has helped the local corporate bond market to grow to the size it is today with many household names among the issuers who successfully tapped the market. While interest rates on bank financing are normally variable in nature, the main advantage for a bond issuer is that the interest rate is fixed for the duration of the bond. This helps a company to budget ahead with more clarity after locking-in a fixed interest rate. Some companies may also wish to opt for a bond issue in order to improve its corporate governance structures and making management more accountable to shareholders due to regular scrutiny by financial analysts. Other companies may also view a bond issue as a stepping stone to a more effective route to succession planning since sometimes this may also lead to an equity listing in due course.

“…before investing in any bond, it is important for investors to seek independent financial advice in order to understand all the risks involved.”

Since the current low interest rate environment is expected to be maintained for many more years which has resulted in a decline in yields also across the corporate bond market as evidenced in recent weeks following the announcement of the quantitative easing programme by the European Central Bank, other companies may be encouraged to launch new bonds in the months and years ahead. One would therefore expect other companies to tap the market not only in the first six months of the year but also during the second half. Furthermore, the hunt for yields by investors in the prevailing low interest rate scenario has already led to an increase in trading volumes across local corporate bonds. In fact, the value traded in the local corporate bond market during 2014 increased by 29.4% to €43.2 million. Moreover, this trend continued during January 2015 with local corporate bond trading reaching €9 million. This represents the highest monthly level of trading activity since July 2010 when €9.5 million worth of transactions took place. The higher liquidity across the corporate bond market is not only expected to be maintained but could also increase further due to the upcoming liquidity injection by the ECB through its quantitative easing programme.

Although Maltese investors have been accustomed to investing in corporate bonds over the years, certain enquiries made by retail investors continue to indicate that market participants and the regulators need to invest in adequate investor education campaigns to ensure that the growing investor base seeking publicly listed investments as opposed to the traditional fixed-term deposits from banks understand the mechanics of bond and equity investing and the way the market operates.

As such, before investing in any bond, it is important for investors to seek independent financial advice in order to understand all the risks involved. Moreover, all the documentation issued at the time of any issue is nowadays easily available online to enable the more avid investor to read through the prospectus to gather a good understanding of the business. The Financial Analysis Summary prepared by the sponsor (the stockbroker assisting the issuer to obtain approval from the MFSA) and appended to the Prospectus for bond issuers is also a very good summary of the business operations, the historic financial performance and more importantly the financial expectations of that issuer.

Investors need to understand that although a bond is an obligation by a company to repay interest on a yearly basis and capital upon maturity, there are risks involved in any business proposition and a good review of the financial position and the strength of the controlling shareholders behind the company are fundamental factors to take into consideration before taking any investment decision.

Apart from the expected corporate bond issuance in the months ahead, the Treasury is expected to launch its first new Malta Government Stock issue in the coming weeks. The size of the offering and the details are not yet known but the Treasury had indicated that the total issuance for 2015 of €500 million is expected to be spread over three or four issues throughout the year. As such, this month’s MGS issue should amount to circa €150 million. Although this may seem to be a large offering, given the take-up in the last retail offering in July 2014 where investors applied for €193 million, the upcoming MGS issue may also be over-subscribed since the amount may be insufficient to ensure full allotment for the retail segment. The only deterrent to this over-subscription materialising may be the low interest rate as investors may find it difficult to accept to invest in a Malta Government Stock at a yield of less than 3% per annum. Given the surge in MGS prices over recent months and the resulting downward movement in yields, if the Treasury opts to issue a bond with a maturity of less than 20 years, the yield will have to be below 3% per annum. Otherwise, this would not be in line with yields on the secondary market and this could trigger a sharp movement in prices of other MGS already in issue. The only way for the Treasury to issue a bond with a yield of above 3% is for the maturity date to extend beyond 2035. With €172 million in corporate bonds earmarked to hit the market in the coming months together with €500 million in new MGS issuance, some people may think that this is too large an amount for the market to absorb. However, it is worth remembering that although new MGS issuance is expected to reach a total of €500 million throughout the year, this amount is not high. In fact, it is €150 million below that issued in both 2014 and 2013.

“…the upcoming MGS issue may also be over-subscribed since the amount may be insufficient to ensure full allotment for the retail segment.”

The tentative listing calendar published by the MSE does not include any equity listings. This is unfortunate especially in the light of two possible de-listings of Crimsonwing plc and Island Hotels Group Holdings plc in the coming months. Although many retail investors have a preference towards bond investing generally on age considerations and individual circumstances, a larger variety of equities are required for retail and institutional investors to achieve a good diversification in their investment portfolios. The benefits of equity investing have become evident over the years and an allocation to equities in any portfolio is generally advisable. Moreover, there is likely to be an increased demand for dividend yielding equities due to the impact of QE on bond yields. This was already evidenced in recent weeks with a marked increase in trading activity also in the equity market. This heightened activity could instigate companies to opt for an equity listing especially some property companies that can offer attractive and sustainable dividends to shareholders. The launch of the new PROSPECTS market by the MSE towards the end of 2015 could also assist in a new wave of equity issuance in late 2015 and in 2016.

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