Loans or bonds amid the global recession?

  • Business
  • Saturday, 14 Mar 2009

CORPORATE loans are theoretically more expensive because the risk is taken up by only one counter-party. With bonds, the risk is spread among many lenders. The stronger the lender’s cashflow, the more flexibility he has in being able to lend at a cheaper rate.

Bonds normally come with standard clauses that leave issuing companies with more latitude. For instance, if investors think that the risk they are undertaking is manageable, they may be willing to lend at a cheaper rate. Previously, borrowers went to the bond markets as they were able to obtain longer-term fixed interest rates, as well as long-term rates that were often lower than bank loan rates.

“Those looking to raise capital from the bond market should have at least an AA rating. Any ratings below that, then it won’t be worth it as yields will skyrocket to compensate for the risk,” says the head of fixed income at a foreign investment house.

He says that during good times, it is a lot easier to get cheap financing from the bond market. In bad times, issuing bonds could be more costly than bank loans.

The present overnight policy rate of 2% is just a guide. Borrowers still need to factor in the credit risk. Hence, the bond interest rates (or coupon rates) could be a lot higher. Apart from being usually cheaper than bank loans, bond financing also helps raise the profile of a company. It is not all dandy though.

For instance, when a bond issuer needs to make a big decision (particularly one that may affect its ability to meet its debt obligations), it will normally need to get the go-ahead from its bondholders. In the case of corporate borrowers, they each often deal with only one bank.

For the bond issuers, there are also immense documentation and other approvals every step of the way.

That is not to say corporate loans do not come with corporate governance clauses. Banks too impose covenants on their borrowers.

“For transactions such as disposals, acquisitions and issuance of new debt, the borrowers must obtain the banks’ agreement beforehand. All this can be a nuisance,” says a corporate loans officer at a local bank.

She adds that some banks offer credit lines that give companies more flexibility in deciding when to use the funds.

Bonds, on the other hand, must be issued for significant sums, although the company may not necessarily have instant cash needs.

Tapping the bond market for the first time also takes a comparatively long time. “The company will need to obtain a rating from an agency, and investors must be familiar with the company,” says the head of fixed income.

He says that the current preference is for corporate loans. “The introduction of a windfall tax on independent power producers and plantation companies on July 1 last year has left a sour taste among lenders. There is a fear of adverse policy changes,” he adds.

Thus, if financing from bond markets were cheap, wouldn’t it supersede financing from banks? No, says the head of fixed income. “In Malaysia, banks are major holders of both corporate and government bonds, and they act as managers for retail investors,” he explains.

He cites a study done by Bolton and Freixas. In their model, bank financing is more flexible because banks have better information and can show leniency towards a firm that has liquidity, or even solvency, problems. This sort of “bank surveillance” imposes more conditions on the company.

Bonds do not have the same flexibility but have a lower cost. The implication is that firms that are less likely to fail will prefer bonds. Nonetheless, as banks are also major holders of government bonds, this lowers the risk of default, apart from lowering the cost of issuing bonds.

As part of the RM60bil economic stimulus package announced earlier in the week, Bank Negara will help companies raise some RM15bil of bonds through a soon-to-be-created Financial Guarantee Institution (FGI).It will likely function as a bond guarantee agency, which will issue guarantees to issuers so as to boost their credit ratings.

Malaysia’s domestic bond issuance in 2008 dropped 11% to RM48.6bil from RM54.6bil raised in 2007. In the fourth quarter, the issuance dropped significantly to only RM5.2bil compared with RM26.7bil in the same period in 2007.

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