With prime lending rates at 17% in the first half of 2003, many companies with unwieldy capital structures are starting to feel the pain, and those at the limit of their borrowing capacity may not survive the year.
Most companies rely on bank borrowing to fund working-capital requirements. The volatility of interest rates creates havoc with business planning, which explains some companies' distrust of borrowings. Many have bitter memories of 1998, when interest bills shot up 40% as interest rates increased to 25%.
Before 1998, a JSE listing was often the cheapest source of working capital, but that door has been closed as the listings boom turned out to be little more than a financial bubble, though the JSE hopes to lure small companies back with the imminent launch of its small-cap market. Some, however, are turning to alternative sources of finance such as banks, private equity, corporate bonds, securitisation and medium-term debt notes.
Given the current inverse yield curve, raising long-term debt is an attractive option for some companies. As interest rates drop , large companies, with good credit ratings, may consider floating a corporate bond and locking in interest rates at low levels. Those with steady cash flows are showing interest in securitisation as a source of funding.
JSE-listed companies rely heavily on equity funding. An analysis of debt:equity ratios among JSE-listed companies by RMB and the Bond Exchange of SA (Besa) showed a strong reliance by nonfinancial companies on equity finance between 1994 and 1999. The average debt:equity ratio for these companies was 46%, with 39% being short-term debt financing. The figures are out of date, but they are unlikely to have changed much.
The limited use by JSE companies of debt funding, and long-term debt in particular, is striking. An aggravating factor is the large cash pile amassed by local companies because of strong profit flows from mature businesses, modest investment opportunities at home and a taxation system that discourages the payment of dividends.
As interest rates drop, larger companies, with good credit ratings, are likely to dive back into corporate bonds and medium-term debt notes (MTDN), which allow companies to tap the bond market at short notice as cash demands fall due.
"SA companies are excessively capitalised," says Bravura Equity Services executive director Ian Matthews. "This is partly a consequence of interest-rate volatility in the past, but also exchange controls that forced institutional investors [not companies] to invest surplus funds locally."
Companies with good credit ratings are now able to secure five-year-term lending rates of about 7,7%, as opposed to equity capital costs of 16% or more. AAA borrowers can secure term lending rates of about 11% on which they receive tax deductions, reducing the effective rate to 7,7%.
Matthews says one way a company can increase its leverage is by compartmentalising its balance sheet into more comprehensible risk profiles. For example, taking fixed assets off the balance sheet and rendering them bankruptcy-remote and raising debt against these assets. Another way is to securitise debtors by packaging future debtor cash flows into a tradable bond paying an attractive coupon and sell them again to investors. Using this approach, companies can double the gearing on their balance sheets.
More than 80% of Besa's R454bn nominal bonds were issued by government, but a growing number of corporations now have bond issues.
SA Home Loans, for example, has issued two mortgage-backed bonds worth R2,3bn. Now interest rates are headed lower, expect a rush back into corporate bonds and securitisation. Companies will want to lock in lower rates of interest and build war chests for the uncertainties that lie ahead, particularly if the economy splutters into recession.
