1. What is it?
Promissory notes, also known as commercial papers, are short term private notes issued by companies in order to reinforce its cash flow, by paying out inventories or paying suppliers. It has the same objective than debentures, with different expiration dates and dynamics though, as they allow a cheaper and faster restructuring process. Besides, CVM does not require prospects for promissory notes with less than 180 days of lifecycle. Both open and closed anonynous societies can issue promissory notes. Banks and brokers, however, can’t do it.
For companies, advantages of issuing promissory notes include the possibility of getting capital directly from investors, with more speed and lower interest taxes than those practiced in bank loans. Also, it is exempt of the IOF tax. However, a company is only permitted to issue new promissory notes if all previous notes are paid.
Promissory notes must be issued altogheter – different series are not allowed, like happens with debentures. A company that issues promissories must be appointing a mediator to post the notes in the market.
The smaller period of expiration for a promissory note is 30 days, and the maximum fixed on 180 days for closed capital societies and 360 days for open companies. To invest in promissory notes, it is necessary to have a bank account in one of the mediators of the operation. All notes emitted are registered in CETIP.
Investing in promissory notes is something possible to any kind of investor, who should be analyzing risks, once there is no actual guarantee for that (although it can be backed by bank securities). Thus it is a tool for well-rated companies. If the investor wants to leave its position beforehead, he can trade the notes in the secondary market, with no guarantees of repayment and subject to the market conditions. In the secondary market, promissory notes can be traded at Bovespa Fix and Soma Fix, with brokerage.
This kind of investment is quite more frequent in US, as here in Brazil it has been more advantageous for companies to issue debentures instead, given their longer expiration dates. Lately no new promissory notes have been issued.
The profitability of a promissory note is defined by the interests paid by the issuer to investors, which usually stand 1-2% above the Selic interest rates. Payment for these notes can be either pre (most cases) or post fixed. Eventually, notes can be also issued in dollars.
Profitability may be linked to Selic rates remuneração pode estar atrelada à taxa selic, or to other indexes like IGP-M (índice geral de preços – mercado), CDI change rates (certificates of desposits), or even the IPCA index (índice de preço ao consumidor amplo).
As the profits from promissory notes change depending on the company and the note itself, we must be acquainted with the prospects for each one of them, to learn how much we are exactly entitled to earn, and whether it is advantageous to invest or not.
Risks from investing in a promissory note are related to the credit risks, meaning the possibility of the issuer to not honor the payments. Companies that have no good financial health are the riskier. We should always look at their balance sheets beforehand, in particular to the cash flow. This kind of information is open to investors and can be easily found. Another class of risks existent in promissory notes is the low liquidity or the lack of investors willing to buy them (liquidity risk) and/or undesirable changes on the interest taxes or indexes (market risk).
Companies issuing notes are ranked and classified according to their risk level, by agencies like Moody’s and Standard & Poor’s. Such analysis is widely reliable and considered an important risk indicator by the market in general.
In case of bankruptcy, promissory notes are taken as chirographic credits, which means they have no rights of preference. This way, holders of promissory notes are equal to any other non-priviliged creditor.
Taxes incident over a promissory note are pretty much the same of those affecting debentures. While redeeming the note, we must pay income taxes. Actually, the institution that sold the notes is responsible to deduct the tax before paying it back to you.
Income taxes are decrescent, depending on the note lifecycle:
- Notes with less 180 days of lifecycle: 22,5% (over interests only)
- Notes with 181 to 360 days of lifecycle: 20% (over interests only)
- Notes with 361 to 720 days of lifecycle: 17,5% (over interests only)
- Notes with more than 720 days of lifecycle: 15% (over interests only)
As promissory notes have a minimal lifecycle of 30 days, there is no incidence of IOF, and as the maximum lifecycle is currently 360 days, the income tax is never lower than 20%.
On top of the income tax, other two charges may affect these notes:
1. CBLC charges for holding and making the information and moves available. It charges 0.3% per year over the value of the investment, or it can cost BRL 6.90 each six months, if the investors already has any notes in custody.
2. To be investing in promissory notes, having an account in a broker is mandatory, in these so-called custodians. Frequently, they charge a small fee for their services, previously agreed once you firstly open an account. The percentage hugely changes depending on the broker. As a general rule, if a broker charger more than 1% of the invested sum, maybe it is not worth to invest.
5. How it works
When a company needs to balance its cash flow, it can opt for issuing promissory notes. Some companies do it as a first step before closing a larger operation, an acquisition or major project. If the transaction is well suceeded, the company then moves to an IPO or issue debentures to finance the operation.
Promissory notes are usually sold at a discount and in multiples of BRL 1,000.00 – so it’s current value can be found by applying the discount over its par value.
For instance, let’s say a company issues a note valued at BRL1m, due to 180 days from now. The discount is BRL40,000.00 (4%). Thus, the max value for investing in this note is BRL960,000.00. The discount rate equals to the surcharge that the company is promised to pay to investors by the expiration date. So, it means the company, in 180 days, will have to pay back BRL1m to investors overall.
In order to calculate the profits before income tax, you need to apply the following formula:
Profits = Par – Discount Rate x 365 / Discount Rate x N
Being “N” the number of days to the expiration, then we have:
Profits = 1.000.000 – 960.000 x 365 / 960.000 x 180
Profits before tax = 8.4%
So, before taxes, the note provides profits of 8.4% in 180 days.
- Good profitability, usually much higher than certificates of deposit;
- It can be a good option to diversify your investments in fixed rate;
- Short term investiments;
- Helps companies to finance their growth.
- No guarantees;
- Not backed by the local guaranty fund (FGC);
- Depending on the note it can be particularly risky. It is always good to make a thorough analysis of the company and be aware of its rating before making any move.