High returns attract banks to corporate bonds

Banks have turned a missed business opportunity into a cash cow by investing heavily in corporate bonds in response to thinning opportunities for commercial lending in an uncertain economic environment.

Uncertain of their ability to service commercial bank loans and with a bleak business outlook, corporates have preferred debt instruments like bonds and commercial paper over bank loans to fund their operations and expansion.

But rather than weep over the loss of business to dealmakers in the capital markets, banks have taken refuge in the safe havens, with bonds offering assured returns on their investments with virtually no risk of default that would stalk lending during depressed times.

According to bankers, the preference for corporate bonds arises more from their longer repayment period and relative ease of arranging.

“A bond issue is much simpler and the terms are determined by the single issuer, with advise from an investment bank/adviser,” said Mr James Macharia, the Managing Director of NIC Bank.

In the last five months of last year, for instance, the bond market registered the busiest season with five corporate bonds and one government infrastructure bond coming to the market.

The corporate bonds raised a total of Sh35 billion with the government two infrastructural bond netting Sh37 billion.

Three other corporate bonds estimated to be worth over Sh2.3 billion are in the pipeline while the government will issue the third infrastructural bond in February this year.

For banks, competition has arrived at their door step. But they are taking it in their stride.

For instance, the Sh25 billion KenGen Infrastructure bond had 80 per cent reserved for institutional investors.

A market player closely involved in the KenGen bond informed Business Daily that commercial banks were actively involved with close to 50 per cent application for the Sh21 billion reserved for the institutional and foreign investors.

In deed, a middle size bank is reported to have put in Sh1.3 billion.

Beside the issuance of corporate bonds, the setting up of shop by private equity (PE) and venture capital (VC) is set to up competition for funds by businesses seeking to expand their operation but are held back by capital scarcity or the unwillingness on the part of the lender to assume business risk.

PE and VC operate on the premise of offering funds to start ups, early stage and growing business but at the same time assume the risk associated with the business.

Typically, PEs and VCs will avail funds and take a stake in the running of the business.

Though they may not be involved in the day- to -day operation, they normally offer management expertise and strategic investment decision.

This is done to safeguard their stake in the business.

Currently, there are close to eight PEs and VCs which have set up shop in Kenya in the last one year.

Some of these funds are Fanisi Venture Capital Fund, AfricInvest Capital Partners East Africa, TBL Mirror Fund, Citadel Capital and Business Partners International (BPI).

The rush to issue corporate bonds by various blue chip companies has invigorated the country’s capital market at the expense of commercial banks which traditionally have been the main source of funds for many companies.

Banks’ corporate business, especially loan syndication, has been hard hit as the bonds being issued amount to business moving away from their radar screen.

Loan syndication involves more than one bank coming together to provide finance which is likely to be in the range of billions of shillings.

The arrangement can be either done by the principal bank or a third party such as an investment bank.

Bank executives cite the tedious arrangement process and documentation and pricing as some of the reasons syndicated loans are not attractive to corporate players.

Lending terms

“Syndicated loans have never been popular for a variety of reasons, including the need for financiers to agree on lending terms, complex security documentation and inter-lenders agreements, which means that an inordinate amount of time is spent before the customer can draw down on the funds”, said Mr Macharia.

With the banking regulation capping lending to a single entity at not more than 25 per cent of a bank’s capital base, it limits how much a single bank can lend hence locking out the type of borrowers offering corporate bonds.

For instance, the largest bank in terms of capital, Barclays Bank, has a capital base of Sh24 billion.

In the event of lending, Barclays cannot lend more than Sh6 billion which is a quarter of say, the Sh25 billion raised by KenGen in its bond.

In comparison, the syndicated market has seen Total Kenya, one of the leading oil marketers in the country, receiving Sh4.7 billion as a syndicated loan from a consortium of six banks to pay for its acquisition of Chevron assets which folded shop in Kenya.

Companies have traditionally used their banks to borrow money to meet their growing capital expenditure (capex needs).

But the flow is changing mid stream as corporate players turn to corporate bonds, commercial papers and now private equity and venture capital firms to raise the funds.

Analysts indicate that the determinant of borrowing structure lies with the borrower who considers many factors before determining which financing method to adopt.

“Corporate companies consider many factors when they are planning to borrow funds from the market which may include the cost of borrowing, time limitation and benefits to be accrued”, said Mr Job Kihumba executive director of Standard Investment Bank.

A corporate banker who prefers not to be named due to protocol within his bank says that loan syndication will continue to compete with bonds due to its ease of arrangement, and quick turn around time.

“Loan syndication does not require any regulatory approval like bonds which need a green light from the Capital Markets Authority (CMA) before issuing,” said the banker.

In addition, the cost of arranging a bond is comparatively high with no guarantee of full subscription.

Due to the growing status of the capital market, many issuers prefer issuing bonds in tranches to ensure full uptake.

For instance, Barclays Bank and Safaricom issued their bonds in two tranches, with the first tranche of Sh3 billion and Sh7 billion for Barclays and Safaricom registering total uptake.

The other two tranches of Sh3 billion and Sh7 billion are set to be issued this year.

But Mr Kihumba says the preference for corporate bonds is largely driven by its long term nature as opposed to bank loans which have a short to medium term time frame hence expensive to many corporates in terms of repayment.

The banker agrees that bank loans are typically of short term to medium term periods of not more than five years leading to high cost of repayment over the short time.

“Corporate bonds are issued for longer period of up to 10 years, generally longer than the syndicated loan market or even normal bank loans are prepared to take”, said Alfetta Mungai Koome, regional head of Debt Capital Markets at CFC-Stanbic Bank.

For instance, the KenGen infrastructural bond has a time limit of 10 years while the Total loan is for five years.

Ironically, commercial banks are key players in the bond market as it presents an investment opportunity hence boosting their revenue.

Banks simply use deposits which cost them less than five per cent and pump it into bonds and reap a more than twice handsome return.

The KenGen bond and Safaricom bond were priced at 12.5 per cent giving the banks a seven per cent mark up margin.

However, banking executives say that much of their business charges are driven by the corporate entities hence their margins are not huge.

“Corporate depositors tend to bargain for better returns on their deposits while at the same time they seek preferential lending rates when borrowing,” said Mr Isaac Awuondo , the managing director of Commercial Bank of Africa.

Another factor making bonds preferable to bank loans is the application of benefits such as tax waiver granted by the government.

In an effort to encourage corporates to issue bonds the government waived the taxes that are applicable for infrastructural bond.

Major challenge

“The long-term financing especially for the development of our infrastructure remains a major challenge and to encourage investment, the government will reduce withholding tax from 15 per cent to 10 per cent on interest arising from long term bonds of ten years maturity and above”, said Finance minister Uhuru Kenyatta in his budget speech last June.

The growing preference for bonds is also being fuelled by companies reluctance to be shackled with the demands and stringent conditions that come with loan funding.

Through dis-intermediation which involves taking funds directly from investors, corporates have the leeway to deal with different “capital lenders” and not one entity.

Commercial banks tend to require the execution of collateral before releasing the funds whereas bond issuance is based on future ability to repay.

But companies issuing corporate bonds must meet the minimum regulatory requirements with all key ratios being healthy.

The issuance of corporate bonds allows companies not to exhaust their borrowing avenues hence can turn to banks for short-term financing.

The Governor of the Central Bank, Prof Njuguna Ndung’u, has advocated the active growth of the bond market as a signal to the deepening of the country’s financial market which will not only provide borrowers with a wide choice but also investors with various investment instruments.