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How commercial papers provide a lifeline for corporates seeking cash

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Nigerian lenders are now cautious to provide credit to private sector as risk of default elevates given the tepid posture of Africa’s biggest economy.

Figures from the National Bureau of Statistics revealed that total bank credit to private sector slumped by 2.54 percent to N61.67 trillion in 2018 compared with N63.28 trillion in 2017.  Also, gross loans contracted by 2.28 percent to N62.63 trillion in 2018 from N64.09 trillion a year earlier.

As the primary equity markets remain inactive for fund raising combined with banks’ reluctance to give credit, corporates rush to commercial papers market to raise money to finance their short-term projects.

This situation of credit crunch prompts corporates to embrace commercial papers as an alternative source of funding.

Commercial papers (CP) ended last year in green territory. Data from FMDQ OTC Securities revealed that sum of N505.30 billion were raised by various corporates through CPs in 2018, indicating an elevation of 232 percent over N152.35 billion in 2017.  The total number of CPs quotation spiked 81.82 percent to 60 in 2018 from 33 in 2017.

There seems to be hope for investors wishing to diversify their portfolio towards CP on the back of the continued efforts of FMDQ to revive the CPs market.

The FMDQ-led CP market reforms based on CBN’s guidelines has largely revived the market in recent times.

What commercial paper means?

A commercial paper is an unsecured short-term debt instrument issued by corporates with good credit ratings to raise funds to meet near-term obligations. CP is regarded as unsecured because it is not backed by any form of collateral.

CP shares similar attributes with Treasury bills. Both are discounted instruments. This implies that interest is paid upfront and they are tax-free.

The main difference is that while the former is issued by corporates the latter is issued by the Apex bank on behalf on the Federal Government.

This connotes that CPs are riskier than treasury bills, and most times attract higher returns compared to government-issued securities. Maturities on CP rarely range longer than 270 days.

Subscribing to commercial papers

The issuing company dictates the minimum subscription, which is usually N5 million, or may be lower. CPs are issued at a discount to the face value. This means than an investors will pay less than the amount of the face value and will earn full value at maturity.

The interest on CPs is the difference between the face value and the discounted amount the investor paid at the time of investment.

Investment banks do introduce available CPs in the market to their clients when offer is opened for subscription.

Alternatively, individuals wishing to invest in commercial paper enquire from their bank. It is as simple as asking their account officer. Information on the available CPs, interest rate, tenor and minimum subscription will be provided.

The offer for subscription of CPs opens for a short period of time – in most cases, one week.

Yields

Most times, yields on CPs are usually higher than those on treasury bills. However, the risks inherent in investing in former are higher the latter.

CPs is issued within the range of rates obtainable in the money market.  This means that borrowers obtain funds at a rate cheaper than borrowing from the bank, and lenders are compensated with attractive yields for taking the risk to give their cash out.

Rating

Commercial papers are issued with credit rating. This means that investors can evaluate the credit risk of the issuer and also predict their ability to repay. Commercial papers are issued by corporates with good ratings.

Risk of Default

It is most unlikely for corporates seeking funds through CPs to default. The implication of a risk default means that the issuing company would have its creditworthiness damaged.

Generally, CPs are relatively low-risk investment because of their short maturities and because they are issued by corporates with sound creditworthiness.

Regulations

The Securities and Exchange Commission (SEC) regulates the CP market in Nigeria and protects investors’ interests to ensure an organized market.

The quotation of commercial papers on FMDQ platform involves credit rating. This is to protect investors and create confidence in the market. CPs are listed on FMDQ, where they are bought and sold.

It is noteworthy to state that CPs investments are relatively liquid as they can be traded on the secondary market if investors want to sell them prior before maturity.

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