The launch of the Pakistan Investment Bond (PIB) in FY01 (December 2000) created a market determined yield curve helping the corporates to have a better benchmark to price their bonds. This helped further deepening of the corporate bond market in Pakistan. Occasional bearish trends in equity market also shifted investors towards more secure investment in Term Finance Certificates (TFCs).
Interestingly, however, not all the funds generated through TFCs were channelled to industrial sector to finance its expansion. A growing chunk is used to finance consumer durables like cars, motorcycles, electronics etc. For this reason perhaps, most of the TFCs had been launched by the Leasing Companies since these companies needed long-term funds to match their lease portfolios.
Notwithstanding the presence of irritants here and there, the companies that previously relied heavily on Development Finance Institutions (DFIs) for term borrowing now look at the bond market to meet their future financial needs: 10 new issues were floated in FY01 for Rs 9.3 billion, 17 issues totalling Rs 9.5 billion were floated in FY02, 21 issues worth over Rs 10.4 billion in FY03, 7 issues for Rs 3.3 billion in FY04, 12 issues for Rs 15.6 billion in FY05 and 7 issues for Rs 7 billion in FY06.
Although the first ever biggest amount through TFCs was realised in FY03, mainly because prevailing low interest rates extremely helpful luring lock-ins long-term funds, the outstanding stock of listed corporate debt still remained abysmally low (See Table A).
In fact, one of the major reasons for a slight decline in issuer interest in TFCs towards the end of FY03 is the increased availability of cheap loans from commercial banks. Of the FY03 total issues, eight TFC issues worth over Rs 3.4 billion were by manufacturing concerns, while another seven worth approximately Rs 2.2 billion were by leasing companies. The remaining issues were by banks or services companies.
The corporate debt market saw a growth of listings of new debt instruments, reflecting in part, expectations of a rise in interest rates. The period FY05 saw 12 listed debt instruments worth approximately Rs 15.5 billion, in contrast to FY04, which witnessed a total of seven listings worth Rs 3.3 billion. Out of 12 new listings in FY05, seven listings were launched by the commercial banks, two by other financial institutions, two by oil and gas companies and one by telecommunication company.
The issues by banks were aimed principally to increase their Tier II capital to meet the higher capital adequacy ratios required under the SBP prudential regulations. Going forward, other banks are also likely to issue TFCs for this purpose. The growth of the corporate debt market in Pakistan remained weak during FY06 both in terms of the number of TFCs issued and issue size ie seven listings of new debt instruments worth approximately Rs 7.0 billion compared to 12 issues worth Rs 15.6 billion during FY05.
Out of seven new issues during FY06, three were by commercial banks. As mentioned earlier, secondary market in TFCs, however, remained largely underdeveloped as most of the investors preferred to buy and hold the Debt Certificate.
MAKING TFC ISSUES MORE ATTRACTIVE The SECP is actively streamlining the process for issuance of TFCs by reducing costs and simplifying the procedure for approval. On similar lines, KSE in collaboration with the Central Depository Company (CDC) has reduced the annual listing fee for TFCs. The KSE has also reduced broker commission from 1.0 to 0.25 percent, and the fixed service charge of Rs 25,000 has been revoked.
Additionally, the initial listing fee has been reduced from a maximum of Rs 1.0 million to Rs 0.5 million. Also, the CDC has reduced its annual registration fee for TFCs by 25 percent effective November 1, 2000. These changes would lower the issuance costs for TFCs, which should help develop this market.
Furthermore, the government has continued its policy of reducing stamp duties and withholding tax on profits in 1995. But withholding tax on TFC profit was reinstated in March 1998. However, the 1999 Federal Budget again exempted payment of withholding tax to all including companies.
Also, in order to make issues more flexible and affordable, issuers are adding different features from shelf registration to the green shoe option to TFC structure. The former implies that the issuer can split the TFC issue into tranches, which is useful for periodic financing requirements of the issuer and also allows optimal pricing of the individual tranches.
This option is, however, valid for a maximum period of twelve months for an issue amount of Rs 250 million and a maximum period of three years for an issue greater than this. The latter allowed the issuer the right to retain the over subscribed portion of the initial public offer (IPO) though the issuer has to specify in advance the amount it would retain under this option.
Other options available to the issuers are Floating Coupon Rates, Asset Securitization and Call & Put option. A call option on TFCs gives the issuer the right to retire the debt prematurely. Likewise, a put option on a bond allows the investor the right to redeem his/her investment prematurely (commonly at fixed option dates).
IDENTIFICATION OF IRRITANTS LINKED TO TFC MARKET Despite these positive developments, some irritants remain to be addressed. Although appetite for TFCs by institutions and retail investors is abundant, supply is by and large limited.
While listed TFCs are not approved securities for commercial banks' SLR, non-bank financial institutions (NBFIs) were allowed to invest in TFCs for SLR from May 1997 onward. Major institutional investors would be more than willing to invest in TFC issues but only at acceptable profit rates. Moreover, many investors (especially retail investors) do not fully understand these debt securities.
Additionally, intermediaries, have difficulty participating in the market due to the lack of short selling (See Table B). Market makers are therefore unable to provide two-way quotes to secondary market players, which would strengthen and deepen this market. The approval of short selling is unlikely in the near future because of limited TFC issues.
By the end of FY02, the country has already achieved a moderate level of capital mobilisation through the bond and equity markets at 25 and 11 percent of gross domestic product (GDP) respectively. However, the figures are deceptive as government issues dominated the bond market with corporate bond market accounting for only about half a percentage point of the GDP.
It was expected that long-term securities would be priced relative to government bonds. In practice, TFCs' pricing (coupon and price) was being based on the National Saving Schemes (NSS).
The reason is twofold: first, secondary market for long term government papers was not in a stage where their yields were long-term benchmark rates; and second, NSS constitutes more than a quarter of all domestic government debt and is aimed mostly at the public, which the TFCs, through listing at the stock exchanges, were also targeting.
FLOATING RATE ISSUES AND THE EVOLUTION OF THE PRICING STRUCTURE OF TFCS A very interesting development is the gradual evolution in the pricing structure of the TFCs. Starting from the plain vanilla structure with fixed coupon rates, the market has witnessed an increasing number of bonds with floating structures.
In floater TFC, coupon rate is variable which changes with market conditions by being anchored to a benchmark rate (usually the SBP Discount Rate). This pegging protects the investors from any upward fluctuation in interest rate that would cause a fall in yield. It is interesting to note that, in contrast to FY02, all of the listed corporate bonds in FY03 were floating rate issues, probably reflecting the volatility in interest rates and had floors between 7 percent and 12 percent.
The cost of funds for these issuers, therefore, remained significantly higher than the prevailing market rates for corresponding tenors. Given the rising interest rate environment and the need to hedge against interest rate volatility, in FY05 and FY06 new issues of TFCs were anchored to floating rate instruments.
But instead of pegging corporate instruments to any long-term benchmark (ie, PIBs), all the floating rate issues in FY05 and FY06 were anchored to the short-term KIBOR rates. In fact, the lack of fresh PIB issues not only made the secondary market relatively illiquid, but also made the longer end of the yield curve unrepresentative.
Thus, PIB rates are no more used as benchmark rates. However, given the expectation of continuing volatility in rates many issues also incorporated embedded options to protect both issuers and investors.
The size of the corporate debt market is still very small although the prospects of growth had improved due to a number of recent developments. On the supply side, rising interest rates have led corporates to lock-in funding costs, even as the demand profile is improving due to: (a) the increasing number of mutual funds; (b) rising maturity of institutional NSS investments; and (c) the increasing role of professional fund managers in pension & provident funds, trusts, etc.
While the primary market of TFCs has made some progress and has potential to grow, the recent decision to allow institutional investment in NSS scheme is a setback to the prospects of the corporate debt market.
While yields on NSS long-term instruments appear similar to returns on PIBs, the comparison appeared inappropriate, as the NSS investment incorporates an implicit put option which makes the yield on similar tenure PIBs significantly less attractive. Similarly, issuers of long-term corporate bonds would have to offer significantly high yields to compete with NSS instruments.
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Table A Schedule Schedule
FY Size of Growth % Schedule Banks Growth% Schedule Bank Growth % Banks Credit Banks
GDP in Credit to Private Investment in to Private Investment in
current factor Sector (Rs in bn) Government Sector as Government
cost (Rs in bn) Sector (Rs in bn) % of GDP Paper as %
of GDP
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1999 2921.9 6.80 826.8 8.18 46.6 -43.65 28.30 1.59
2000 3529.3 20.79 936.5 13.27 221.1 374.46 26.54 6.26
2001 3876 9.82 997.7 6.53 253.7 14.74 25.74 6.55
2002 4095.2 5.66 1011.1 1.34 375.9 48.17 24.69 9.18
2003 4479.8 9.39 1122.2 10.99 617.2 64.19 25.05 13.78
2004 5250.5 15.80 1440.1 28.33 669.8 8.52 27.43 12.76
2005 6203.8 18.20 1921.3 33.41 602.7 -10.02 30.97 9.72
2006 7295.2 17.60 2468.7 28.49 591.2 -1.91 33.84 8.10
2007 NA NA NA NA NA NA NA NA
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(Concluded)
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