In need of equity

From the title of today’s article, one would presume that I am writing about the need for additional share offerings to be launched on the Malta Stock Exchange. Although the domestic capital market is indeed in great need of additional companies seeking an equity listing, today’s article will instead address an important topic that is central when assessing bond issuers given the increased media coverage of the bond market in recent days.

One of the main considerations that one must undertake in order to gauge the financial strength of a company is an assessment of the leverage. Several bond issuers in Malta need to understand that they cannot simply rely solely on borrowings (banks and bonds) to fuel their growth without becoming over-leveraged. Unless their current operations are generating sufficient profits which are being retained and not being distributed, or current shareholders have sufficiently deep enough pockets to continue funding the company’s requirements, they need third-party investors to inject fresh capital in order to maintain reasonable levels of leverage.

This is evidently one of the major problems with a number of the companies that have recently been disclosing their challenges in respect of their upcoming bond redemptions. Moreover, it is also fair to say that from a cursory review of the financial statements published by the various bond issuers across the MSE, there are also some other bond issuers that are clearly over-leveraged (too much debt compared to equity) and which may not be currently receiving media attention since their bonds still have a number of years before reaching maturity.

Companies in need of additional equity funding either due to the fact that they are currently over-leveraged or are seeking expansion (locally as well as internationally) should consider the capital market for an equity injection. The involvement of third-party investors, both institutional as well as retail investors, is one of the key functions of the MSE especially given the abundance of liquidity across the banking system searching for investment options. Naturally, appetite from such investors is hugely dependent on the investment proposition and competitive position of a company.

The recent media coverage of the bond market also included some opinion pieces calling for reforms required to safeguard Malta’s financial stability. In the second part of today’s article, I will share my views on three important discussion points that were raised.

One of the proposed reforms that was mentioned is the “necessity of building a sinking fund for the eventual repayment of the bond upon maturity and the abandonment of the concept that a bond can be refinanced, preferably at a lower interest rate, upon maturity”. The concept of a sinking fund has long been debated in Malta and it is important to remind the investor community that this was a requirement for several years in Malta which led to a complete standstill of the bond market in Malta with virtually no issuance.

The MFSA had then published Listing Policies in early 2013 specifying that a sinking fund (the requirement for companies to set aside an amount of cash annually in order to have sufficient funds to repay bondholders upon maturity) was only required by those companies who are dependent on the sale of assets to honour their repayment obligations. In fact, various property development companies that utilised the bond market in recent years do indeed have a sinking fund in place which is working well and matches the business model of such companies.

However, as the Listing Policies rightly indicate, a sinking fund is not a requirement for those companies that have assets generating revenue and cash flow over the long-term. Companies within the hospitality sector, maritime sector, manufacturing and other conglomerates exposed to various industries are correctly excluded.

This is similar to the requirements across bond markets overseas. Companies such as Bayer, Deutsche Lufthansa, Deutsche Post and Nestle just to name a few, do not have the requirement for a sinking fund and regularly issue bonds across international bond markets.

The second part to the proposed reform that a bond should not be refinanced possibly at lower rates also needs due clarification. Most foreign companies such as those mentioned earlier regularly refinance their bonds upon maturity. Likewise, in Malta, companies having recurring revenue streams, should be encouraged to utilise the bond market for long-term capital allocation plans. The importance as always is an assessment of the leverage and other factors to assess the financial strength of a company. With respect to the fact the refinancing can take place at lower rates of interest is dependent on a number of factors mainly the prevailing interest rate environment at the time or the term of the bond.

While these reforms are being debated solely for corporate bonds, one should also think of the sovereign bond market (issuance of bonds by governments). The Government of Malta is not required to build up a sinking fund to have sufficient cash for repayment of bonds upon maturity. Indeed, in view of the budget deficit being incurred annually, not only is the Government not in a position to build a sinking fund but needs regular issuance of MGS to finance the deficit and also to raise new funds to meet their repayment obligations. This is indeed why total MGS issuance will remain elevated at over €1 billion per annum in the coming years despite the projected reduction in the budget deficit. A fresh insight into the amount of future MGS issuance will be available on 27th October when new financial estimates are presented concurrently with the 2026 Budget.

Another suggested reform centres around the requirement for corporate borrowers to “issue yearly updates on their financial statements, scrutinised by regulators, to ensure that investors know how their capital is being affected by developing operational issues”. This was indeed put in place a few years ago with the introduction of the requirement by the MFSA for bond issuers to publish a Financial Analysis Summary on an annual basis to provide financial forecasts. It was a very important and positive step by the regulator to enable financial intermediaries and investors to have added information to assess the progress and financial strength of a company. It is important however for all stakeholders to use this valuable information wisely and ensure the ongoing monitoring of companies is being undertaken.

The other proposed reform mentions the long-debated issue of a credit rating agency for bond issuers in Malta. Although this would undoubtedly be a good initiative since such an agency would provide an independent opinion on the creditworthiness of an issuer, I do not believe it needs to be a mandatory requirement for issuers. I believe that a financial intermediary acting as a distributor of an issue of bonds has a responsibility to carry out an assessment of the financial strength of an issuer and/or guarantor of bonds. Moreover, investors should also demand reviewing the results of such an assessment before carrying out a transaction. This information is already widely available through the Prospectus and Financial Analysis Summary depicting various important financial ratios to gauge the financial strength of an issuer and ultimately its ability to honour obligations.

Numerous Maltese companies are indeed undercapitalised. Business owners (typically family members) cannot continue to pretend that they can simply borrow unlimited amounts to fund their expansion. The concept of leverage is critical in corporate finance. This is one of the key factors in the debate on the challenges currently being faced in the bond market. The shareholders of a company issuing bonds or having bonds already issued on the market need to have sufficient capacity to support the business in times of need. Otherwise, a fresh equity injection from private investors is fundamental and the capital market is the ideal medium for a company to introduce third-party investors.

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