Not enough incentives exist for firms to issue corporate bonds

A couple of weeks into 2003 and a few months after government officials made public their intention of tabling a law in Parliament in early fall 2002 to facilitate the creation of a functional, liquid corporate bond market, the government seems ready to make good on its promise. Yet the main roadblocks to the creation of a liquid local corporate bond market have not been removed, casting doubts over the success of the long overdue project. Faced with a slumping Athens Stock Exchange, now in its fourth year, which has brought new IPOs (Initial Public Offerings) to a near-standstill and made money-raising exercises, such as rights issues, by listed companies an almost impossible task to complete, Greek companies have to continue to rely on bank borrowing to finance their investment plans and working capital needs. Lower interest rates have eased the pain of servicing these loans although banks have grabbed the opportunity to quietly widen the spreads they charge over Euribor, the reference rate. The tougher economic environment in Greece and abroad has nevertheless taken its toll on some companies, especially those operating in recession-hit sectors with a high debt-to-equity ratio, increasing the odds of bankruptcy. Published nine-month results showed that at least 30 listed companies exhibited excessive debt-to-equity ratios. A couple of weeks ago, listed clothing retail company Connection was reported to be experiencing difficulties. On the other hand, the Bank of Greece and some large banks, realizing that things may get tougher down the road, especially if Greek economic growth decelerates, as expected, in the next few years, have started tightening up the screws. Commercial banks, themselves relying on capital-consuming loan growth to boost operating income but unable to count on declining profits to enhance their capital base, are eager to see a liquid corporate bond market in place. Substituting bank loans with corporate bonds would save them precious capital, keep their corporate clients happy and make space for more loans in their books. Nevertheless, this ambitious project, which Finance Minister Nikos Christodoulakis is trying to revive by simplifying issuance procedures, such as giving boards the right to decide on corporate bond issues without asking shareholders’ approval, is not likely to do the job. It must be noted that the previous two important steps on the road to creating the local bond market was passing legislation on tax income earned on government and corporate bonds at the same 10 percent tax rate and the setting-up of a platform where corporate bonds can be traded in electronic bookkeeping form in October 2001. The first corporate bond traded on the Athens bourse in electronic form was Attica Enterprises’ three-year, 3.25 percent bond, convertible in the shares of the same company, followed by another convertible corporate issue by Edrassi-Psalidas and Attica Enterprises’ bond, exchangeable into shares of its subsidiary Strintzis Lines. The Athens bourse board approved listed company Ridenco’s convertible bond just last week. Yet the fact that all issues are convertibles is not accidental. Bankers close to the deals say local corporations prefer to issue convertibles rather than straight bonds because they hope they will never have to repay them in full, counting on their share prices rising enough to make it profitable for bondholders to convert them into shares. This way, companies will not have to pay the enhanced principal – principal increased by a certain percentage – they would otherwise pay at maturity. Even bankers agree that it is cheaper for a Greek company doing business with a bank to get a loan rather than issue a corporate bond, even today, despite the fact that banks have gradually but steadily increased the spreads. Most Greek companies have learned to rely on a couple of banks for credit and other business for years and downplay the importance of differentiating financing sources by tapping the local or the international corporate bond market. By the same token, it is difficult for local banks to raise their spreads as much as justified by international credit rating standards without taking into account the deposits and other business fees these companies bring to the bank. «It is very difficult to change this without alienating your client,» admits the deputy head of the loan division of a major Greek bank. «It may take some time but it will happen.» Another private banker, however, suggests this is not a purely Greek phenomenon. «It is a Pan-European phenomenon but manifests itself to a much lesser degree in other countries like France,» he says. This status quo, where local companies borrow at much lower rates than other eurozone companies with much better credit ratings, gives firms no incentives to issue bonds. Some contend that banks, hard-pressed by their shareholders to generate higher profits, will be forced to up corporate loan spreads. They even say they may do so quietly again in the near future in the context of the central bank’s recent move to increase provisions for some categories of bad loans. Increasing spreads on corporate loans may be a major step in creating a liquid corporate bond market but it is cannot be the only one. The small size of corporate bond issues which does not help compress bid-ask spreads is another one. However, the relatively small size of Greek companies which are the prime candidates for tapping the local bond market creates a constraint. Moreover, commissions charged by the Athens bourse are regarded as an impediment to active trading needed. Last, but not least, there is an apparent lack of end-users since the average Greek retail investor is still not familiar with the product. Some analysts even say that the short-dated investment horizon of the typical retail client does not bode well for corporate bonds. Instead, they say banks and companies should approach these people first with commercial paper, that is, short-term unsecured promissory notes with nine-month maturities or less. «Commercial paper seems to fit the Greek retail investor’s profile best,» said the head of an asset management unit at a major bank. No one doubts that the Finance Ministry’s move to simplify issuance procedures and other matters related to corporate bonds is a step in the right direction. It will take more than that, though, to create a liquid local corporate bond market. Banks seem to hold the key but may find it difficult to use despite their eagerness to find ways to boost their capital base and retain their clients.

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