By Henry T. Azzam
AMMAN — In the boardrooms of Jordanian corporates, serious consideration is being given to the prospects of borrowing medium to long-term money in the domestic bond market.
The advantage is not only to lock in historically low interest rates for say a five year period, but also to diversify sources of funding, reduce the corporates' overdependence on short-term lending from banks and have the advantage to repay the principal amount borrowed in one bullet repayment upon the maturity date of the bond.
Equally important, companies will be able to capitalise on the process of issuing bonds to enhance financial transparency and improve the corporate image of the issuer.
Jordan's corporate bond market is still in its early stages of development, with the total value of the 13 corporate bonds listed on the Amman Stock Exchange not exceeding JD130 million by the end of 2003.
Only four corporate bonds were issued last year: The Business Tourism Company issued a JD10 million 5-year bonds with a coupon of 7.5 per cent. The International Tobacco & Cigarettes Company issued a JD5 million 3-year bonds with a coupon of 5.75 per cent, and Cairo Amman Bank issued two subordinated bond issues with a 7-year maturity, one is JD3 million with a 7.5 per cent coupon and the other is 6 million priced at Libor 3 per cent.
Not only the primary market, where new securities are issued, are thin, but also the secondary markets where corporate bonds are traded remain generally illiquid. Bond trading accounts for less than one per cent of total trading on the Amman Stock Exchange.
Investors, typically banks, the Social Security Corporation, insurance companies and other institutional and individual investors tend to hold bonds till maturity. Investors are basically reluctant to part with any bond allocations they receive from primary market issuers due to the lack of continuous flow of bonds coming to the market.
This naturally results in thin trading and considerable mispricing of existing issues. Getting a competitive quote on a corporate bond listed on the Amman Stock Exchange takes much longer than the few seconds needed to execute a transaction in the Eurobond market.
There has been a noticeable increase in bonds issued by the Jordanian government and institutions of the public sector recently.
The amount of treasury bonds outstanding by the end of 2003 is around JD808 million, plus JD65 million worth of development bonds, giving a total for government bonds of JD873 million. This accounts for around 87 per cent of total outstanding fixed income securities available in the Jordanian market.
Most of the government bonds issued in the past three years had a maturity of five years and the coupon on those bonds ranged between 4.25 per cent and 4.58 cent.
At the end of 2003, the spread in yields between bonds issued by the government of Jordan and those issued by the US government dropped to just under one per cent for 3- years maturities and to 1.25 per cent for the 5-years maturities. This is way below the historical spreads of two per cent that used to prevail, and reflects basically a noticeable improvement of Jordan's sovereign rating.
The Kingdom has been upgraded recently by Moody's and Standard & Poor's and this lowered the risk spreads on bonds issued by the government of Jordan.
On the other hand, because of low trading and the limited number of new issues coming to the market, existing corporate bond yields declined only slightly. Spreads between prime corporate bonds and government bonds of the same maturity is still in the range of 2.15 per cent to 2.50 per cent.
For example yields on the 3-years bonds issued by the International Tobacco is trading at 5.60 per cent, compared to the yield on a three year government bonds of 3.38 per cent. The spread between the two is a wide 2.22 per cent which is much higher than the difference in yields between a new 3-year bond currently being issued for Jordan Phosphate Mines Company at five per cent, and the 3.38 per cent yield on the latest 3-years government bond, i.e. a spread of 1.62 per cent.
We expect corporate bond yields in the secondary market to adjust lower in the months ahead as new bonds with lower coupons are issued in the primary market. For example, Royal Jordanian is currently tapping the local bond market for a 5-year paper and Jordan Telecom is expected to come to the market soon with an 8-year bond issue.
The presence of excess liquidity in the domestic banking system should not be a reason to delay the development of the local corporate bond market. The argument that banks can provide all the capital that corporates need does not always hold. A viable local bond market would provide "patient capital", i.e. a new source of long-term financing for corporate borrowers, that would help reduce their overdependence on short-term lending from banks.
In the US market for example, corporates depend on the bond market for more than 50 per cent of their financing requirements. The shortage of medium to long-term funds at fixed interest rates is perceived to be a significant impediment for industrial growth in Jordan.
A government bond market needs to be deepened even if the borrowing requirements of the public sector are low and there is plenty of liquidity through bank savings. Not only would government bonds help to establish a benchmark for pricing of corporate bonds, but also the yields on these bonds could serve as a reference point in the derivative markets and could also be used as discount rates to value equities and when appraising investment projects.
Government bonds of different maturities should be issued to determine a yield curve that would make it easier for arrangers of corporate bonds to come up with the right price for new bond issues in the primary market.
Although standards of reporting have improved, especially for the incorporated and publicly traded companies, yet more is needed to enhance the transparency of public or private shareholding companies which are planning to tap the local bond market.
Bonds do not require collaterals or guarantees and are usually issued to companies that have solid financial positions. Full and transparent disclosure is needed, otherwise no reputable investment bank will be willing to underwrite and place the bond issue.
The secondary bond market also needs to be supported by an institutional infrastructure that includes, among other things, the ability to list and trade dollar-denominated bond issues and the presence of active market makers.
There is a growing trading culture in Jordan as seen by the rising number of individual investors in the local stock market. The challenge is to transfer the same process to the bond market, where trading bonds rather than holding them to maturity becomes the norm. So far bond holdings by individuals are still negligible and there is a need to expand the number of participants in the local bond market.
Bond markets rely, even more than equity markets, on strong corporate governance, transparency and full disclosure, viable legal system, contract enforcement, international accounting standards and active market participants.
Another factor that is also hampering the development of the Kingdom's bond market is the lack of market makers with access to liquidity. An efficient bond market will not only promote the general development of Jordan, but will also reflect it.
Writer is the Chief Executive Officer of Jordinvest.