The recent Medserv bond issue marked what is likely to be a turn in the fortunes of the new-issue market for corporate bonds in Malta. Not a moment too soon. After peaking at €303 m illion in 2010, new issuance collapsed to just €40m in 2012 (see table at right) and so far this year issuance is still at a meagre €23m, including the €13m Medserv issue.

The reasons for this collapse in the market are well known. Misguided regulation proved effective at making listings all but impossible. This regulation has now been amended and companies are actively reviewing their options. The outlook for such new bonds is now looking busy. This is good for both investors and the Malta Stock Exchange. But there are some interesting lessons that can and should be learned from the recent Medserv bond issue.

The Medserv bond was by all accounts a resounding success. Investors flocked in their thousands to try and get a piece of the action. The very heavy scaling back on all applications is solid evidence of this. Perhaps it was the quality of Medserv as a credit, the coupon rate, the lack of alternative homes for investors’ moneys, the lack of government bond issues, the pent-up demand for such issues, the words “secured and guaranteed” in the name of the bond, or a mixture of all of them. Whatever the case, it is clear that Maltese investors are a sporting lot when it comes to such corporate bond issues. With the pipeline for new bonds starting to build, investors ought to be reminded about a few basic facts on the structure of bonds.

Rule 1) the higher the coupon the higher the risk, 2) secured is better than unsecured, 3) unsubordinated is better than subordinated and 4) guaranteed is better than no guarantee at all. Medserv’s bond was both secured and guaranteed. This was an interesting mix, given the nature of the company’s operations.

The problem arises when it becomes clear that the issuer is extremely dependent on the guarantor for its revenues and profits

Perhaps investors failed to understand the true significance of such statements and equated this bond to a risk-free proposition offering a 6 per cent coupon. Even if a bond is “secured and guaranteed” as the Medserv one clearly was, risks can and do exist. A cursory read of the prospectus explains this. In fact the directors of Medserv are correctly upfront and clear on this subject.

Take the guarantee aspect of the bond. Medserv Operations Ltd, a 99.9 per cent owned subsidiary of the issuer Medserv plc, is the guarantor of the bond. The prospectus clearly states that “the guarantor has agreed to stand surety jointly and severally with the issuer thus guaranteeing the payment obligations of the issuer under the notes.” Thus, if the issuer does not pay up, the guarantor will step in. In theory this is fine, yet the problem arises when it becomes clear that the issuer is extremely dependent on the guarantor for its revenues and profits. The prospectus is also clear on this. Risk factor number one states “the issuer is dependent on the business prospects of the guarantor”. And the figures back this up.

In 2011-2012 Medserv plc generated over 93 per cent of its revenues from Medserv operations. This figure is expected to increase to over 96 per cent in 2013 before falling to 76.5 per cent in 2014, according to the financial analysis summary provided.

The issue of the guarantee therefore becomes a circular one. It is likely that the cause of the issuer not being able to meet its commitments is because the guarantor is not performing to expectations. A guarantee in this context probably has limited value, though it is still better to have it than not to have it. One can also argue that the guarantee is backed by a mixture of general and special hypothecs. This is also true and very valid, but the prospectus also clearly points out the limits to which this security is “cashable”, given the nature of the assets held by Medserv and the relationship with both the Freeport authorities and the Government of Malta.

The point here is not that Medserv misled investors in any way. They clearly did not. However, given the nature of the investor in Malta and the way in which such bond issues are marketed directly to the retail investor (it is unlikely that many read the prospectus), perhaps more care ought to be taken when allowing the use of such terminology. The other alternative could be to try and ensure that retail investors take advice when deciding whether to invest in such instruments.

This article is the objective and independent opinion of the author. The information contained in the article is based on public information.

Curmi and Partners Ltd is a member of the Malta Stock Exchange, and is licensed by the MFSA to conduct investment services business.

David Curmi is managing director at Curmi & Partners Ltd.