As much as the recent announcement of a retail TFC offering coming to the market is heartening for investors, it is that much of a point which financial institutions should be pondering upon. Interest rates remain high despite the last 150bps cut, which makes bank borrowing unattractive either because it is an expensive proposition or to put it mildly ‘restrictive’. Banks are averse to lending anyway; a lot has already been said about how private sector credit has been crowded out by public borrowing. But when investment opportunities exist and companies want to borrow, one wonders what avenues do they have left? The high cost of bank borrowing and the covenants that accompany makes them think twice and sometimes thrice about that recourse. Equity markets are depressed owing to liquidity issues and general investor pessimism. Foreign investment is scarce on the back of the negative perception tag regarding security in the country. The answer: tap the retail market.
KESC’s intended offering of a RS2.0 billion retail bond follows in similar fashion to Engro’s Rupiya Certificate which was able to raise Rs8.0 billion for the company at a 14.5 per cent rate under two separate issues. It has to be kept in mind that this rate was offered at a time when interest rates were hovering around a similar mark themselves. As per market expectations at that time, this rate was also lower than what other instruments issued to institutional investors were yielding. The Rupiya Certificate issues, which were fully subscribed both times, were able to reduce the company’s borrowing costs: on a debt quantum of above Rs100 billion, even a slight reduction in rate of return implies significant benefits for the issuing entity. Even now when the interest rate has been cut, the instrument still costs lower than what banks would offer after adding spread on top of KIBOR. The offering by KESC also seems to reflect the same reasoning, although this depends greatly on what rate the instrument is issued at.
So is financial cost saving the only reason for issuing retail TFCs? Certainly not as they also provide a much sought after characteristic in the form of investor base diversification. The subscribers of retail TFCs are mostly the general public. These commonly comprise those who are seeking a good return on their savings and are usually not highly rate sensitive. Peak returns offered by Term Deposit Certificates these days are around the 11-12 per cent mark or 12.68 per cent to be exact by Defense Saving Certificates and these too for a holding period of five years or more. It is likely that retail TFCs would be offering a higher rate for there to exist an incentive to invest for the common man. Effectively companies are saving the spreads paid to banks by bypassing the financing medium altogether and investors are getting a better return than what they would have if they had put their money in more traditional avenues. This makes for a win-win situation for both.
However, retail investors more than the institutional creed, are sensitive to reputation and brand recognition. This perhaps is the major impediment that restricts the management of corporations from taking such an initiative, apart from thinking out-of-the-box naturally. Logic dictates that although the public would want a higher return, at the same time would be concerned with the soundness and safety investment, comfort on which is dictated by their familiarity with the company’s name. Negative perceptions about the company would certainly be a factor, which is where the credit quality of the instrument on offer comes into play; high credit quality would act to placate concerns. Moreover, the reputational consequences of failing to meet commitments as promised is another aspect entities should be concerned about.
Having said this, retail TFCs certainly open up avenues which were previously left unexplored by Pakistani corporations. Given the liberal capital flow environment, they make reasonable economic sense as far as feasibility is concerned provided proceeds are utilised for funding appropriate investment opportunities. Is this new fashion going to gain popularity with others is a question that only time will tell. But from the perspective of the investor and a proponent of developing the paltry bond market, this is certainly a positive development.
The writer is a financial analyst with Pakistan Credit Rating Agency (PACRA)