With Ukraine's investment appeal growing, fundraising through bond issues is becoming an ever more common. The domestic bond market is demonstrating rapid growth, with corporate bond volumes in 2006 showing a 66% or USD 4 billion increase on 2005, according to preliminary data from Dragon Capital, Ukraine's leading securities brokerage, investment banking, equity and asset management firm.
"Market trends are definitely ascending. The economy is growing, companies are growing and many of them have realised the advantages of bonds. There's no need for collateral, no need for a business plan, although a company should convince an investor that one is available. The understanding is there that bonds are an efficient alternative in attracting funding and finance growth," says Olena Bilan, an analyst with Dragon Capital.
Although the market growth is evident, it is still relatively small and is not predicted to take off in a big way until there is a revised pensions law in place and insurance companies become serious institutional investors - common practice in the western capital markets sector.
A bond is a due-bill and sometimes the only way out for companies in financial trouble. A state, enterprise, bank or city can issue many standard bonds of the same type to investors, with the promise to return the money borrowed with interest. Anyone can buy a bond, earning interest at regular intervals and, at the end of the bond's term, recouping their original investment.
Coupons
Ukraine's most commonly used type of bonds take the form of coupons. Payment of a coupon - a security that allows an investor to receive a fixed yield interest - is normally performed once every three or six months. The coupon rate is generally not much higher than the interest that would be received on a UAH bank deposit.
"Three years ago, corporate bond yield was some 17-18%. Gradually, it has been lessening, and for nearly a year it has stood at 15-16% for most issuers," says Oleksandr Pecheritsyn, a bond expert with the Kyiv-based Alfa Bank.
The yield that can be expected from municipal bonds is even less, around 11-12%, because they are considered more reliable than corporate bonds, carrying less risk on the part of the investor. Investors can claim their money back if an issuer decides to buy the securities back before the scheduled time, a situation that can arise if the bonds sink in price or there is an urgent need for the investor to raise cash.
In 2004, according to the Cbonds Agency, the total volume of securities traded in Ukraine was UAH 34.8 billion (USD 6.9 billion), of which 12% was corporate bonds and 0.14% municipal bonds. In 2005, the total volume stood at UAH 62 billion (USD 12.3 billion). Of this, 20% was corporate bonds and 0.5% municipal bonds.
Corporate bonds
The Ukrainian corporate bonds market emerged in 2001. A number of companies, including mobile operator Kyivstar and Raiffeisenbank Ukraine, launched the first public bond issues, with a total volume of USD 22.4 million. In 2002, the total volume was USD 60.6 million, while in 2003 it rose to an impressive USD 483.3 million.
Then, in 2004, the total volume decreased by a factor of three, slumping to USD 150.7 million. This fall was caused by a number of factors, including a lack of large bond issuers during the period.
The cause of the 2003 boom was simple. Companies borrowed money from banks, but to avoid exhaustive loan procedures, the companies issued bonds and the banks bought them up. For the banks, the bonds' yields were similar to the interest they would have received on loans while also facilitating more flexible use of their resources.
Initially, more than half of the bond volumes were in so-called non-market issues. There were minimal coupon bonds, around 0.01% per annum, through which enterprises moved money between each other legally. An addressee issued bonds, and a donor bought them. As a result, tens of millions were shifted from one to another, sometimes with up to 100-year terms.
Banks and bonds
Banks are the main issuers of bonds, as the only way they can attract long term liquidity funding at acceptable rates. However, given that interest rates are never below 6% in Ukraine, this affects the cost of lending.
What investors should be aware of
Although bond yield and popularity is high throughout the world, investors may face a number of problematic issues in Ukraine. The first is tax. According to Ukrainian legislation, income from securities is subject to state assessment. "Let's imagine that an investor buys a bond with a relatively high yield of 15-16%," says Maria Maiboroda, an analyst with the Troika Dialogue Ukraine investment firm. "They will have to pay a 15% tax on the income obtained, decreasing their income by 13-14%. Taking this into account, the investment becomes rather risky - on the one hand, money is put into a company's liabilities, without risk diversification. On the other hand, the cited yield is typical for bonds with middle and close-to-high risk levels. Besides this, some part of the income will be eaten by commission."
Maiboroda adds that the bonds with low risk, for example, bonds issued by large banks and state owned companies, have a yield of some 10-13%. An investor might also be disappointed by the complexity and price of the bond buying procedure. To buy securities in the primary market, i.e. during the flotation period, the investor has to appoint an underwriter. Normally, this underwriter takes the form of a securities trader or a bank with a trading license. The underwriter names a minimal block of bonds, or lot, that he can sell and if the price satisfies the investor they will submit their data, usually passport number, ID number and bank account details. Usually the underwriter opens a securities account immediately, then the investor signs all the necessary paperwork with an independent intermediary before transferring the funds to the underwriter and having the securities placed on account.
The secondary market
It is also possible to buy bonds in Ukraine on the secondary market. Usually the investor informs the trader of the intention to purchase bonds and if the trader has the required securities, they will disclose the price. If the trader has no available securities they will source them on the market and then inform the potential investor of the price and their fee. From there the procedure follows the same lines as primary market purchase: the trader buys securities and places them on the client's account.
However, at every stage, additional expenses emerge. Both broker and keeper are supposed to be paid, as well as the bank opening the account and transferring the money. Sometimes all these expenses make an investment unfavourable and in extreme cases completely devouring any profit.
Another disadvantage of bonds is the occasional review of their yield. Bonds are issued for terms of over three years. Their yield is fixed for the first year and then reviewed. So, to make an investment efficient, an investor needs a reasonable sum at the outset. Large attendant expenses can be compensated only if an investment is large enough to provide impressive yields. A retail investor may be better to place money in bank deposits, thus saving time and money.
Bond funds
"Investing in bonds makes sense if it concerns a large diversified portfolio. In all other cases it is better to place money in a bank or, even better, in a bond fund. The latter is interesting because the risks are low compared to stock funds, while the yield is usually higher than a bank deposit interest," says Maiboroda.
Currently, there are three bond funds in Ukraine: UkrSib Stable, which is controlled by UkrSib Asset Management; the Parex Ukrainian Bond Fund, which is controlled by Parex Asset Management Ukraine; and Synergy Bond controlled by KINTO Asset Management Company. According to investfunds.com.ua, UkrSibS table gained 30% per annum in 2006, Parex Ukrainian Bond Fund - 22.9%, and Synergy Bond 11.58%.
