With more companies turning to commercial papers as less expensive financing means in Nigeria, there is a need to educate investors on some of the nuances surrounding commercial papers or CPs as they are often called.
Just like treasury bills, commercial papers are short-term debt instruments. However, while treasury bills are issued by the government, commercial papers or ‘CPs’ are issued by private corporations, companies, and financial institutions to raise capital for short-term funding needs.
They are typically unsecured and are used to finance current obligations such as payroll, accounts payable, and inventories. In Nigeria, commercial papers usually have a maximum tenor of 270 days (nine months).
Here are six things you should know before investing in commercial papers:
Commercial papers just have a fixed interest rate which is set at the time of issuance
They are not vulnerable to price or rate fluctuations. Similar to Treasury Bills, these instruments are usually issued at a discount to their face value and then repaid at the full face value when they reach maturity.
This fixed interest rate calculates the discount that investors receive when they purchase commercial paper.
For example, if you invest N2,000,000 in an MTN commercial paper program with a yield rate of 16.00%, you will pay a discounted value of N1,680,000, and at maturity, you will receive N2,000,000.
Commercial papers typically have a higher yield rate than FGN treasury bills
It is quite typical for commercial papers to offer higher interest rates than FGN treasury bills because of the risk profile of the issuers.
Federal government-issued T-bills are viewed as low-risk investments by investors because of the very low-risk profile of the Federal government.
It is almost certain that the Federal Government would not default on its obligations, however, this surety doesn’t exist for many private companies.
For example, MTN’s Series 8&9 commercial paper issuance program offered yield rates of 14% and 16% respectively on the 182-day and 267-day CPs, as against the 11% yield rates offered for the 182-day NT-bills issued on November 8.
Always look out for the creditworthiness of the issuer
Always carry out due diligence on the company issuing the CP. Ensure to read the credit rating report of the issuer before investing in the commercial paper.
In Nigeria, Agusto&Co and Global Credit Rating Co (GCR Ratings) are the major credit rating agencies for corporate organizations.
Ensure to carry out a critical appraisal of the issuer’s creditworthiness. In line with this move, only buy the CP of companies with a history of profitability and a reputable, organized corporate structure.
Some experts would advise that in Nigeria, it is advisable to only invest in CPs with a minimum rating of A.
Commercial papers are subject to a withholding tax of 10%
On January 2, 2012, the Federal Government decided not to tax bonds and short-term Government Securities for 10 years.
The exemption ended on January 1, 2022, except for bonds issued by the Federal Government. Hence, earnings from commercial papers are subject to a withholding tax of 10%.
For example, if you are to invest N2,000,000 on a commercial paper with a 15.00% interest rate, the net return after tax is expected to be N1,970,000.
The CP will be issued at a discounted value of N1,700,000, and the expected return after maturity will be N2,000,000.
However, a withholding tax of 10% on the N300,000 interest is N30,000, thus, the net returns will be N1,970,000.
Always take note of the net returns after tax before investing in commercial papers.
The CP program should be registered and quoted on the FMDQ Exchange
FMDQ Exchange is a securities exchange majorly focused on the trading of debt securities in Nigeria. At the moment, the NGX is mostly focused on the trading of equities in Nigeria, while the FMDQ Group is focused on the trading of funds and bonds in the country.
While commercial papers can be listed on NGX and NASD OTC Securities Market, FMDQ has carved a niche around listings for CPs and other debt securities.
Hence, before you invest in a commercial paper, ensure that it is listed on FMDQ.
Ensure that the value of the issued commercial papers is a small proportion of the issuer’s total net asset or equity.
If it is, it suggests that the company is not relying too heavily on commercial papers as a source of financing.
Essentially, the value of these papers should be a modest fraction of the overall financial health or value of the company.
This approach helps to manage risk and ensure that the company’s financial stability is not overly dependent on commercial papers.
Disclaimer
While this content provides information about commercial papers, readers need to seek professional advice from qualified investment advisors before making any investment decisions related to commercial papers.
The information presented here is for general understanding and should not be considered personalized financial advice.
Individual circumstances may vary, and consulting with a financial professional is recommended to assess suitability and potential risks associated with investing in commercial papers.
