Quick Links
Download account opening forms Download NSE Price List Central Bank of Nigeria The Nigerian Stock Exchange Central Securities Clearing SystemSecurities and Exchange Commission
Adverts
News

Corporate bonds, implications for financial institutions
October 20, 2009

Corporate bonds, implications for financial institutions

Corporate Bonds appears to be the latest craze in the Nigeria Capital market. In the past two months, First Bank of Nigeria (FBN), United Bank of Africa, and Guaranty Trust Bank, all intend to issue corporate bonds of N500 billion, N500 billion, and N200 billion respectively. It is very interesting to note that most of these banks are deciding to issue bonds and increase their debt burden in the current economic environment. Additionally, it is amazing that the shareholders of some of these banks have approved the bond offers without considering the negative impact the issuance of these bonds will have on their positions as shareholders. It is pertinent for shareholders to understand that bondholders take precedence over shareholders in terms of interest payments versus the payment of dividends.
Why aren’t the shareholders of these institutions asking very probing questions about these banks motive for issuing bonds when most of these banks raised funds in the capital market through public offers and rights issue two years ago?. Has there been any accountability to the shareholders for the funds raised a couple of years ago? 
In a July 2009 article” Bonds as investments are not risk free” I discussed the benefits and risks of Bonds to investors. However, this article focuses on whether the aforementioned three banks have the ability to internally generate sufficient Net profit after tax to pay the semi-annual interest obligation on the bonds and the additional dividends to shareholders.

 First Bank Nigeria Plc
There is no doubt that FBN is one of the better run banks in Nigeria. However, in 2007 FBN had a hybrid offer of public offer and rights issue. The offer was oversubscribed and the bank raised more money than was originally projected. However, FBN decided to keep only N250 Billion.  The excess funds raised were returned to subscribers in spite of objections from several influential shareholders. The motive behind the reason for FBN to go to the capital market to raise expensive funds that might be detrimental to the future growth of the bank and its stock price barely two years after it refused to keep the cheap non-interest bearing shareholders funds is not clear.
For example, FBN intends to raise N500 billion. If the offer is not a hybrid and the entire amount is raised through bonds, the annual interest payments to bond holders will be approximately N75 Billion at a 15% coupon rate.  Additionally, since FBN has approximately 25 billion shares outstanding, the bank will need N25 billion to pay an annual dividend of N1 per share. Therefore, FBN will need approximately N100 billion (interest payment of N75 billion “plus” dividend of N25 billion at N1/share) annually, to pay interest payment on the bonds and its shareholders’ dividends.
Reviewing the company’s FYE financial statements for the most recent five years, this appears to be a daunting feat. For example, the most recent two (2) fiscal years (2008 and 2009), NPAT after tax for FBN were N12 billion and N36.5 billion respectively. However, it should be noted that the FYE 3/09 NPAT would have been N36.7 billion if it wasn’t for a onetime charge of N26 billion to cover losses from margin loans. Therefore, if the results of the last two fiscal years are any indication, it appears that FBN will be unable to generate sufficient NPAT to pay interests on the bonds and any meaningful dividends to shareholders.
The implication is that even if FBN is able to pay the dividend and fulfill its bond interest obligations, this annual payment will put significant constraints on cash flow and negatively impact the fair value of the banks share price. Shareholders should understand that this might result in future share-reconstructions and it might require the conversion of some of the bonds to equity to ease the pressure on the bank. Additionally, the conversion of bonds to equity will further dilute the equity position of existing shareholders.

United Bank for Africa Plc
As previously mentioned, UBA proposes to raise N500 Billion through the issuance of corporate bond.  Assuming an interest of 15 per cent, the annual interest payments on bond if fully subscribed will be N75 billion. Additionally, UBA has approximately 21.5 billion shares outstanding. To pay annual dividends of N1 per share, UBA will need N21.5 billion. Therefore, to service the bond interest obligation and pay annual dividends to shareholders, UBA will need approximately N96.5 billion for the first year. A review of UBA financial statements for the most recent three fiscal years ended 2008 as highlighted below reveals that the bank will be unable to meet the obligations. Even on the best case scenario that Earnings and Net profit will double by the fiscal year ended September 2010, it will still be a tough feat for the bank to meet its obligation unless bonds are issued at lower interest rates than the hypothetical 15 per cent used in this example.
 
Guaranty Trust Bank Plc
GTB proposes to raise N200 billion through the issuance of corporate bond.  Assuming a coupon of 15 per cent, the annual interest payments on bond if fully subscribed will be N30 billion. Considering that GTB has approximately 18 billion shares outstanding, the estimated annual dividends at N1 per share will be N18 billion. Therefore, to service the bond interest obligation and pay annual dividends to shareholders, GTB will require approximately N48 billion for the first year for the interest payments to bond holders and dividends to shareholders. Since interest on bonds are paid semi annually, GTB will need approximately N15 billion every six months for interest payments to bond holders. A review of GTB’s financial statements for the most recent three fiscal years ended February 2008 and the ten (10) months financials ended December 2008 highlighted below indicate that it might be difficult for GTB to comfortably service the bond obligation from current period earnings. However, it appears that GTB will be most likely be able to service the interest payments on the bond, if dividend payments to shareholders are reduced compared to the other banks.

Conclusion
The current bond craze appears to be history repeating itself. I remember during the boom days of the Nigeria Stock Exchange that shareholders continued to approve banks proposals to consistently raise funds through public offers and rights issues without asking some probing questions such as:
1 How the funds raised by these financial institutions (i.e., banks and insurance) will be utilized.
2 An accountability of how the funds from previous offerings were employed from banks that had subsequent offerings.
3 What the dilutive impacts of the incessant offers were on their share holdings?
Again shareholders of the three banks that want to issue these bonds have already given their blessings to the banks. I doubt if most of these shareholders asked the right questions before giving their consent. History tells us that those who ignore past events are bound to repeat the same mistakes. This is beginning to look like an old movie modified for re-runs. While I am not against investors buying these bonds, I believe that investors should ask the right question (i.e., hold these institutions feet to the fire). It will be sad for these banks to raise these funds and end up losing most of the funds due to lack of proper risk management procedures like most of the banks did with the funds they raised through public offerings and rights issue.  Corporate bonds are not cheap funds. Therefore any mismanagement of these funds might be these institutions Achilles hill. These institutions can decide not to pay dividends to shareholders, but obligations to bondholders must be paid since the consequences of non-payment will be profound.

The Financial Standard, Tuesday October 20, 2009.

 

Related News
counter easy hit