In creating its financial plan, a company has several options for sourcing funding. Among these are equity capital, subordinated shareholder debt, commercial bank loans and bonds. Regarding bonds, a further choice is to be made between offering bonds to the public and a private placement under exempt distribution arrangements. Exempt distribution arrangements in Jamaica refer to arrangements under the Financial Services Commission’s (“FSC’s”) Guidelines for Exempt Distributions which provides for relatively simple regulatory procedures to be complied with for private placements. Exempt distributions are available in limited circumstances such as when securities, typically bonds, are purchased only by accredited investors as principal (not agent). Accredited investors include certain institutional investors and individuals with comparatively high net worth. The guidelines for exempt distribution came into force on June 15, 2008.
On the other hand, the documentary, disclosure and regulatory requirements in effecting a public bond issue are relatively onerous. Issuing bonds to the public for instance requires registration of a prospectus or offering document with the FSC. Public bond issues are far less common than exempt distributions and will often be limited to occasions when the cost of funds is significantly lower than alternative methods of financing or when the search for funding requires that the number of potential investors be as wide as possible.
There are indications of increased use of corporate bonds in Jamaica. The FSC’s statistics show that the issuance of securities by way of exempt distribution has grown significantly since 2008. For instance, in 2008, there were a total of 32 issuances of which Jamaican dollar denominated securities totaled over J$4.5 billion. This increased over time. For 2018 there were 104 securities issued of which Jamaican dollar denominated securities totaled around J$129.66 billion. In addition, over US$2 billion in US dollar denominated securities were issued during that 10-year period. Meanwhile, provisional data from the Bank of Jamaica indicate that commercial banks’ loans and advances, excluding those for personal use by local residents, grew from approximately J$ 116.8 billion as at March 2008 to around J$ 378.3 billion as at March 2019.
Although there has been growth in both forms of financing, this data may suggest that in Jamaica corporate bonds have increasingly been viewed by borrowers as an attractive alternative to commercial bank loans (which for simplicity will be referred to below as “loans”).
Highlighted below are some of the legal and commercial factors which should be considered by borrowers in choosing between these two funding sources. The specific use to which funding is to be put is a significant determinant of whether a loan or bond issuance is the better option. This article does not attempt to apply the merits of the financing options to each of the range of uses to which a company can put funding but illustrates the principles by reference to financing infrastructure projects.
Traditionally, such projects have been financed by loans. Commercial banks have flexibility to manage construction drawdown schedules, and dual currency draws and the capability to be responsive in working with borrowers to respond to unexpected events affecting a project. Loans provide significant flexibility to the borrower in this context. During the construction period, funds can generally be drawn down on a monthly basis, enabling the borrower to get funds only as needed thereby minimizing interest costs.
However, internationally, it has been observed that commercial banks have increasingly demanded shorter loan terms, enhanced options for recourse not only to assets of the borrower, but to equity investors in projects, less leverage compared to equity injections and tighter lending covenants in loan agreements. This may be a contributing factor to borrowers turning to bonds as an alternative. Bonds though, if issued during construction, are generally funded in a single issuance and may be deposited into an escrow or similar account until required to fund project costs. Interest will accrue on the bonds from the date of issue at a rate which would unlikely be offset fully by earnings on the escrowed deposit. This is sometimes referred to as “negative arbitrage”. Thus, debt by way of bonds may be used most efficiently at a time when proceeds can be applied to significant outstanding project costs or to refinance other debt.
Loans are generally priced with floating interest rates. For Jamaican dollar denominated loans these are sometimes formulated with reference to Government of Jamaica treasury bill rates or more unusually to a bank’s prime lending rate. In relation to US Dollar loans, for the time being, these remain commonly based on ICE LIBOR (the London Interbank Offered Rate administered by ICE Benchmark Administration Limited). By comparison, bonds often are issued with fixed rates. Borrowers and equity investors constructing infrastructure projects generally find fixed rates more attractive.
One of the most significant considerations a borrower has is the matter of financing commitment. The absence of a firm financing commitment by an underwriter up until the time the bond offering is made can be a source of undesirable uncertainty for an issuer. This type of uncertainty usually does not exist to the same extent with loans.
Because commercial bank lenders will want to monitor the project closely, loans tend to require a higher level of regulation. Accordingly, many changes that may occur during the implementation of a project, (such as those requiring amendments to underlying contracts, replacement of suppliers and similar events) require consents or waivers from the commercial bank lenders. Covenants in bond documentation tend to be less restrictive than in loan agreements. Borrowers usually find this more appealing. Such less restrictive bond covenants may reflect recognition of the fact that coordinating and finding consensus among all the bondholders when necessary for consents or waivers can be a challenge.
When one looks at the pros and cons of the loan versus bond financing decision, it may be easy to conclude that the sensible method for benefiting from the advantages of each and overcoming the shortcomings would be to find ways of combining both forms of financing. There would seem to be value in such solutions. For example, the creation of what is sometimes termed a “mini perm” structure contemplates the use of bonds to refinance loans at a convenient point in the life of a project.
Instead of such a refinancing plan, the bondholders and lenders may agree upfront to each contribute a set percentage of the overall debt throughout the period in which financing is required. This latter solution has potential for allowing bondholders to benefit from some of the expertise that commercial banks have developed over time in lending and regulating loans. To say these are perfect solutions however could be a stretch. Structuring the drawdowns to abide by this agreed percentage can be tricky. Added to this is the fact that while drawdowns under the loan facility may typically require only a few days’ notice prior to the drawdown date, the bondholders will usually require a longer advance notice period, or a fixed pre-set time for drawdown. The possibility of intercreditor challenges cannot be ignored. This may occur particularly in “workout” scenarios when the project is not going according to plan and financial difficulties arise. Commercial banks and bondholders could have different agendas in such a troubled situation. For example, while one type of lender may wish to grant a waiver and consider restructuring the debt, the other may simply wish to call the debt and take a write-off.
The upshot of the analysis is that companies seeking financing need to assess their own circumstances and plans in order to choose the type of financing that is most suitable to them. Considering the availability of funds for loan and bond financing in the market is therefore only a start. Companies need to take far more into account in order to ensure the right fit.
This article is intended to provide general information only and is not to be relied on in place of legal advice.
Topaz Johnson is an Attorney-at-Law at the law firm DunnCox. You may contact her at topaz.johnson@dunncox.com