Central Bank Supports State Insurance for Corporate Debt

The turmoil has all but shut down the capital market as a source for companies, leaving them to the mercy of the banks, which aren't eager to lend either these days.

A proposal for the state to guarantee corporate debt is gaining momentum, now that the Bank of Israel has thrown its weight behind the idea. Yet Finance Ministry officials continue to oppose the notion.

Issuing bonds is a way for companies to borrow money from the general public rather than from banks. During the boom following the high-tech crash of 2002, Israeli companies were welcomed on the capital market. Even companies bereft of income or long-term reputation were able to tap investors for cash. But come the economic crisis, many companies are defaulting on debt or scurrying to reach new arrangements with creditors.

The turmoil has all but shut down the capital market as a source for companies, leaving them to the mercy of the banks, which aren't eager to lend either these days. Some companies starved for loans, or the ability to recycle old loans, are collapsing.

What Securities Authority chairman Zohar Goshen proposes is that the state guarantee new corporate bond issues, to jumpstart that ailing segment of the market.

Goshen suggests that the state guarantee 80% of the amount of money Israeli companies raise on the capital market this year, which would cap the potential loss by investors at 20% if the borrowing company becomes insolvent.

The watchdog organization argues that this proportion would restore confidence to institutional investors, assuaging their fear of losses - but a loss of 20% is still steep enough to deter them from taking rash risks. That 20% would come first, by the way: only after it's gone would the state guarantee come into effect.

Goshen estimates that "natural growth" of new credit in the corporate bonds market should be between NIS 6 billion to NIS 10 billion a year. State insurance for 80% of that amount would run between NIS 4.8 billion to NIS 8 billion.

The plan's supporters originally argued that the plan is insurance, and that no actual budgets need be set aside. But as the Finance Ministry officials pointed out, insurance claims could be made. That objection led Goshen to tweak his plan.

At first he proposed that the guarantees be confined to the strongest and biggest companies. Later he amended that to suggesting coverage for a "basket of bond offerings." According to his idea, each institutional investor would concentrate investments in new bond offerings this year in a special portfolio. The state would guarantee 80% of that portfolio. The probability of that basket losing 20% of its value, requiring the state's insurance to kick in, would be remote, and certainly smaller than the probability of a given company defaulting on its bonds.

That second proposal has the advantage of not limiting coverage to bond offerings by corporate juggernauts.

However, the insurance coverage wouldn't be without limit - each institutional investor will be allocated a ceiling, based on its relative share of the Israeli pension market.

Many economists share Goshen's analysis that the non-bank credit market, meaning, the bond market, has seized up, and that the credit crunch won't be relieved until it's working again. The banks and the Bank of Israel itself continually insist that the banks can't bear sole responsibility for relieving the credit squeeze.

There is a theory that it's the banks' job to lend money to poor, weak companies on the verge of the void. The banks are best equipped to help guide the company out of its troubles, goes the argument. The capital market is there to lend money to the strongest companies.

However, with the capital market dead in the water, the corporate behemoths are tapping the banks and using up their resources. The banks simply don't have any more money to lend to the minnows. But, if the capital market recovers and investment-grade companies are able to borrow there again, goes the logic - the small and weak companies can start plying their bankers again.

The only snag is that the Finance Ministry doesn't buy it, noting that the bond indices have clawed back some ground recently, and that big companies are borrowing in the capital market again. The Israel Electric Corporation, Mekorot, Bank Hapoalim and Mizrahi-Tefahot have all sold bonds in the last month. Also, the treasury is terrified of the budgetary implications of intervening in the bond market.