Bond market developments

In my articles over the past two weeks, I gave an overview of the first half performances of the Maltese equity market as well as various asset classes internationally. The first half of 2019 was characterised by positive performances across the main asset classes with strong gains in equities, sovereign bonds and various commodities.

In the context of the developments both in Malta and internationally during the past six months, it is also worth reviewing the developments across the Maltese bond market.

As a start, it is worth reminding the investing public of the differences between the Regulated Main Market and Prospects. While most investors may be aware of the structure of the Regulated Main Market or the Official List wherein issuers must compile a prospectus and obtain approval for the listing of securities from the Listing Authority, Prospects is not a regulated market in terms of the Markets in Financial Instruments Directive (MiFID). Prospects, which was launched by the Malta Stock Exchange (MSE) in 2016, is a multi-lateral trading facility operated by the MSE which serves as a platform for debt and equity securities mainly targeted at start-up companies as well as small and medium-sized enterprises (SME’s).

During the first half of 2019, the Listing Authority approved the issuance of bonds of 6 companies on the Regulated Main Market totalling €138 million. The companies were Mercury Projects Finance plc, Endo Finance plc, SP Finance plc, Tum Finance plc, Bank of Valletta plc and Together Gaming Solutions plc. With the exception of BOV’s €50 million subordinated and callable bond issue, all the other issuers are new to the market. Moreover, while three of the companies are once again involved in the property sector, it was the first time that a company in the petroleum sector and another from the i-gaming sector raised finance from the Maltese capital market.

Among the 6 new issues, three are classified as complex financial instruments. BOV’s bond issue is a complex instrument as a result of  the subordinated feature,  the BRRD regime as well as the callable option. The bond of Together Gaming Solutions is also a callable bond and therefore also a complex instrument while the Tum Finance plc bond is a complex instrument since it is a ‘puttable’ bond. This is a feature which never appeared in any of the bond issues in Malta so far to date. Essentially, the securities note stipulates that if the ownership or control of Tum Finance changes, bondholders have the right to ask the issuer to redeem their holding at a price that will be determined by the issuer at that point in time.

It is also worth highlighting that following the bond issue of Von Der Heyden Group Finance plc in 2017, the recent prospectus of Together Gaming Solutions also represents the second instance wherein a company whose shareholders are non-Maltese, utilised the Maltese capital market for the raising of finance. This could gather momentum in due course given the difficulties generally encountered by small companies by international standards to raise finance of a certain size across the larger international financial centres.

Meanwhile, across Prospects, there were 7 bond issues in the first half of 2019 in which a total of €31 million was raised. The companies that utilised the Prospects market in the past six months were Borgo Lifestyle Finance plc, Horizon Finance plc, FES Finance plc, The Convenience Shop Holding plc, Calamatta Cuschieri Finance plc, Smartcare Finance plc and Busy Bee Finance Company plc.

Given the varying characteristics of the different issuers across the both the Regulated Main Market and also Prospects, it is important for the investing public to remain extremely vigilant before contemplating any investment in such offers.

As I have articulated in several articles over the past few years, investors should not proceed with an investment solely on the basis of the rate of interest being offered. Although some of the interest rates being offered may indeed be tempting given the increasing difficulties being faced by retail investors in obtaining some yield from alternative investments or banking products, investors should consider the various characteristics before proceeding with any investment.

The sector in which a company operates is also an important feature given the possible cyclicality of certain sectors or the impact that a company’s operations may have due to a change in regulation across a particular industry, a possible economic downturn, a change in legislation, etc.

A company’s track record is another important determining factor. Investors should ascertain whether the company has been operating profitably for a number of years or whether it is a ‘start-up’ and therefore a riskier proposition. Another essential feature is the strength and profile of the main shareholder or group of shareholders. This can be important should the company experience financial difficulties and it would need to resort to its shareholders for additional financing. A company with weak shareholders could have severe difficulty in an economic downturn.

Apart from these various factors, naturally, the financial position of the company and the level of indebtedness are crucial elements that investors need to consider before contemplating any investment.

As I explained in prior articles, there are a number of ratios which assist financial analysts and investors to gauge the creditworthiness of the issuer, such as  the interest coverage ratio and the gearing level. On an annual basis, I had also published a table ranking the issuers on the Regulated Main Market in terms of the interest coverage ratio and the gearing level.

The financial information required to calculate these important financial metrics is obtained from the annual financial statements which must be published within 4 months from the end of the financial year of each of the respective companies. Since most companies have a December year-end, the financial statements were published by the 30 April. Moreover, in line with the Listing Policies of March 2013, most of the issuers on the Regulated Main Market must also comply with these policies and also publish a Financial Analysis Summary. This document must be published not only at the time of the initial fund raise but it must be updated annually and published within two months of the publication of the annual financial statements. As such, most issuers on the Regulated Main Market published their updated Financial Analysis Summary by the end of June. The FAS provides invaluable information to the market at large since it gives financial projections of the issuer and any guarantors to the bonds.

The assessment of a company’s financial strength and its level of creditworthiness should not be carried out only at the launch of a bond issue but also on a continual basis to ensure that investors remain aware of any changes in the financial fortunes of the companies to which they may be exposed. Investors should utilise all the information available in the public sphere especially the information within the FAS to ensure that they remain comfortable retaining an exposure to any of their existing bonds or whether they may contemplate a fresh investment in another company with stronger financial metrics which are more consistent with their risk appetite.

Although this information is widely available and documented in the media for those companies on the Regulated Main Market, it is equally important for investors to gauge the performances of those companies that issued instruments via Prospects.

The calculation of certain ratios may be impacted as of the 2019 financial year due to the adoption of IFRS 16 which basically requires companies to recognise all lease agreements on the balance sheet. In fact, with effect from 1 January 2019, companies will have to recognise a ‘right-of-use’ asset as well as a lease liability which upon initial recognition will equate to the present value of the future lease payments. Furthermore, in the income statement, the lease expense will no longer be accounted for within operating expenses. Instead, the expense will now be treated partly as amortisation and partly as finance costs. Therefore, lease related charges will not be included within earnings before interest, depreciation and amortisation (EBITDA) and thus this figure will automatically increase. Moreover, total debt is also expected to increase as all leases will now be treated as finance leases and hence will be incorporated in a company’s total borrowings. The adoption of IFRS 16 will generally lead to an improved interest coverage ratio (given the higher increase in EBITDA than finance costs) and a weaker net debt to EBITDA ratio (given the higher increase in borrowings than in EBITDA), keeping everything else unchanged. Moreover, many companies have opted not to re-state previous years’ figures which will make a comparison with past ratios even more difficult. Meanwhile, it is important to highlight that these changes in accounting standards will have no effect on cash flows.

It would be unwise to ignore these various features and ratios and simply carry out an investment due to the interest rate being offered. Investor education remains a key factor to ensure that the Maltese capital market continues to advance in a sustainable fashion. As in previous years, my articles will seek to help promote financial literacy and the dissemination of information to assist investors in the decision-making process.

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