2021 February-March Analysis Featured

Georgia’s corporate bond market is ticking upwards – but for how long?

Banks have traditionally been the main source of capital financing in Georgia, but the local corporate bond market has been posting impressive gains in recent years, and is buoying hopes that capital markets in the country at large will expand their offerings in the coming years as well.

As could be expected, 2020 was a difficult year for Georgia all around, but there were several high points. In July, Georgian Global utilities, a water and renewable energy holding company in Georgia, released the first-ever green bond issuance in the country, with $250 million in eurobonds. Meanwhile, Kakhetian Georgian wine company KTW, a newcomer to a market generally stacked by a recurring array of familiar faces, issued $10 million in bonds.

While activity lagged in 2020, 2018 and 2019 delivered extremely strong performances, with the market posting 63% and 47% growth respectively.

This is about more than access to financing for a select few companies: corporate bonds are an intrinsic part of any developed capital market, and offer an attractive alternative for Georgian companies looking to raise capital by helping them diversify away from traditional loans.

They are also a necessary option for large companies that can max out the limits of single banks’ risk tolerance for investment in a single entity. Moreover, bonds can offer alternatives for how to structure repayments, since they usually require payment at maturity and not before, unlike bank loans, which require consistent repayment on both interest and principal.

Bonds are good for market health as well, offering yet further directions for money to flow instead of them being directed toward the traditional safeholds of deposits and real estate, and thus put to more use, avoiding upward pressure on housing and development prices.

The table below gives an overview of the growth of the corporate bond market in recent years.

While the majority of these loans are corporate Eurobonds, from which the market began to grow in 2014, GEL bonds listed on both foreign and local exchanges have posted solid growth since around 2017.

Some of this growth is misleading; while they have grown in scale, Eurobonds continue to be dominated by financial institutions and state-owned enterprises, with Silknet, one of the country’s largest communications operators, the only non-financial corporate to take advantage of this instrument in 2019.

TBC Capital Managing Director Meri Chachanidze confirms why: “Local currency placements are primarily bought by financial institutions, not retail investors, because only they can do repo [repurchase] operations with the NBG [National Bank of Georgia].”

Unlike retail investors who have yet to stir up an appetite for GEL bonds, banks can use the bonds as collateral to get liquidity from the NBG in repo transactions, thus allowing them to significantly increase their yield.

One of the first to venture into corporate bonds in Georgia was Bank of Georgia brokerage Galt & Taggart (G&T), whose managing director Otari Sharikadze told Investor.ge that the corporate bond market began to take off in Georgia in 2014, after G&T began seeking an alternative to falling rates of USD deposits in the mid-2000s.

“The big question for us at the time was: if we only continue to offer deposit products to customers, we will lose them, because while 8% returns may justify the risk of investing in Georgia, 3% doesn’t.”

The most obvious choice of new product, Sharikadze says, was bonds, “because [Georgians] hate losing principal, and the product is easy to explain. The fact that they are generally short-term investments makes them an attractive investment option as well.”

What has helped propel the corporate bond market forward?

Markets require all sorts of conditions to be in place for growth, but two pieces of legislation in recent years have helped propel the market forward.

One change that has helped in particular are transparency requirements in place from 2016 that companies must abide by:

“New legislation in 2016 [On Accounting, Reporting and Auditing] made companies of certain sizes report their audit statements, meaning they must be transparent. [This has stimulated the market because] if you are a public organization, this means that investors can get to know you, and this decreases the fear that they will encounter problems when investing with you,” TBC Capital’s Chachanidze told Investor.ge.

The second most important factor in recent years has come from the National Bank of Georgia allowing repo operations.

In 2016, the NBG established a set of regulations aimed at supporting development on the GEL bond market, enabling banks to use GEL corporate bonds as collateral for repo transactions and increase their liquidity, thus making banks and other commercial institutions a serious customer for the investment vehicle, incentivizing them to become active investors on the bond market.

Hurdles ahead

Of course, issues remain, the largest being that while the quantity of bonds issued may be on the rise, the number of companies interested in sourcing capital with a bond issue has remained small, and the same players remain on the market without many new entrants.

“One reason is the fact that many who have come to know and use this product are connected to the Bank of Georgia or the Bank of Georgia group. The established reputation of the group, its transparency in its business dealings and the strong corporate governance in place and networks within the group have facilitated their entry onto the market,” G&T’s Sharikadze comments, noting that one of the brokerage’s highest priorities in the coming years is to stimulate the entry of other players onto the market.

Sharikadze makes note of another problem: there is product mismatch on the market.

Investors have been eager to invest in corporate bonds in Georgia, he says, but this has largely concerned Eurobonds, which are a concern for local companies due to currency fluctuation.

TBC Capital’s Chachenidze concurs: “It’s about managing your interest rate and the exchange rate. If you earn in local currency and are borrowing in hard currency, you are immediately exposed to local currency risks.”

Meanwhile, she notes, companies have been eager to float GEL bonds, but a lack of trust in the lari, which has steadily depreciated against the dollar since 2018, has also held back investor appetite for GEL-denominated bonds, which are the safer bet for medium-sized companies with less hedging capability than large corporates.

One other issue mentioned by Sharikadze is that Georgian corporates have long-term experiences of working with commercial banks and IFIs, which often times means that companies prefer to stick with the same methods of sourcing capital they are used to, despite the higher interest rates in the case of banks, and the more bureaucracy-loaded and time-consuming negotiations with IFIs.

There is an upside, Sharikadze notes: “Overall, the demand for the product is there, which is a great place for the market to be in if you can stimulate supply.”

But this entails a waiting game, and fintech offerings are growing rapidly. “This will make new investment products increasingly more available, perhaps for even more attractive products elsewhere. So what we have to do is stay ahead of the curb,” says Chachenidze.

Looking ahead

Both Sharikadze and Chachanidze remain positive about the years to come despite the continued dampening of the economy due to the Covid-19 pandemic.

“There are a number of rollovers coming in 2021, so I think it’ll be an interesting year. But overall the market is not growing at the rate we would like to see. A real encouraging sign would be to see more companies entering the market,” Shakaridze says. Further ahead, the pension fund , and the recent law on investment funds are set to become drivers for both share and bond markets.

The pension fund is the most immediate potential source of new demand for publicly traded assets, with more than 1.2 billion GEL (around $360 million) at its disposal.

The fund could be a significant driver for capital market development as it is obliged to invest, for the most part, in Georgia and only in publicly available investment products.

Georgia’s open and Western-style business environment, its intention to apply for EU membership in 2024, sturdy financial expertise and strong regional connections have led many people to assume that Georgia would be the natural place for setting up a regional market. Georgia is gradually improving in the ratings of international rating agencies.

However, some commentators suggest that the development of Georgia as a hub for regional capital markets has failed to develop so far due to lack of a coherent strategy.

Sharikadze of Galt & Taggart says that while many of the capital market reforms, like the Law on Investment Funds and the Pension Law, have been helpful and moved the country in the right direction, they have failed to encourage the development of a more coherent strategy of where Georgia should be in the next 10 years.

Even if Georgia does not manifest as a regional capital market, the continued development of Georgian corporations will ensure a need for non-bank financing.

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