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Corporate bond issues set to take off

Though still underused as a means of company finance, bond issues are expected to attract more and more firms in Slovakia this year and next as a way of raising finances. The engine of this growth is an ongoing credit crunch and the pressure of maturing bonds issued years ago.
For the last four years, banks have been reluctant to lend to corporates, creating a finance squeeze that has put a stranglehold on expansion and growth in the business sector. But companies are now beginning to turn to what has been a standard method of finance in the West for years.

Though still underused as a means of company finance, bond issues are expected to attract more and more firms in Slovakia this year and next as a way of raising finances. The engine of this growth is an ongoing credit crunch and the pressure of maturing bonds issued years ago.

For the last four years, banks have been reluctant to lend to corporates, creating a finance squeeze that has put a stranglehold on expansion and growth in the business sector. But companies are now beginning to turn to what has been a standard method of finance in the West for years.

"I would expect more companies to adopt this method of financing, and if you look at the situation compared to five years ago, when there were few bond issues, we'd have to say that things have improved," said Pavel Habšuda, analyst at Slávia Capital brokerage house.

"Even though the volume of company bond issues is low in comparison with western Europe, it is gradually expanding and the volume of issues is going up," he added. "Firms which have already issued bonds, say, five years ago, will most likely look to issue new bonds, in order to roll over the old issue, and repay the old bonds which mature this year from the funds of the new issue."

Over the last five years, company bond issues have ranged upwards from 10 million crowns ($217,000), with large, often state-owned corporates topping the issue range. One of the largest issues over the last five years was a 1996 dollar-denominated issue by recently-privatised bank Slovenská sporiteľňa (SLSP) of $80 million. Company bond issues in the West are relatively larger.

"Much higher numbers are traded in the West," said Ivan Chodák, equity analyst at CAIB Securities. "You would be looking at issues of 4-6 billion euros, and it's much easier there to issue bonds in such relatively large sums of money."

One of the most recent issues was one of 50 million euros in September by the gas distributor Slovenský plynárenský priemysel (SPP), which was itself an extension of a 150 million euro issue from 1999.

The use of eurobonds was significant, experts say, in that it allowed more scope for the involvement of foreign buyers. Ruling out the exchange rate risks with Slovak crown-denominated bonds and issuing them in euros is something which big, successful firms such as SPP can manage, but is not open to all Slovak firms.

"Whether the issue is denominated in eurobonds or crowns depends on the company. Criteria for risk management and principles of financial management have to be met [if the bonds are to be issued in euros]," said Chodák.

"If a firm is to issue bonds in foreign currency it has to be able to issue enough bonds to attract the interest of foreign banks and buyers, and there are very few companies like this," added Chodák, pointing out that a company would have to have turnover of $500,000 per year to back up repayments of the volume of bonds necessary to issue a large amount of company securities.

The success of company bond issues in comparison with issues by western firms is also tied to the ownership structure of the firms involved.

"Most companies large enough to issue bonds in a volume attractive to investors are at least partially state owned. The sovereign guarantee - implicit or explicit - therefore applies, and backs up these issues to make them attractive," said Jaroslav Viťazka, portfolio manager at Schroders in London.

Companies which have issued bonds denominated in foreign currencies over the last five years include SPP, oil and gas storage firm Nafta Gbely, state railways ŽSR, and formerly state-owned mobile operator Eurotel.

Indeed, as Viťazka pointed out, forthcoming privatisations will also have a great effect on which companies can and will offer bonds.

"With upcoming privatisations, bond markets will become more important to Slovak companies, but a lot of work has to be done in terms of transparency of ownership, management control and product viability since soft government subsidies [as in the case of utilities SPP and Slovenské elektrárne - ed. note] will be withdrawn," he added.

SPP is due to be privatised at the end of this year and SE in 2002.

A battle with state papers

Predictions of greater corporate bond activity also rest on evidence that banks are looking beyond state Treasury Bills and Bonds for other safe places to put their money. A January issue of state papers drew a subscription of 16.4 billion crowns ($35 million), while only 4 billion crowns was accepted. The good news in this for companies was that banks now have excess cash which they are willing to push into securities. While this liquidity may translate into greater lending, it may equally go into company bonds, analysts argue, although the continuing attractiveness of the state issues mean companies will have to work hard to impress with their own issues.

"The growth of company bonds as a phenomena in Slovakia will depend on market liquidity. There are some free funds now," explained Slávia's Habšuda.

"Currently we can see that a lot of the free money [which banks have] is going into state bonds, so company bonds will have to offer yields above those on state bonds and T-bills [currently about 8%]. Banks may indeed look at corporate issues with higher yields - but only those from the best corporate risks, the best-performing companies which have strong exports and were in black figures over the last couple of years."

Corporate bonds are usually issued with yields 300 to 500 basis points above sovereign issues to make them attractive enough for institutions to take the perceived higher risk of investing in company, rather than state, securities.

"There has never been a default on state securities, so an investor has that 8% guaranteed. And what also makes the state papers more attractive is that they are much more liquid, meaning that they can be sold more easily than company bonds," said Habšuda.

"The company bonds can be sold as quickly as state bonds, but usually under much more disadvantageous conditions than those under which they were bought," he added.

While yields on company bonds may be up to 11 or 12%, the situation now, Habšuda explained, favours company issues far more than it did a few years ago when many firms had little chance of issuing anything because of the exorbitant yields demanded by banks.

"Look back to 1997, 1998 and 1999 and you can see that there were unbearably high yields being demanded," said Habšuda.

At one point at the end of 1998, yields on state papers touched 30%, making it virtually impossible for companies to offer bond issues with a yield high enough to make up for the company/state risk differential.

"No one will issue bonds with 35 - 40% yields. The conditions were too disadvantageous back in 1998. Things have certainly improved," he added.

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