Risks of high interest rate corporate bond

There is conflict as to why most real estate companies have issued bonds at high interest rate rather than issuing more shares at cheaper rate. The competition to issue bonds, to raise capital, between many companies has caused the interest rate of corporate bonds to increase. Bond interest rate has been even higher than lending interest rate of banks.

Illustrative photo.

Illustrative photo.

Sai Gon Investment had a discussion with Phan Dung Khanh, Investment Consulting Director, Maybank Kim Eng Securities, to further clarify solutions for this issue.

Recently, many companies announced their plan to issue corporate bonds and majority of them are real estate companies. According to 6M/2019 data, about VND 117,000bn of bonds have been issued, an increase of 74.3% YoY. The average interest rate was 9.5-11%/year, in which over 90% of total issuing amount was sold at interest rate below 11%/year. Some issuances offered clients at an interest rate of 13-14%/year or even 14.5%/year.

The main reason for this situation is the requirement of the State Bank which asked banks to reduce their lending to high risk sectors like real estate. This has created barriers for real estate companies in approaching for bank loans.

JOURNALIST: - Why do many companies raise funds through bonds rather than share issuing?

PHAN DUNG KHANH: - Currently interest rate of corporate bonds of some companies is very high. It is even double the deposit interest rate of banks and 1.5 times of bank lending interest rate. Note that, this interest rate does not include the fee of bond issuance. It is understandable as many companies need more capital simultaneously, hence, they have to increase the interest rate to attract investors.

It shows that real estate companies are facing difficulties in raising capital from bank loans or share issuance, and they have no choice, hence, they have to borrow at high interest rate through bond issuing.

Why do real estate companies not issue more shares? The stock market was at its peak in April 2018. Since then, it has been falling continuously, in both price and volume. Hence, issuing more shares at a price that companies want is not easy. Furthermore, issuing new shares, which have been considered papers when the market is in the down-trend, will destroy the reputation of these companies in the eyes of investors given the loss they incurve. Furthermore, some companies have not been qualified to issue more stocks or they refused to issue shares because they do not want the share issuance to impact their financial ratio.

- Does the bond issuance of companies create a competition between banks and companies? And will this competition create a risk for the bond market?

- Frankly speaking, there has been a competition between banks and corporates in issuing bonds to raise capital. This creates difficulties for both sides. While banks could not ease their lending criteria given their bad debt situation, companies also face risks when issuing bonds. For example, if real estate companies do not meet construction dead line or they are not able to sell the projects, they will face difficulties in creating the cash flow.

In the long term, this creates a negative impact on ability of companies to pay debt. These companies will face more difficulties when they want to issue more bonds.

While most issuing companies have not been evaluated by an independent credit rating institution, their prospects are too complicated. Hence, investors who buy corporate bonds which do not have collateral assets and are not guaranteed by third parties will face risk of default.
Furthermore, real estate companies now have to pay high interest rate amidst low liquidity in real estate market. In a good case scenario, when real estate companies are successful in selling all their projects, the higher interest expense will also affect most of their profits. To survive, real estate companies have to cut other costs or apply new technology to save costs to offset with higher interest expenses. However, these ways are not easy to apply as they require more ability and management as well as a change of mindsets.

The other channel that competes directly with corporate bond is gold. This investment channel has been the interest of many investors recently given the forecast that gold price will increase in coming times.

This means that companies find it hard to raise more funds through bonds if they only offer low interest rate.

- Is there any solution to decreasing risk for real estate companies in issuing bonds?

- It is hard to find a perfect solution. In my opinion, real estate companies should consider some of the following issues when issuing bonds:

  • Only issue bonds when companies raise funds for feasible and marketable projects
  • Divest from unfeasible projects
  • Refuse projects that consume huge costs
  • Cut all costs that are unnecessary

Especially, companies have to proactively cut their bond interest rate. They should consider offering investors other benefits which are related to project sales like better price, preferable position, or premium choice in the project, rather than increase the bond interest rate.

- In your opinion, do authorities need to intervene in the market to reduce the risk?

- Practically speaking, authorities also find it hard to resolve this problem. If authorities constrain bond issuance activities, they have to encourage banks to loan to real estate companies. This way has more risks. In my opinion, authorities should allow companies to run by themselves. Authorities may govern the corporate bond market by creating a complete set of standards of bond issuing, such as allowing maximum interest rate, however, this way will distort the market. Furthermore, it is not easy to change the legal framework. Authorities must get approval first. Hence, for now, authorities should not intervene in the market if it does not cross certain borders, to avoid the bad impact on other companies.

- Thank you very much.

Hai Ho

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