In its Financial Stability Report (FSR) 2017 published earlier this month, the Central Bank of Malta makes some interesting observations on the development of the local corporate bond market, a market which has continued to grow strongly in recent years.
A liquid and functioning corporate bond market is an important ingredient of a successful capital market, offering companies the opportunity to diversify their sources of finance, tapping into the vast array of savings resident in Malta while also offering investors an ever wider array of investment opportunities.
Against a backdrop of both a low interest environment and a banking system that has, on balance, focused more on de-risking its balance sheets than providing finance to non-financial companies, the corporate bond market offers an interesting alternative for companies wishing to strengthen their capital structure.
In 2017, €158 million of net new bonds were issued, building on the net issuance of €227 million in 2016. Issuance slowed in 2018 with €67 million of bonds being issued, before accounting for the redemption of the €55.4 million BOV 2018 bond, bringing the value of the total bonds outstanding on the market to the impressive €1.59 billion level. Further issues are expected in Q4 2018.
It is interesting to note that in its review, the FSR 2017 highlights the continued strong participation of the retail investors in such bonds, with retail investors continuing to own some 81 per cent (unchanged from 2011) of all bonds issued by non-financial companies. The support of the retail investor has been crucial to the success of this market. It has long been known that retail investors are key participants in this market, however the extent to which this is the case remains impressive. This is probably a reflection of the low interest rates available locally, both on bank deposits and government stocks, as well as the lack of institutionalisation of our market.
The FSR 2017 also makes the good point that retail investors need to consider carefully the type of bonds they purchase. The increasing number of bonds available is good news for investors, offering the possibility of portfolio diversification. However, the quality of bonds varies immensely.
It would be a grave mistake for retail investors to assume that simply because the MFSA has approved a bond for listing, that this approval is a stamp of quality assurance, most especially about the credit worthiness of the issuer. It is not. It primarily reflects the fact that the issuer of the bond has met a set of predominantly disclosure criteria required by the Prospective Directive and has met the governance requirements laid down by the authority.
Likewise, our role as investment advisers in the intermediation process is to advise and guide investors on which type of bonds to invest in and the extent to which to invest in such bonds. Local bonds, like all international bonds, contain risks; risks that the issuer may enter into financial difficulty and be unable to meet its financial obligations. Thankfully this has never happened domestically, and although one hopes that this never occurs, it would be a fallacy to base one’s investment decision on this shaky assumption.
It is also interesting to note the FSR’s analysis on the switch between bank lending and borrowing from the corporate bond market. According to the FSR 2017, banks reduced their lending to the construction and real estate market by some €150 million in 2017, while the value of new bonds originating from this same sector amounted to €139 million, indicating that there probably was a strong element of issuers replacing their bank debt with bonds.
From a diversification perspective this could be positive but investors must also be conscious that 29 per cent of all bonds listed on the market are property related. If one had to include those that also contain a strong element of property (such as hotels) the figure rises to 50 per cent. Perhaps this reflects the strength of conviction of the local investor in the property market, as well as reflecting one of the main drivers of the current economic strength locally. But the contagion effect should this sector face difficulties should not be underestimated.
It is wise, therefore, for investors to look carefully at the source of repayment of the bonds they invest in and select carefully the degree and extent to which they wish to be exposed to this sector.
David Curmi is managing director of Curmi & Partners.
The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd is a member of the Malta Stock Exchange, and is licensed by the MFSA to conduct investment services business.
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