Whenever I look at the current situation of financing in Nigeria when it comes to an individual trying to raise capital, my heart stops beating since the present macroeconomic environment calls for strategic acumen in tackling problems. Being a financial analyst who tracks the dynamics of the local market, I know that the prevailing environment is completely different from what used to be years ago. Given the Central Bank of Nigeria keeping the Monetary Policy Rate firmly at 26.5 percent in order to counter the problem of inflation in the country, the cost of obtaining funds from the existing traditional channels has become very high. Should you rely exclusively on commercial banks for developing your business, you would likely face borrowing costs that are above 30 to 35 percent when all additional costs are included. These figures could prove very dangerous for your profits.
However, your business cannot standstill; you need cash to procure goods, optimize your logistics, expand, etc. This is why it is time for us to go beyond the overdrafts and consider other kinds of debts. In particular, I would like to compare corporate debt notes with normal banking facilities.
The New Reality of Funding in Nigeria
In order to understand why it is hard to acquire capital at this point, we need to focus on the monetary authorities’ actions. The rigorous tightening monetary policy adopted by the central bank and how CBN policies affect money and investments have locked liquidity in the banks. With a benchmark rate of 26.5 percent, commercial banks are bound to increase both their prime and directional lending rates. The commercial banks are safeguarding their margins against losses amid the massive cash reserve ratio of 45 percent.
What this implies is that out of each naira deposited in commercial banks, a big chunk is kept off and there remains little cash to finance the private sector. As such, when you visit the bank for finance, you will be given tough conditions. To corporate treasurers and businessmen who want to find alternative sources of finance, the knowledge of issuing corporate debt securities has become mandatory.
Deconstructing the Bank Loan Model
The conventional bank financing arrangements have, for many years, been the norm when it comes to doing business in all parts of Nigeria. Regardless of whether it is business loans in Lagos or equipment financing in the industrial centers, banks provide the direct and relationship-based approach to lending where you meet your account officer, provide your audited financials, provide your collateral, and get your lump sum facility or overdraft facility.
However, the inherent weakness of the traditional bank credit arrangement under the high interest rate regime is obvious. Firstly, the cost of funds is variable and burdened with systematic risk. Majority of the commercial loans provided by banks in Nigeria are at floating rate, and thus, any increase in the policy rate of the apex bank during the tenor period will result in an immediate rise in the cost of the loan. Secondly, the requirements for providing collateral are highly stringent. Banks require that one provides immovable property worth 120% to 150% of the total loan amount.
In addition, the red tape associated with the processing of loans by banks can result in the delay of necessary business interventions. Should there be a need to raise quick funds to fulfill an urgent purchase order, waiting for months just for a credit committee’s decision to come through will only end up killing the deal.
The Rise of Commercial Papers as an Alternativeto Raise Capital
This is precisely where short-term unsecured promissory notes, otherwise known as commercial papers, come in to play. If you would like to finance your business without the cumbersome overheads involved in a commercial bank loan facility, then a commercial paper program would be an excellent choice. In essence, commercial paper is a short-term borrowing tool issued by a corporation to the public without any collateral, with the maturity period being anywhere between 30 and 270 days.
According to Research Leap, through avoiding the use of commercial banks, your business reduces the intermediation cost that comes with banks. You do not end up paying a bank, which pays you back at lower interest rates to the investors. Through commercial paper, your company ends up reducing the cost of funds while giving the investors higher returns than the conventional bank deposits.
In the past, the Nigerian commercial paper market was made up of only blue-chip conglomerates and multinational firms. However, due to changes in the dynamics of the financial environment within the country, medium-sized firms with good credit ratings are now actively participating in the market. According to the structure that has been set out on the FMDQ Exchange, there has been an easing of the process of listing and quotation of commercial papers.
Comparing Key Attributes: Commercial Papers vs. Bank Loans
In order to assist you in selecting the most suitable structure to fund the corporate requirements, we shall analyze the key operating contrasts based on different variables:
- Obligation of Collaterals: The normal bank borrowings are backed by assets. You must have proof of occupancy or cash as collateral. Otherwise, the deal does not happen. In stark contrast, commercial papers are uncollateralized promissory notes. It all boils down to your credit worthiness, consistency in cash flow, and goodwill of the organization.
- Time Required: Establishing the initial commercial paper structure may take some prearrangement. However, after the structure is set up, it takes just a few days to draw down on the tranches. Bank funding will usually need multiple credit committee reviews of each individual usage request.
- Predictability of Interest Rate: The commercial paper is usually sold on a discount basis; hence the interest rate becomes very predictable immediately at the time of issuance. For instance, if you issue a 90-day note with a discount rate of 22%, that cost will not change no matter what actions the central bank takes during the three-month period. On the other hand, bank credit lines expose you to high risks of mid-tenor rate adjustment.
- Tenor & Flexibility: Bank credit lines can be stretched up to become a two to five year tenure. However, the commercial paper is a strict short-term product. Although you can continue to renew the notes after their maturity to have an indefinite credit facility, you need to be always ready to sell off or finance back the debt within 270 days.
Structural Requirements for Accessing the Commercial Paper Market
I have to reiterate that you will not just wake up one day and feel that you should be issuing commercial papers and meet certain standards that are not in place. You must convince the investing community that you are financially sound enough to pay off your debts in good time. In order to finance yourself from the money markets, you therefore need to create your corporate history.
To begin with, your accounts must be carefully audited by an authorized firm. The investors will be keen on your operating cash flows, gearing ratios and efficiency in working capital management. Secondly, you must obtain a credit investment grade rating from an authorized local rating agency like Agusto and Co. or DataPro. This is what will determine how high your yield premium will be.
For those who manage a growing business that is searching for complete SME financing in Abuja, a transparent approach to their finances will open up the way to the world of debt capital market, with the hope that inflation will drop. The lack of any governance structure will cause institutional investors to ignore the company’s bonds.
Navigating Working Capital Needs Across the Regions
The method used to acquire funds should also take into consideration the operating environment as well as the industry characteristics in which you are operating. For example, where you are running a trading company and considering the working capital sources utilized by the Kano businessmen, a fast sale of the commercial papers at a discount to finance bulk purchases can be justified. The high volume and fast cycle of cash flow is ideal for corporate notes of indebtedness.
On the other hand, where you are managing an engineering and logistics company that provides services to oil and gas installations, it is likely that the time to get your funds will take a bit longer. In this case, during the time when your major corporate customers will clear the invoices, it will be prudent for you to adopt a combination of both bank overdrafts and commercial papers.
The Hybrid Approach: Balancing Debt and Equity
However, while we mainly talk about the selection between money market notes and bank facilities, I always recommend that my clients should keep an eye open for other capital options as well. Long term capital investment like investing in factories and heavy machinery will put you at a risk of maturity mismatch if you opt for short-term borrowing. In case your cash flow pattern is erratic, repayment of your debts within 270 days can put your organization into a risky liquidity crunch situation.
In such a situation, you may want to explore the option of equity financing or issuance of company shares that can be subscribed by Port Harcourt investors. Equity does not come with the risk of interest payments and maturities, giving you the opportunity to invest all the operational profits back in the expansion of the organization.
Steps That Can Be Actioned by Corporate Treasurers
If indeed you are committed to perfecting your financial policy and raising money without spending too much, here is what you should do now:
- Do a Cost-Benefit Audit: Do an audit of your present bank statements and determine the actual cost of debt finance. This means adding all costs such as processing fees, commitment fee and premiums on insurance to know exactly what the traditional method of borrowing will cost you.
- Improve your accounting process: Organize yourself by getting rid of related party transactions and ensuring your quarterly management accounts are spot on.
- Work with an Issuing House/Investment Bank: Contact an authorized player in the capital market to examine how ready you are for the quotation of your commercial papers. The Issuing house will assist in structuring your program, working with rating agencies and marketing your notes to institutions.
- Observe Monetary Policy Frameworks: Always be watchful about the rules stated in the official documents issued by the Central Bank of Nigeria regarding changes in interest rates.
Final Thoughts on Managing Corporate Debt
All in all, running an effective company amid high interest rates necessitates emotional strength and an unwillingness to accept poor conditions for financing. The fact that you may not have cheap bank financing should never be a hindrance to fulfilling your entrepreneurial plans. Improving your corporate governance, delving into the world of commercial papers, and correctly aligning your assets and liabilities will ensure smooth sailing in the context of the local financial crisis. Manage your corporate treasury; make sure your funding comes from multiple sources, and be ready to do well irrespective of macroeconomic indicators fluctuations.
