Commercial Paper issuances by corporates have been on the rise so far in 2018 as companies finance expensive debt amidst a much lower interest rate environment. Treasury yields have averaged 12.4% in 2018 vs. 2017 average of 17.9%.
A breakdown of the current Commercial Paper Issuances from the FMDQ OTC Exchange shows that interest in the market has been cut across major sectors, including Financial Services, Consumer Goods, and Industrial Goods. Currently, the discount rate on Commercial Paper (CP) listings as quoted on FMDQ show discount rate range of 12% – 14%, much lower than typical bank overdraft rates and a mild spread on treasury securities.
Dangote Cement PLC currently has the largest outstanding CP value on the FMDQ after raising ₦50 billion out of its ₦150 billion CP shelf programme. Overall, we foresee further interest in the Commercial Paper market going forward, further supported by the CBN’s recent commitment to invest in Commercial Paper issuances by large corporates at single digit interest rates.
But what is a Commercial Paper (CP)? When and why was the CP introduced?
The Central Bank of Nigeria (CBN) defines it as “an unconditional promise by a person to pay to the order of another person a certain sum at a future date. Such an instrument may or may not carry the bank’s guarantee.” Where the bank guarantees the CP to make it more marketable in the money market, the instrument is said to have acquired the force of a Banker’s Acceptance and the bank incurs a contingent liability. Where the CP is not secured or guaranteed by the bank (clean CP), it needs not be reported as a contingent liability.
In simple terms, companies borrow money from the public by issuing commercial papers. It is essentially an unconditional promise to pay back your money on an agreed future date with interest. The offer includes all the details of the transaction. You may be wondering why a company would approach the investing public for the loan rather than go to a bank. One advantage is the lower interest rate. Commercial papers are issued within the range of rates obtainable in the money market. That means you get to borrow at a rate cheaper than borrowing from the bank. This makes it cheaper to run their operations. For taking this risk, you also get an attractive return on your money.
CP was introduced in Nigeria in 1962 to finance the export-marketing operations of the then Northern Marketing Board. Under that arrangement, the Marketing Boards met their cash requirements by drawing ninety-day bills of exchange on the Boards. The bills were then discounted with the commercial banks participating in the scheme. The role of the Central Bank of Nigeria (CBN) then was to provide rediscounting facilities for the bills. In 1968, the CBN took over the responsibility from the Marketing Boards.
The maturity of commercial paper is typically less than 270 days; the most common maturity range is 30 to 50 days or less. They are usually sold, like Treasury bills, at a discount.
Why Do Companies Issue Commercial Papers?
Commercial Paper issuance can serve as a preamble to any future bond offering by the issuer. Balance sheet efficiency creates greater potential funding capacity for the issuer. Issuance of Commercial Paper helps a company complement its other sources of working capital while diversifying its funding sources to include non-bank investors. It also enables companies to acquire investments that are tradable without a penalty.
How do you invest in them
Investment in commercial papers is regulated by the Securities and Exchange Commission. In addition, the quotation of commercial papers on FMDQ Platform (financial market daily quotes) is a rigorous process that involves credit rating etc. This is to protect the investing public and to create confidence in the market. Since commercial papers are listed on FMDQ, you can buy and sell them on the platform.
When you invest in a commercial paper, you purchase at a discount to receive the full value at maturity. For example, when you buy a commercial paper with a face value of N100,000 and an implied interest rate of 10% you actually pay the company N90,000. Upon maturity, the company redeems the commercial paper by paying you N100,000.
Investment in commercial papers is open to accredited investors. An accredited investor is any person or institution capable of understanding and affording the financial risks associated with the acquisition of unregistered securities. This means you understand what you are doing (financial education) and can handle the risk if things do go otherwise.
The accredited investor includes qualified institutional investors or an eligible individual investor.
An eligible individual investor or accredited individual investor is:
- Any person who alone, or with a spouse has a net worth of over N2m
- Any person who alone had income in excess of N400,000 in each of the two most recent years (or with a spouse, in excess of N500,000 during this period) and had a reasonable expectation of reaching the same income level in the current year (annual income).
The summary is that if you and your spouse earn up to a combined annual income of N500,000, and understand what you are doing, you are an accredited investor.
Subscribing to commercial papers
The minimum level of subscription for an issue may be determined by the issuer and stated in the offer documents.
To invest in commercial paper, all you need to do is to make an enquiry at your bank or discount house. It is as simple as asking your account officer or relationship officer at the bank. They will get the information for you. You will be advised what commercial papers are available, the terms including interest rate, tenor and minimum subscription.
Below is an example of the summary of an offer:
Indicative terms
Issuer: ABC Nigeria PLC
Arranger: XYZ Bank Limited
Issuer rating: ‘A2’(Short term, 2016) and ‘BBB+’(Long term, 2016) by Global Credit Rating Co. Limited
Status of the notes: Senior Unsecured
Programme size: N50bn
Issue size: Up to N5bn
Tenor: 181 days
Discount rate: 19.0194%
Implied yield: 21.2000%
Offer open: 26 Feb 2017
Offer close: 02 Mar 2017
Funding date: 03 Mar 2017
Use of proceeds: Working capital financing
Tax considerations: Free and clear of withholding taxes
Minimum Subscription: N5,000,000 and multiples of N1,000 thereafter.
