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Business News of Thursday, 10 June 2021


When is the best time to issue a bond?

The photo used to illustrate the story The photo used to illustrate the story

Established in October 2000, the Debt Management Office (DMO) was empowered to oversee and coordinate Nigeria’s public debt. Before the formation of DMO, public debts were reportedly managed by establishments such as the Central Bank of Nigeria (CBN) and the Federal Ministry of Finance (FMF).

The injection of efficiency and improved coordination of public debt by the DMO was expected, among other things, to translate to a sustainable borrowing framework for the country, improved support for the fiscal and monetary authorities, and lower debt stock and servicing cost.

Nigeria’s total debt stock and related servicing expense were quoted at N32.9 trillion and N2 trillion, respectively, as of the end of 2020 (versus N12.6 trillion and N1.0 trillion apiece in 2015), highlighting ever-expanding funding needs amidst intermittent revenue setbacks and multiple naira devaluations. Interestingly, despite representing only a tiny fraction of the country’s Gross Domestic Product, the sovereigns boast a larger share of total outstanding debt across the country.
On the other hand, the corporate bond market remains smaller even though the private sector contributes more to the country’s output than the government.

This corporate bond market is mainly regulated by the Securities and Exchange Commission (SEC), which reviews and approves bond or debt issuance programmes of public companies.

Giant corporates seeking cheaper long-term funding options that would not dilute their ownership structure often resort to bond issuances. These companies typically enjoy tax waivers that, among other things, reduce their issuance cost and benefit investors in the note.

These exemptions cover taxes under personal income tax, value-added tax, and capital gains tax; and are expected to last for an initial period of 10 years after issuance (vs infinite tax exemptions for sovereign bonds). However, the benefits harnessed from debt markets are not identical across firms as market timing ability and other company-specific factors such as earnings profile, current leverage levels, credit ratings, et cetera, play a differentiating role among issuing companies.

Though it is not always possible to accurately predict the best time to issue bonds, the prevailing interest rate environment is usually a good indicator. Specifically, the pricing of corporate bond instruments is likely affected by investors’ return expectations based on benchmark FG instruments and the yield offered on recent similar issues by comparable companies.

Indeed, a few companies saw an opportunity to raise debt at very favourable interest rates in the second half of 2020, aided by the unique circumstances that resulted in the material decline in interest rates.

For context, interest rates plummeted to multi-year lows in Q4 2020, on the impact of excess market liquidity and a second monetary policy rate cut in the calendar year that investors primarily interpreted as an indication of CBN’s intention to remain dovish in the near term. In addition, the Nigerian stock market was relatively unattractive in Q4 2020, which made the debt market a safer haven for investors despite the low rates.

While market analysts and commentators expected a yield reversal later on in 2021, few anticipated the rapid acceleration in interest rates witnessed in the first four months of the year. This sudden hike in market rates has raised borrowing costs for individuals and corporates, who may be ruing the opportunity to raise cheap debt in the immediate aftermath of the liquidity-induced crash in interest rates in the first half of 2020.

However, at least 18 companies took advantage of lower rates within the nine months of May 2020, and February 2021, raising a combined N410.6 billion of debt at below a rate of 10 percent per annum for bonds and 4.3 percent per annum on average for Commercial Paper issuances.

Worthy of note are three capital market operators who specifically leveraged expertise to take advantage of the low-interest environment.

Perhaps buttressing the significance of the timing of the bond borrowings, CardinalStone Partners raised N5 billion through a 5-year bond at the height of the interest rate crash in December 2020 at a coupon of seven percent per annum; this is the lowest-priced bonds for any non-bank financial institution in Nigeria for a similar tenor in the last ten years. Coronation Merchant Bank and United Capital also issued 5-year bonds at six percent and 12.5 percent per annum, respectively, while Flour Mills Plc and Dangote Cement issued similar tenored notes at 5.5 percent and 12.5 percent per annum, respectively, in April and December 2020.

Notably, bond issuances by high-quality corporates have continued in recent times. Specifically, Fidelity Bank raised 10-year funds at 8.5 percent per annum in January 2021, while MTNN raised seven-year funds at 13 percent per annum in May 2021.

A good understanding of market timing will help companies plan their proposed debt issue and hedge against higher finance costs. It will be ideal for companies to engage an investment bank to assist in optimizing the capital structure and identify the ideal funding gap that requires long-term funding so that the company is better positioned to issue bonds at the best time.

Awodu wrote in from Lagos

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