Al-Ahram Weekly 24 - 30 June 1999 Issue No. 435
Published in Cairo by AL-AHRAM established in 1875

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Year of the bond

By Sherine Abdel-Razek

"This year will be the year for bonds in the stock market," said Abdel-Hamid Ibrahim, head of the Capital Market Authority (CMA), at a press conference at the beginning of 1999. Time has proven him right in a way as 1999 has become a year of heated debate about bonds and especially corporate bonds.

The first five months of the year witnessed LE1.5 billion worth of bond issues, pushing up the overall volume of the traded companies' bonds to LE4.7 billion. This value represents 33 corporate bond issues. Moreover, there is about LE955 million worth of new issues in the pipeline, waiting for the CMA's approval before they can see the light.

Such an increase can be considered an improvement in an emerging market like Egypt that is seeking to diversify its capital market investment instruments. But it is still a controversial development in what opponents of this trend call a "still immature market".

Egyptian and foreign companies and banks have the right to issue bonds within the value of their net assets, according to CMA regulations. These issues are underwritten by banks which are either committed to fully cover the issues or sometimes to guarantee the principal and interest liabilities of the bonds. Moreover, all companies with publicly offered bonds must have a credit rating from one of five rating agencies authorised by the CMA to assess the creditworthiness of these companies. These agencies are Moody's, Fitch IBCA, Standards & Poor's, Nile Rating Agency and the newcomer to the list, Thomson Bank Watch.

These safeguards seem to give investors a hedge against all risks. However, this is not how proponents of a more conservative approach see things. In fact, the critics have many reservations about all parties and rules involved in the fledging bond market.

The controversy initially grew out of opposition to the idea of banks granting bond issues for fear that the bank would have to shoulder the debt burden in case the company defaulted, thus jeopardising the interests of its depositors.

"It is risky for banks to underwrite these bonds. In a number of recently offered bond issues, we find banks guaranteeing ordinary, unknown companies which might collapse at any time and jeopardise the interest of the bank's depositors, as the loan would then be added to the bank's budget," said Mustafa El-Assaal, head of the fixed income department in EFG-Hermes.

Moreover, he pointed to the fact that in an immature market like Egypt the investors still lack the necessary background to assess different investment instruments, so they are attracted by the names of big and well-known underwriters rather than by the well-being of the debt issuer. Furthermore, these investors do not know that the bonds of such companies are hard to get rid of in such a limited bond market where only a few people prefer bonds as investment tools. El-Assaal pointed out that a limited bond market is a fact Egypt might have to live with for quite a while since interest rates, the determining factor in whether an investor chooses bonds or bank deposits as an investment, are going up. This adds to the appeal of bank deposits.

Such fears led to the issuing of a recent decree prohibiting banks from underwriting bond issues of companies unless they acquire approval from the Central Bank of Egypt (CBE).

This is not the only guarantee for the well-being of the bond issue. A recent CMA regulation obligates companies issuing bonds to update their credit ratings on an annual basis throughout the lifetime of the bond.

But what if even the credibility of those ratings is questioned? Many market observers have expressed their doubts about the reliability of the ratings, and raised questions about whether the rating agencies take into consideration important factors, such as the soundness of the company's management or its future potential and whether they use objective criteria that apply to the fundamentals of the Egyptian market.

Hazem El-Dalli, chairman of Nile Rating Agency, Egypt's only local rating agency, seems to have an answer for all of these questions.

The rating assessment is based on a review of the key strengths and weaknesses of the company being rated, he said. "The rating process requires a review and analysis of the historical financial statements of the company, and its current performance in terms of its ability to maintain its track record. Its future projections are studied in the context of its strategies and potential," El-Dalli explained.

The ratings given to companies that issue bonds take into account the industry risk, the company's market position, its management structure, the quality of its accounting and the stability of its earnings, El-Dalli added.

While noting that his company, as well as other rating firms, enjoy independence in terms of what objective criteria they employ to rate a company, he emphasised the company is regulated and supervised by the CMA.

Other people have reservations about the possible adverse effect that private corporate bonds might have on the government's treasury revenues. Advocates of this school believe that as long as private bond issues bear interest rates higher than those of the state treasury bills -- most of these issues bear 10.5 -11.75 per cent coupons compared to the treasury bills' 10 per cent -- the corporate bonds will surely attract those who were previously interested in government papers.

EFG's El-Assaal pointed out that the difference between these two kinds of coupons is normal worldwide since the high yield of private bond coupons compensates for their higher risk compared to the government-guaranteed treasury bills.

"It is well known that the government, any government, is the most creditworthy debtor in any country, followed by big banks and then companies," said El-Assaal.

Another shortcoming of corporate bonds that will also have a negative effect on treasury revenues is that the bond coupons are considered a cost to be deducted from the companies' taxable income, thus lowering tax revenues.

Nevertheless, El-Assaal looks at this fact from a different perspective. He said that the value of interest on both bank loans and bond coupons is considered a cost of acquiring capital and is deducted from the company's taxable income. When comparing bonds with the other means of finance, bank loans, using this criteria, he believes that issuing bonds is better. This is because its cost, the 10.5-11.7 per cent coupon, is less than the 14 per cent charged on bank loans; therefore, the deducted sum is smaller.