Corporate bonds: could this underused tool help Ukrainian businesses to expand?

Ukraine offers favorable corporate bond conditions but lack of awareness holds market back

Corporate bonds: could this underused tool help Ukrainian businesses to expand?
About the author: Sergey Vaskov is Managing Partner of ESKA Capital leasing company
Sergey Vaskov
Wednesday, 18 July 2018 14:05

Corporate bonds are an investment instrument with considerable potential to become one of the key drivers powering Ukraine’s continued economic recovery. They can provide businesses operating in Ukraine with the resources to fuel development at a time when bank lending remains almost completely frozen. For investors, corporate bonds create the opportunity to preserve available funds and even earn despite the fact that deposit rates have fallen below the level of inflation in the country.

There have been relatively few corporate bond issues so far in Ukraine. TASCOMBANK and Idea Bank have placed corporate bonds, while more recently Ukrposhta and ESKA Capital have joined them. The most attractive securities for private investors have a three to five year maturity and quarterly or semi-annual coupon payments.

A general lack of awareness means that it is difficult for many companies to place their bonds under the current market conditions. These securities have not yet acquired the reputation that they deserve among investors. Large corporations can always resort to investment banks. Medium-sized businesses, meanwhile, might want to consider the option of investing in a public awareness campaign.

Part of the reason for the current failure of the corporate bonds market to take off in Ukraine is the lack of media support. In most cases, the name of the company itself is not enough to guarantee success. On the contrary, it is difficult for both large and medium-sized businesses to generate market interest. At present, the market desperately needs success stories. The more bonds that are successfully placed, the easier it will become. There is little reason to doubt that all these efforts will pay off once people become more aware of the potential this avenue offers.

To cite one specific example, the volume of ESKA Capital’s first bond issue, which started on 15 March 2018, was UAH 30 million, which represents a relatively small amount. This costs the company a little more than the price of a hypothetical bank loan. However, the purpose is not limited to the attraction of financial resources for development. This bond issue should show investors, both private and institutional (insurance companies, pension funds, etc.), that they can invest money in the company. It will be profitable, and all debt obligations will be repaid on time.

Today, rates on corporate bonds in the Ukrainian market can reach 18-20%. This is much higher than the present inflation rate in the country, which last year was 13.7%. It is also higher than the rates on OVGZ, the government debt securities of the Ministry of Finance of Ukraine, which is 14.5%-16.5% per annum. Is Ukrainian business capable of servicing such interest? Yes, if it is already a sustainable enterprise and not a startup. Such companies issue corporate bonds in order to get funds to expand one of their activities. At the same time, the debt burden is distributed among all directions, including those that area already successfully operating.

Nevertheless, the investor, as in any other instance, must thoroughly examine the company that issues the securities before diving in. Firstly, it is necessary to find out how long the company has been working in the market. It is crucial to chart and assess the progress of the company up to the present period. Who are the people that run the business? What kind of people are they, what is their background? How long have they been working in this company and what are their professional histories prior to managing this business? Finding the answers to these and other questions typically raised by investors should not cause difficulties. A company in which you can invest money must be open to such inquiries. It should provide free access to all financial reporting. Its credit history should be impeccable.

The outlook for the market in which the company operates also matters. For example, it is preferable to invest in a business that is involved in modernizing the Ukrainian economy. At present, there is an urgent need to update the automotive and agricultural industries. The energy market is also very interesting for investors, as is the Ukrainian retail market. An attractive business would be one that works in these priority fields while showing good progress and, accordingly, needs additional funds. On the other hand, it might not be such a good idea to get involved in the construction industry, because property prices have declined in recent years and concerns remain over the market.

Any financial instrument comes with risks. In Ukraine, even bank deposits can be very risky instruments. More than half of the country’s banks have disappeared in the last four years. In light of these market realities, the unavailability of the Individual Deposits Guarantee Fund (FGVFL) in the corporate bonds segment should not overly affect investor thinking. In addition, tangible income is obtainable when investing in bonds valued at over UAH 200,000. This is the figure at which state guarantees for bank deposits are limited to today. Ukraine’s state regulator (National Securities and Stock Market Commission or NSSMC) has already done a lot to protect investments. The market is clear of garbage securities. Issuers undergo careful screening to prevent fraud. Work continues on additional legislation that will further protect investor rights.

For many Ukrainian businesses, corporate bonds are far from the easiest way to attract additional resources today. Not many investors know about this option and this general lack of awareness continues to constitute a major barrier. Nevertheless, without domestic investment, Ukrainian businesses will not be able to grow stronger, and the broader Ukrainian economy will struggle to reach the kind of growth rates that will transform the country. Corporate bonds could be part of the solution.

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