Physical Address
Victory Est, Ogombo Ajah, Eti-Osa, Lekki 101245, Lagos
Every time when reflecting on the current state of things regarding funding in Nigeria and earning money, I feel a kind of breathing difficulty since there are certain skills needed to manage the problems that are created by the current state of affairs. As a financial analyst who is engaged in analysis of the market dynamics, I can say that the current state of macroeconomics is quite different from that of many years ago. Since the Central Bank of Nigeria maintains the Monetary Policy Rate at 26.5 percent in order to cope with the problem of inflation in Nigeria, the cost of getting funding in traditional ways has become extremely high. If someone wants to receive some funding in the commercial banks, he/she needs to be ready to pay more than 30 to 35 percent in order to get the money, which will be too risky for the business.
However, your business needs to move on; you need money to buy goods, to improve logistics, to develop, etc. Therefore, the moment has come when we need to get out of overdrafts and find some other ways to borrow money. Specifically, I want to compare corporate debt notes and banking facilities.
The New Reality of Funding in Nigeria
To understand what problems are being encountered as regards capital, one should analyze what the monetary authorities do. It is clear that the tight monetary policy of the Central Bank and how the policies of CBN affect money and investments have made sure that liquidity has been trapped in the banks. With the interest rate at 26.5 percent, the commercial banks are likely to raise prime and directional interest rates.
This implies that when deposits are made in the commercial banks, much of the money is held and there is no enough money to lend to the private sector. This is because when one goes to the bank for money, one is likely to be faced with tough requirements. For corporate treasurers and businessmen seeking alternative sources of finance, it has become necessary for them to understand about issuing corporate debt securities.
Deconstructing the Bank Loan Model
The traditional methods of raising capital through banks have been practiced in Nigeria for many years in terms of conducting business operations there. Whether it involves business loans in Lagos or financing of machinery in the industrial zone; banks provide the relationship-based method of funding whereby one goes to his account manager with his audited financial records and collateral in order to get his lump sum facility or overdraft facility.
However, it has become very apparent that the major issue with the traditional method of bank funding, especially in the high-interest rate environment, is quite obvious. First, the cost of funding changes with the high level of risk in the system. Most of the loans raised by the banks in Nigeria are based on the floating rate, meaning that in case of the rise in the interest rate regime of the apex bank in the tenor period of the loan, the cost of borrowing will increase as well. Second, the collateral requirements are relatively strict. One has to provide immovable assets ranging between 120% to 150% of the value of the total loan amount.
The Rise of Commercial Papers as an Alternative to Raise Capital
This is the point when short term unsecured promissory notes or commercial papers make an entry. For the purpose of raising funds for your organization without undergoing the cost of taking loan from the commercial bank, commercial paper will be the appropriate option for you. In this case of commercial papers, there is a process of borrowing money from the people of the public in absence of any form of security with the maturity period of 30 to 270 days.
According to Research Leap, when you use commercial papers, then you save on intermediation cost by avoiding commercial banks. This is because you do not pay banks who lend you money at low interest rates to repay the investors. Commercial papers save you on the cost of funds while at the same time giving the investors high interest rates as compared to bank deposits.
In regard to commercial paper market in Nigeria, initially there were only the blue chips or multinational companies. However, because of the change in the dynamic of the financial market of Nigeria, it can be seen that the medium sized firms having creditworthy status have started making entry into the market. This is because of the fact that there is a listing and quotation of commercial papers in an easier manner at the FMDQ Exchange.
Comparing Key Attributes: Commercial Papers vs. Bank Loans
In order to help you select the right structure for your financing need, we will analyze the difference between these two structures depending upon some factors:
- Collaterals Requirement: Borrowing from banks is always collateralized by some form of asset. There must be evidence of possession or cash collaterals, otherwise, the transaction would not occur. Whereas, commercial papers are unsecured promissory notes. It is entirely up to your credit worthiness, cash flow regularity and company’s goodwill.
- Time Taken: To create the first commercial paper structure requires some preplanning. However, once that is done, it takes just a couple of days to utilize the tranches. The bank funding process will normally entail many credit committee approval for each utilization of the fund.
- Interest Rate Predictability: Regarding the commercial paper, it will mostly be sold on a discounted basis; hence, the interest rate becomes very predictable at issuance time. For instance, if you issue 90-day note with a discount rate of 22%, it remains the same even if central bank does something else in the next three months. On the other hand, bank credit line has higher chances of changing rates in between.
- Tenure & Flexibility: The bank credit line can have tenors of up to 2-5 years. However, the commercial paper has tenor that lasts for very short time period. Even if you continue renewing the notes after expiration to have the facility continuously, you have to either dispose or refinance the debt within 270 days.
The Hybrid Approach: Balancing Debt and Equity
Nevertheless, when considering the possibility of making a decision regarding the choice of the two options of funding discussed above, you should always remember that you cannot neglect other possible sources of finance as well. When opting for long-term capital financing where you have to invest in the purchase of infrastructure and machinery, there can be maturity mismatch as you borrow the money in the short term. In case of uncertainty about the inflow of cash, paying back your loans within 270 days can cause liquidity problems.
In this situation, it is crucial for you to think about the opportunity to attract money through equity financing which will enable you to sell stocks of your company to Port Harcourt investors. Equity financing does not have the problem of interest and maturity; therefore, you will have an opportunity to reinvest all your profit from the business into business.
Steps to Be Implemented by Corporate Treasurers
Now that you are determined to improve your financial policy and raise funds without incurring high costs, here are the steps that you should take:
- Do a Cost-Benefit Audit: Carry out an audit on your present bank account and know the actual cost of debt financing. This entails adding all the cost which include the processing cost, commitment fees, and premium on insurance.
- Improve your accounting: Set yourself up by getting rid of the transactions from related parties and obtaining reliable quarterly management accounts.
- Work with an Issuing House/Investment Bank: Work with an authorized player in the capital markets to know your level of preparedness in the quotation of your commercial paper. The issuing house will assist in the structuring of your program, working with the rating agencies, and marketing your notes to institutions.
- Pay attention to the Monetary Policy Framework: Always be aware of the guidelines that are outlined in the guidelines of the Central Bank of Nigeria concerning changes in the interest rate.
Conclusion on Managing Corporate Debt
Finally, in order for one to successfully manage his/her business amidst an environment of high interest rates, the need for resilience as well as the ability to endure adverse financial conditions becomes important. It is simply the reality that lack of low interest rate loans must never prevent you from pursuing your entrepreneurial aspirations. Through corporate governance, knowledge of commercial papers, and the balancing of liabilities and assets, things shall always be alright amid the current local financial crisis. Make sure that you take care of your corporate treasury and get funds from different sources to succeed despite the economic environment.
