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Evolution in the capital market

Evolution in the capital market

Robust activity foretells economic growth ahead

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The Bahamas Investor Magazine
June 27, 2007
June 27, 2007

The robust expansion of The Bahamas’ economy since the beginning of the millennium has resulted in the development of a formidable domestic capital market—one that is attracting a growing number of security investment advisors and global corporate banks as it matures. Increased competition in the marketplace has, in turn, brought about the introduction of new, non-traditional security instruments, with some of the larger players even taking the bold step of becoming market makers in developing the various investment instruments offered to investors.

So rapid has been the growth of the domestic capital market that it caught even financial services regulators, such as the Securities Commission and the Ministry of Finance, a bit off guard, leaving  authorities for some time now looking to revamp the existing securities legislation. James Smith, former Minister of State for Finance, revealed while in office that the Securities Commission had engaged the services of a Canadian-based consultancy firm to identify much-needed reforms to the Securities Industry Act (the law that regulates the capital market and investment funds sector). Smith says the focus of the modernization legislation would be to enhance protection of minority shareholders’ rights and tackle transparency and corporate governance-related issues.

Capital source
The Bahamian capital investment market—comprising government debt paper, listed equities, public corporate debt instruments and private placements of equity and interest-bearing stocks—is estimated to have a current market value of between $4.5-$6 billion. The availability and range of investment options open to capital market investors, consisting of primarily financial institutions and pension fund administrators as well as a select group of high-net-worth individuals, was bolstered significantly when the Bahamas International Securities Exchange Ltd’s (BISX) domestic trading floor was launched in the spring of 2000 (there are currently 19 public companies listed on the BISX). BISX’s greatest challenge remains its heavy weighting in a select number of stocks and a lack of trading liquidity. In presenting the 2006-07 national budget to the senate, Smith acknowledged the liquidity problem faced by BISX and indicated that the government was looking into ways of introducing government debt instruments on the exchange in a bid to boost capitalization and trading liquidity.

Today, government-issued debt accounts for about 50 per cent of the total public capital investment pool, whereas in 2002 (at which point global equity markets were experiencing a downturn), government-issued paper made up over 80 per cent of capital funds, according to market data collected by securities and pension advisory firm CFAL. Overall, the value of the domestic capital market based on public security issues has risen over the past five years by about 52 per cent, based on CFAL data.

The size and number of public security issues rose consistently from 2000 when BISX’s domestic bourse came into operation through to the end of 2004 when the value of the market’s total yearly issues peaked at about $272 million. The 2002 to 2004 period also saw a swing to preference share issues (equity notes with an attached interest-bearing component) as investor appeal for traditional common equity issues waned due to lower earnings growth and shareholder value, observes Anthony Ferguson, president of CFAL.

Notably, the market data for 2005 showed a dramatic 35 per cent year-on-year decline in the value of total public security issues, which for that year amounted to about $177 million. While this drop in public capital issues was largely attributed to perceived reduced shareholder value available through public stocks, the domestic capital market has continued to enjoy strong growth through non-listed private placements of equities and interest-bearing paper, says Ferguson. “The [Bahamian] capital market is still in its infancy, and at the moment it is mostly private-investment driven,” he adds.

Private investment
The domestic capital pool is primarily funded by pension plans and financial institutions, observes Ferguson. He estimates that pension plans account for roughly $600-$700 million of the available capital, with insurance companies representing another $650 million.

While there is no public record of private investment deals, Ferguson believes that this segment of the capital market has shown the strongest growth over recent years. Investment activity tends to be cyclical, he notes, driven by acquisition or expansion activity in the corporate/commercial sector. The improved economic environment in The Bahamas has seen increased demand for capital investment over the past 18 months, he adds. Notably, there has been increased activity of Bahamian businesses engaged in buyouts of foreign-owned entities.

The capital market as a whole has seen a proliferation of private deals in the wake of the “drying up” of listed equity offerings, confirms Ken Kerr, managing partner of investment brokerage firm Providence Advisors [Kerr recently bought out the Bahamian asset management arm of SG Hambros Bank & Trust (Bahamas)]. Kerr refers to the recent buyout by a Bahamian investment consortium of Caribbean Bottling Co (Bahamas), which holds the local Coca-Cola franchise, as an example of the increased deal activity. And, he notes, with the planned privatization of several state-owned enterprises such as Bahamas Telecommunications Co (BTC) in the wings, new opportunities for capital investment look very promising. “The [capital] market has significant growth potential,” Kerr declares. “Most money [capital investment] can be gained locally rather than going offshore. Any deal that is properly packaged can easily raise money in The Bahamas—that is, deals of $50 million or less.”

The private capital investment market provides an alternative source of funding to traditional bank loans, says Michael Anderson, vice president of Fidelity Bank & Trust International Ltd. Fidelity regards itself as the “pioneer” in developing and structuring private equity deals, with the merchant banker having decided in 1997 to become a “market maker” by selling and buying back equities, thus becoming the “buyer of last resort” and ensuring tradability of these investment instruments. Notably, Fidelity raises nearly all of the funding for its structured investments from the local market.

A significant area of activity for Fidelity is the structuring of private equity placements, says Anderson, with most such arrangements involving parties of 50 members or less. In the beginning, the bank’s target market was raising financing for private equity deals of between $3-$5 million. In 2001, however, the bank upped the stakes considerably when it structured a private placement of $25 million in preferred shares for Caribbean Crossings, a subsidiary of Cable Bahamas (the funds were raised to lay fibre cable connecting the islands of The Bahamas and linking with the US). “We [Fidelity] act complementary [to traditional bank financing] and create opportunities for Bahamians to do deals that could not otherwise be done,” comments Anderson.

Fidelity also created the first Bahamian Depository Receipt (BDR), a locally listed and traded investment instrument that, in simple terms, reflects the performance of a foreign-listed stock (Bahamian investors cannot invest offshore without permission from the Central Bank due to the currency exchange control restrictions in place). Furthermore, the merchant bank established the first Bahamian property fund with tradable investment units, similar to North American real estate investment trusts, Anderson observes. “Liquidity in the buying and selling of commercial property has always been a problem. By creating this fund and taking it public, we have allowed the average Bahamian investor to gain an equity stake in the property market.”

The capital market opportunities opening up in The Bahamas have also caught the attention of the global retail banks, with several having ventured into commercial syndicated loan arrangements. FirstCaribbean International Bank (Bahamas) Ltd, a subsidiary of Canadian-based CIBC, recently committed to the establishment of a Bahamas-dedicated capital markets operation as part of the bank’s plan to expand its corporate banking services.

“As a result of globalization and the increasing sophistication of our customers, the capital markets are becoming increasingly important to large corporate customers for meeting their financing needs,” says Horace Cobham, executive director of FirstCaribbean’s Corporate Banking. FirstCaribbean opened its Bahamian capital markets hub in 2005, with the aim of enhancing the bank’s regional capabilities, says Ian Chinapoo, executive director of the capital markets division. (FirstCaribbean also operates capital market hubs from Jamaica, Barbados and Trinidad & Tobago.) Capital markets are a new line of business for FirstCaribbean, says Chinapoo, noting the bank has invested heavily in its personnel. “Our team’s intellectual capital is a key source of competitive advantage. … Already the synergies of the team are being demonstrated through the building of a significant transaction pipe-line,” he adds.

Catherine Gibson, an associate director at FirstCaribbean’s Bahamas Capital Markets operation, confirms that there is “a fair amount” of investment capital available in The Bahamas. “Most debt issues are generally oversubscribed as well as initial public offerings,” she notes. Most capital market structured investment arrangements are for at least $10 million and higher, she says, although the type of project for which the financing is being sought will determine whether it will be better serviced through the capital market or traditional bank financing. Most capital market deals require long-term planning, says Gibson, with some arrangements in development for one to three years before reaching completion. “I think there is a competitive advantage for a global bank to have a capital markets desk in The Bahamas. Having direct access to the marketplace can make the difference in a very competitive field,” she adds.

Product development
Development of the capital market in The Bahamas has occurred in set stages, says Ferguson. “At first, financing was done through traditional bank loans, then came public share listings, which were followed by more sophisticated investment instruments like preference shares.” Initially, there were only the government-issued bonds; however, today many corporations are issuing bonds to raise development capital, Ferguson notes, which have provided these companies with the ability to raise funding through an interest-based investment instrument that carries a defined maturity date on the debt paper. The bond issues are not reflected on the company’s balance sheet as equity and so do not dilute shareholder value, while the defined maturity on the interest-bearing paper enables the issuer to better define its cash flow position, he explains.

Another market innovation has been the creation of “perpetual preference shares” that do not hold a maturity date, notes Kerr. “Most private placement deals involved preference shares; now a lot more of these placements are perpetual preference shares.” Essentially, the capital investment market is evolving to cater to the unique funding requirements of borrowers, he adds. He points out, however, that The Bahamas’ capital market has only reached its first phase of development. “Phase two of the capital market’s evolution will be the development of new products.”

Gibson notes that capital market issues in The Bahamas have come a long way over the past five years. “And, there’s still opportunity for growth,” she adds. “There’s been greater innovation in product design that has made the capital market more accessible to a greater number of people.”

Anderson believes that The Bahamas’ capital market is only now at the starting point of growth. Awareness of alternative financing is growing within the business community, he notes, and as more Bahamians develop an appetite for starting their own businesses, the capital market will expand and develop to the marketplace’s needs. “I think there’s huge room for growth [of The Bahamian capital market],” he concludes.

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