Global markets are faced with yet another episode of difficulty, this time with the Greek debt crisis taking the lead role in a tale of ‘remedy worse than disease’ unfolding as the main plot. Who will eventually pay this mounting bill of bailouts and how much more can taxpayers and their economies bear?Our proposition is not to try to add perspective on these events in the developed markets but , as always, we are here to focus on our corner of the sandbox. A world we call the ‘Silk Road Counties’, also known as the Arab and African and Central Asian frontier markets. The events of the past few days have again put in evidence that the economies and the financial markets in this realm find themselves in a privileged position both from a relative and a macroeconomic perspective. There is so much to say and only so much writing a reader can bare, so while we stick to the essentials in this letter, we are always happy to discuss our views in more detail if you would be interested so don’t hesitate to let us know.
The re-pricing of risk is now in full swing, albeit in slow motion. This gives everyone time to rethink relative risk, and an opportunity to redeploy capital towards the fast growing, low-leverage, and often fiscally sane ‘Silk Road’ countries. The degree of contagion has been limited as has been evidenced by most African markets which have proven to be quite vigorous during the month April. Just to name a few examples, Ghana +8.2%, Egypt +7.8%, Morocco +7.6%, Kenya +3.9%, Tunisia +3.8%. These markets have even sought further highs during the past 3 days as the above mentioned problems further intensified. Also worth highlighting is that these markets have performed despite a tumble in commodity prices, this only further accentuates that they are powered by genuine domestic economic growth factors and even more so that investors are starting to understand this has value.
With regards to the ‘Silk Road’ credit markets, I’m not sure if you have been watching, but there are some interestingly positive developments that have taken place recently. Equally refreshing is the fact that the events taking place are mostly driven by local investors who almost seem oblivious to the woes of developed markets!
Dubai Electricity and Water’s (DEWA) bond issue was around 12 times oversubscribed, showing renewed confidence by investors in the Middle East region. A similar trend was seen with the high demand for Egypt’s sovereign issue. Turkey and Morocco announced plans for ‘benchmark’ bond issues. The Ivory Coast debt swap was well received by the market and Georgia was upgraded by Standard and Poor’s on the back of improving fundamentals. Angola shelved plans for an international bond issue and has announced that it will focus on a local bond instead. There is now more demand than ever from local investors to invest in bonds in their own currency. This is only logical as institutions in growing economies have more money to invest for the long term. The assets of financial institutions such as pension funds and insurance companies tend to grow in line with their economies and so does the need or long term investment to match future liabilities.
This local demand is also enormously welcomed by the respective governments as it will help them ‘install’ a more robust yield curve which can be considered as the backbone of any modern economy. Medium and long term benchmark interest rates will provide foreign investors the confidence and liquidity they need to invest in local currency bonds and it will make it easier for lenders to price medium term loans to businesses.
The reality is that it is still very difficult for foreign investors to actually tap into the supply of local currency bonds as roughly 95% local markets driven by local market investors who invest to hold the bonds to maturity. In essence, this is the reason why we created the Silk Road Income fund, it provides investors with access to these markets.
Let’s have a closer look at one of the credit developments that especially caught our attention. John Bates, ourHead of Fixed Income at Silk Invest, provides us with more perspective on Nigeria’s successful largest single bond issue.
Lagos State – A sign of the times
Lagos State’s second tranche of its much-anticipated bond program, was quite simply oversubscribed and swamped by local investors. We can envisage Lagos State building itself a comfortable position in Nigeria’s fledgling bond markets.
The State, which is Nigeria’s most populous and prosperous (GDP per capita is 60% above the rest of the nation) built an order book of N124.5bn ($830mn) on a N50bn ($333mn) tranche of 7 year 10% coupon bonds which formed Lagos State’s second foray into its jumbo N275bn ($1.8bn) debt issuance program. The State took up $57.5bn ($383mn) on the day, the largest individual non-sovereign bond placement ever in Nigeria. When we initially looked at the bond ahead of the launch, the State had announced coupon guidance of 13.0-14.5% – those plans were diluted down to 10% as the order book swelled up. In concert with a general tightening of spreads across the African continent, this 2nd tranche came at a tighter yield than the first tranche of bonds in June 2008, which were afforded a 13% coupon on a 5 year tenor.
The success of the fundraising is partly economic: falling yields on Federal Government bonds coupled with low deposit rates are tempting local investors into state or corporate bonds and equities (and there is very limited supply in the case of corporate bonds). The Nigerian Federal government has benefited from buoyant demand for its paper, following a number of financial sector reforms which in part caused a flight to quality from an uncertain financial sector. 3 year government debt currently yields around 4.3%, and a frequent benchmark issuance programme has led to a deepening of the local market, which now stretches to 30 years in tenor. Meanwhile the Central Bank of Nigeria’s (CBN) recent move to cut the Standard Deposit Facility (SDF) to 1% and interbank lending rate to 1.2% are enticing banks to invest surplus funds in these higher-yielding bonds, which added to the appeal.
The chart illustrates the 250-300 basis point premium over the Federal Government yield curve, and the bonds, which hold an equivalent rating to the sovereign (according to Fitch), were clearly more attractive in relative value terms. We would note that in sub-Saharan African relative value terms we would rate the Federal Government of Nigeria yield curve as tight when compared to other Sub-Saharan African sovereign levels such as Ghana and Kenya, which offer significantly wider spreads for the equivalent tenor at the present time!
Lagos State is somewhat of an anomaly among Nigeria’s 36 states in that it does not rely on oil revenues and derives some 75% of its revenue streams from internally generated public sources. The other states rely heavily on their allocation of Federal oil revenues. Novel features of the bond structure were that it is tax exempt, and that the State directs 15% of its internally generated revenues to a debt reserve fund specifically to service payments to bondholders.
Despite the growing issuance of bonds among Nigerian States, liquidity is still somewhat of a constraint, partly due to the high local content which, again, tends to buy and hold and partly due to the small issue sizes. A fe more examples:
Kwara State: NGN17bn ($113mn), Imo State: NGN18.5bn ($123mn), Niger State: NGN6bn ($40mn)
Also, reforms to the to the settlement platform are in an early stage. Nevertheless, the Lagos State issue marks a major milestone in the development of the Nigerian capital markets. A third tranche from the same issuance programme is expected later this year – we would expect longer and tighter terms!
On the radar in the corporate space in Nigeria are issues from First Bank (NGN500bn), GT Bank (NGN500bn), UBA (NGN200bn), Fidelity Bank (NGN200bn), Diamond Bank (NGN200bn), Crusader Insurance and Oando plc (NGN500bn) as well as Access Bank, Zenith Bank, Afrinvest and C & I Leasing.
We expect the development of Nigeria’s corporate bond market to be rapid, with the first handful of deals offering the best returns to investors. Thereafter yield spreads will likely tighten as competition heats up between the different bond issues.
We look forward to keeping you updated.
With kind regards from the Silk Invest Team
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