CAPITAL IDEA - JSE MAGAZINE

CAPITAL IDEA

With a large number of diverse players in the bond market, there are a host of opportunities for investors too

CAPITAL IDEA

Corporate SA can raise debt capital from banks or institutional investors. However, in terms of cost and administration, one of the most efficient debt capital-raising channels is through a listed bond on the JSE.

Head of debt origination at Nedbank Capital Bruce Stewart says: ‘This can be done either via a standalone instrument or under an umbrella programme, which allows for a variety of debt instruments and issues thereunder.

‘Alongside the listed bond is a securitisation structure whereby corporate SA is able to utilise a specific asset class or classes, ring fenced as security, to improve the credit rating of the specific borrowing and so access attractive pricing.’

Boasting one of the most established and liquid debt capital markets among emerging economies, the JSE holds more than R2 trillion of listed debt.

According to Futuregrowth Asset Management investment analyst Conway Williams, bond issuances are ‘a flexible way for companies to raise capital, since the market can generally accommo-date the needs of the issuer. Bond issuance could be for an acquisition, a new building or for general corporate purposes’.

Stewart says that with more than 30 corporates accessing the debt capital markets (DCM) in 2014 – a year characterised by uncertainty and volatility – ‘the robustness of the DCM has been tested and has not only survived but matured to establish itself as an invaluable alternative to bank or loan finance’.

He notes that, excluding financial institutions, there were 26 corporate issuers in 2014 across a diverse spread of sectors, from construction to mining.

Williams says that so far, quite a lot of bank activity has occurred in 2015, which has been well supported by the market. ‘Before that, the biggest theme was issuances from real estate investment trusts [REITs].’

In 2014 there was a significant amount of new and repeat issuers in the REIT space, for both short-term commercial paper (one-year issuances) and longer-term paper, reflecting where REITs are in their growth phase. This does not come as a surprise, considering the outstanding year that listed property enjoyed on the JSE in 2014. The sector delivered a total return of 27%, compared with the all share index’s 11%.

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‘Bond issuances are a flexible way for companies to raise capital, since the market can accommodate the issuer’

CONWAY WILLIAMS, INVESTMENT ANALYST, FUTUREGROWTH ASSET MANAGEMENT

Stewart says that bonds provide a corporate treasurer with another source to raise capital, reducing the risks that emerge when funding sources are limited. ‘This translates into a stronger negotiating position with traditional sources of funding, which itself manifests in better pricing, less onerous terms and conditions and generally access to a larger funding pool.’

Williams agrees, noting that the advantage for a prospective issuer is the availability of a large and diversified investor base.

On the downside, Stewart says that although generally cheaper with less onerous covenants, the terms and conditions of corporate bonds are less flexible than a bilateral loan arrangement with a bank. ‘Non-vanilla bullet structures such as amortising or roller coaster profiles with bespoke requirements are also less appealing to the tradable listed market and hence better suited to bilateral loan arrangements,’ he says. With a large number of diverse players in the listed credit space, there are a host of opportunities for investors, too. Bond markets offer a means to diversify your asset base, particularly for large pension funds with a wide range of mandates.

Williams says the SA bond market is quite well regulated so a retail investor or one who has a pension fund can take comfort in the fact that there is oversight. ‘For example, before a bond comes to market, a lot of behind the scenes work is put into it to ensure that listing requirements are met. This is quite an onerous process, and provides us with a degree of comfort.’

Similarly, Stewart points out that the debt capital markets provide investors with access to a broad range of fixed-income assets. ‘From the money market funds that focus on short-term commercial paper to the longer-term fixed income, life and pension funds that have appetite for varying degrees of credit out along the yield curve.

‘The benefit of being a tradable instrument is an attractive concept and risk mitigant despite the uncertainty of liquidity. The bond market is also a significant mechanism for the distribution of capital, which facilitates economic growth, and institutional investors play a significant role in facilitating this distribution of capital,’ he says.

Savvy bond investors who have been investing for some time generally have robust credit processes and a good track record. ‘You can’t always predict things like fraud, but if you have a robust set of processes and price things correctly, you might be more protected than the next guy,’ says Williams.

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Savvy bond investors who have been investing for some time generally have robust credit processes and a good track record

He feels the collapse of African Bank Investments Limited (Abil) in August last year has prompted investors and debt capital markets to look more closely at their processes. Describing 2014 as ‘a tale of two halves’, Williams says there was a significant amount of issuance in 2014 prior to the Abil crash. Post the collapse, certain issuers were scared to come to the market, fearing the risk of a failed auction or pricing in excess of their cap.

‘Abil has been a defining moment for the credit market. People are now looking at processes, investing more cautiously and looking at relative value more than at specific counters. Overall due diligence on counters has increased and credit ratings are used as only one input into the decision-making process,’ he says.

Stewart agrees, noting that Abil’s collapse led to a ‘certain level of introspection by most market participants’, prompting debt capital markets in SA to enter a new risk-return paradigm.

‘We should anticipate a market of wider credit spreads, greater focus on compliance with rules and regulations and generally a greater awareness of the sensitivities of market participants in the South African debt capital markets,’ he says.

According to Williams, issuance over the last while has been soft and credit conditions quite tight. ‘If it wasn’t for banks, there would not be much issuance to date,’ he says, noting that in January and the first weeks of February more than R15 billion was made in bank bond issuances.

Low domestic growth conditions, coupled with uncertain local conditions, means that issuers are delaying capital projects or retaining cash, says Williams.

‘Eskom, for example, raised $1.2 billion as an offshore issuance since there hasn’t been local demand.’ Demand for bonds is picking up, however, and Williams says liquidity is slowly returning to the market. He predicts that bond redemptions of between R85 billion and R100 billion will most likely be the key driver of market activity for 2015. He notes that companies will have to either refinance their existing debt or seek to issue additional debt for capital programmes.

Stewart anticipates about R73 billion in bond redemptions this year. ‘Financial institutions should once again contribute significantly to the issuance this year, with 54% of redemptions being attributed to the banks. In addition to the redemptions, the Basel III requirements for banks – whether for capital, liquidity or maturity profile purposes – will contribute to a growth in bank issuance in the years to come,’ he says.

Stewart believes markets volatility should ease, despite the anticipated year of uncertainty. ‘2015 has seen the return of liquidity, albeit initially for the stronger credits and at wider pricing.

‘The historical experience of excess domestic liquidity, combined with a limited supply of assets of sufficient credit quality, created an environment ideal for excessive credit spread compression in the past. This dynamic has changed with investors seeking a new risk-return balance,’ he says.

By Hanna Barry
Image: Gallo/GettyImages