How to Trade Kenya-The buy case for Long End Kenyan Bonds

Since the legislative interventions into interest rate determination in September 2016, investors in Kenyan debt markets have been trying to figure out when the rate cap is likely to be removed or at least amended. For those unfamiliar, Kenyan lawmakers placed a cap on lending rates at 4 percentage points above the Central Bank of Kenya (CBK)’s policy rate in an attempt to limit the cost of borrowing for businesses and individuals and increase credit growth. Though the CBK eased policy rates to 10% subsequently, Kenyan banks unwilling to lend to high risk tiers have redeployed their balance sheet towards short dated government securities.

 

 

As such instead of an increase in credit growth, the rate cap has drawn an opposite reaction as most commercial banks have decided to reduce lending. The index below tracks the outstanding amount of credit (or loans) extended to businesses and consumers.

 

To bolster interest income Kenyan banks decided to go to the capital markets to buy government debt in search for better rates in the bond markets. This increase in bond appetite compressed local bond yields significantly causing bonds in the long end to trade around 14%, 400bps above the lending rate of 10% at the same price of the lending cap.

 

In 2017, after months of election drama and political uncertainty, the country declared the incumbent Uhuru Kenyatta as its president. In the campaign running up to the elections, the president bowing to pressure from the International Monetary Fund, promised to revisit the lending cap law decision as the cap was not conducive to its business environment. The uncertainty surrounding the retention of this cap law caused the yield curve to bull steepen over the past few months.

As the market preferred to buy shorter end paper in order to avoid duration risk in case of the cap removal.

After months of back and forth between members of parliament and the treasury, the former wanting to keep the status quo and the latter desiring for a total repeal or amendment, in August 2018 the lawmakers decided to keep the rate cap (Finance bill 2018). I think as the market starts coming to terms with this decision, liquidity will start to move towards the longer end again, bull steepening in the curve will end and the rate at which short term yields have been falling will slow.

 

The Brownbear

Sharing my views on Ghanaian Banks -CNBC Africa interview

On CNBC Africa sharing my views on Ghanaian banks.

https://www.cnbcafrica.com/videos/2018/08/06/how-attractive-are-ghanas-banks/amp/?__twitter_impression=true

CNBC Africa Interview on Côte d’Ivoire

Last week President Ouattara of Côte d’Ivoire dissolved the government amid tension in the governing coalition. CNBC Africa invited me to speak about my views on the repercussion in the country’s capital market(phone interview).

Curve your enthusiasm

About Six months ago I wrote a buy case for Nigerian local currency bonds. The main reasons, among many were, that slowing inflation, general improvement in Nigeria’s macro outlook and more importantly, reduction in the supply of local bonds would lead to an uptrend in prices.

One of the indices I use to track the Nigerian Bond market is the Bloomberg Nigeria Local Sovereign Index or BNGRI, a market value weighted index that measures the fixed-rate local currency securities issued by Nigeria. This Index has seen a price rally of over 15% over this 6 month period.

The yield in the index has dropped by 200bps over this same period.

This rally has been across the curve causing the yield curve to begin to take a normal look.

The 1yr paper has experienced the highest drop in yield compared to other maturities.

Spreads have tightened at a quick rate over the past 6 months approaching historically low levels. The last time spreads were this tight, was in the last quarter of 2015. Strangely, this was in the period JP Morgan decided to expel Nigeria from its index due to tough controls the central bank imposed to prevent a currency collapse. Oil price began its decent to sub $40 per barrel, and the nation was left with no finance minister. Another factor that should have added to rising yields was the implementation of the Treasury Single Account (TSA). To reduce borrowing costs, extend credit and in the hopes of improving the government’s fiscal policy, the administration decided to fully implement an account that collects all government funds. However, following the implementation of this TSA, the decision of the monetary policy committee (MPC) to lower the Cash reserve requirement around the same period released liquidity into the market causing yields to collapse.

Other periods that show tight spreads are periods of economic stability in the country, mainly due to stable oil prices. One of the fascinating relationships exists between bond prices and crude oil price. Spreads were range bound between 900 and 1100 through this period of relatively stable oil prices. And now with the recent oil rally this year, bonds are now beginning to trade at previous levels.

In the long term, rising oil prices puts downward pressure on yields and vice versa.  In the short term, the chart shows that crude oil prices continue to work harder until bond yields start to fall.

The spread between Nigeria 10y yields and its market counterparts tell me that there is still some downside to go in yields. Nigeria is lagging to a degree.

Visible reduction in issuance of local currency debt can be seen as the Central bank have signaled change in the debt mix, leaning towards US Dollar debt.

These point to a continuous increase in bond prices. Expect front-end yields to continue to decrease in moderation. Although yield downside from here is limited as the central bank has begun signaling a floor in interest rates with a recent hike in 3M and 9M bills at 11.4% and 12.1% respectively pushing yields higher on the secondary market. However, there is still a shrinking supply of the 1y T-bill, which is now offered at a yield of 10.75% at the time of writing. I think the hawkish signals from the central bank will begin to reflect across the curve as Market participants start to reassess their position.

 

The BrownBear.

Ghana: What happened to the E.S.L.A plc Bond?

On the 16^th of October 2017, E.S.L.A plc an independent special purpose company established and sponsored by the Republic of Ghana acting through the Ministry of Finance announced the offer and listing of bonds of up to GHS6bn senior unsecured notes backed by irrevocable assignment of the Energy Debt Recovery Levy receipts under GHS10b Bond issuance program to refinance the legacy energy sector Debts.

The bond issuance was split into two tranches, 7yr (GHS2.4bn) and 10yr (GHS3.6bn) Book building opened on the 24^th of October, set to close on Thursday the 27^th of October, and settle on Monday 30^th. Initial Pricing Talks, were at 17.7% to 19% for the 7yr and 17.8% to 19.5% for the 10yr, vs. the Government 7yr Benchmark trading at 17.24% and 10yr at 17.75%.

Security Type		IPT		Size (up to)
E.S.L.A. 7-Year Bond		17.70% to 19.00%		GHS 2,400,000,000.00
E.S.L.A. 10-Year Bond		17.80% to 19.50%		GHS 3,600,000,000.00

Ghana 10 Year Yield Curve

On Friday afternoon the day after the arranged book build close, the 7yr was only 0.625x subscribed and the 10yr, 0.21x. The book runners had to extend the close by another week. So what went wrong? At the turn of the year, Ghana started to look like a positive turnaround story- a new administration,  stable currency, positive trade surplus, lower inflation and a huge increase in investor demand to name a few, why was the new issue so undersubscribed to the point the book runners had to extend the book building exercise by another week?

Energy.Sector.Levy.Act

Between 2010 and 2015, GHS9.4bn worth of debts and payables within the energy sector had accumulated. Placing burden on the energy sector and taking a toll on banks. The BDC’s and SOEs borrowed from banks to carry out transactions however during this period, Ghana went through an energy crisis and currency issues the government decided to subsidize fuel products which was never paid to the BDC’s and SOE’s leading to their default on commitment to the banks. Accumulating up to billions of Ghanaian Cedis over 5 years.

As part of generating revenue to offset accumulated debts within Ghana’s energy sector the government in 2015 introduced the Energy sector levies, a form of tax collection on petroleum products. This levy was made up of the energy debt recovery levy, as well as price stabilisation and recovery levy. As of last year (2016), the Energy Debt recovery levy had collected up to GHS1.28bn. ESLA plc have assigned 100% of the EDR Levy to the ESLA Bond program.

The structure seemed pretty straight-forward, a ring fenced SPV, levies collected from oil marketing companies (EDRLs) used to service the debt, ensuring a minimum debt service cover of 1.25x. Plus excess cash collected, stored in a ‘lock box’ facility just in case of a shortfall in repayments. Bond holders would have some peace of mind that coupon payments would be met and in 7/10yrs time the bond would be repaid.

So why didn’t the market run for the bond?

Firstly, the lack of clarity on whether the issue was sovereign backed or not, coupled with the uncertainty on whether to classify the bond as sovereign, corporate or quasi-sovereign. I recall after 2 hours of sitting in on the Road Show in Accra, Ghana- turning to my colleague and asking the question, “is this a sovereign or a corporate bond?”. While Ghana used the SPV structure to have the bonds excluded from reported public borrowings, the IMF classify it as government debt as it will be serviced from state revenues. Ghana is a frontier market, once there are doubts as to whether the government will back a paper, investors cannot justify taking on non-sovereign risk for a non-investment grade local currency bond in a frontier market with limited liquidity priced around the same level as the government benchmark. Other Corporate bonds this year have priced at an average of benchmark + 350bps.

Secondly, I think the issuance was too big. The biggest issuance the government did before this was the $2.25bn 15year, 95% of which was absorbed by one investor giving a false idea of actual demand for the local sovereign paper. It would have been wiser to split the issuance into a few more tranches and over a longer period of time in my view. And lastly the size of the local market and its ability to absorb an issue of this size.  According to the National Pensions Regulatory Authority, assets under management of the privately managed pension funds industry as of July 2017 stood at GHS8.3bn, and approximately 70% of these assets are invested in local Ghana sovereign debt. Ghana’s local investor universe appears dominated by short term institutional investors. Ghana needs to deepen its local investor debt universe and deepen collective investment schemes before issuing a local currency paper of this size.

 

The Brown Bear.

The Buy Case for Nigerian Local Bonds

About two years ago, Nigerian bonds went from being a highly sought after asset to a “must avoid” country for most GEM and Frontier managers. Oil prices went south as well as oil exports, the Central bank decided to adopt strict currency controls, this saw the black market trade at a much lower value against the dollar than the official rate, sending inflation through then roof and panic in the capital markets as investors tried to sell assets and flee the country. In September 2015, JP Morgan removed the country from its Emerging Market bond index, followed by Barclays. About a year later the county announced it had gone into a current account deficit and then a few months later, a recession.

In my view, the country is quickly becoming a turnaround story as macro-economic factors begin to improve and bearish drivers slowly turn positive and economic reforms are taking shape- Current Account balance has now moved away from a negative territory, inflation easing, positive GDP growth etc.

Most recent data shows Nigeria has officially come out of a recession. GDP growth showed positive of +0.55% coming from an absolute bottom in Q3 2016 of -2.34%. Although the market expected better results but was disappointed by the contribution from the oil sector.

On the non-oil side, another reason for less than expected GDP growth figure was the contraction from the Telecoms Sector. Mobile subscribers dropped by 11 million.

Policy rate is currently at a 10year high. The Central Bank of Nigeria had to take a hawkish stance in order to control inflation from a weakening currency, stemming from falling oil price coupled with falling oil production due to militants blowing up pipelines in the south-south- oil producing region of the country.

As oil price and production reduced, the central bank was forced to devalue the naira/USD. Also releasing a plethora of forex trading windows in order to accommodate different USD demands.

As a result, we saw inflation increasing towards the end of last year and spike up to 18.7% at the beginning of the year, the highest since 2005. Also worth noting that last year fuel prices increased by 70% and electricity tariffs went up by 45%. All of these contributed to the sharp rise in inflation.

On the turn-around side, Oil production is now picking up from currently at 1,750m bpd from a low of 1390m bpd, as the issues with the militants in the South of Nigeria calm down I see oil production continue to increase to the usual levels of +2,000m bpd. Bear in mind OPEC did not give Nigeria a cap on production.

 

The naira has been stable in the parallel market for the past 3 months, trading around 363/US$, and the current account now in the surplus, I think inflation will continue to ease for the rest of the year going into next year ceteris paribus.

Below is the graph from the BNGRI- Bloomberg basket of Nigerian local sovereign bonds, with an average life of 9.6 years and duration of 4.3. The index shows a downtrend in yields from H2 2017.  Yields start to fall, as the market sees the turn-around macro effect in the country.

Real Yields however are still near and around the negative territory. In recent MPC publications, the tone is reversing from hawkish to a dovish stance and I suspect that policy rates will start to ease as real yields turn from negative to positive.  Declining inflation and a current account surplus will allow the CBN to drop rates further.

In the market Yields dropped on average 90bps, as concerns over re-investment risk drove renewed pension fund buying of longer dated instruments. The strong demand was visible at the monthly bond auction where bid-cover ratios jumped to 3x (August: 0.5x).

One very interesting point to note, In September the Central Bank of Nigeria announced that they have decided to change the debt profile of the country by weighing heavier on USD debt. Following this announcement, they stated that they plan to borrow $5.5bn worth of Eurobonds in Q4 2017 with the first tranche of $2.5b this month. This will likely reduce the NGN local bond issuances and shows why the Q4 2017 issuance calendar has a 19% cutback in planned bond sales.  This will likely reduce the yields offered in auctions.

Against a backdrop of slowing inflation, improved macro outlook, reduction in supply of local bonds and domestic pension funds going into long duration in a bid to avoid re-investment risk, I see an uptrend in prices for the rest of the year, with the odd profit taking trades.  I think it is time to put on the long Nigeria trade again.

 

The Brown Bear.

 

 

BBC World Business Report-6:30GMT +1

Catch me on BBC radio -World Business Report at 6:30pm GMT+1 as I discuss Nigeria and the Naira deval.

Click on the link below:

http://www.bbc.co.uk/programmes/p03y4hlt

 

The Nigerian Baht, I mean Naira -Why I am still short.

In my opinion, there are a few clear signs that show when a country is in trouble. The first is a swing from surplus to deficit or a widening current account deficit, another is also a fall in the price of the country’s exports. Both signs were true of Thailand in the mid 90’s, just before the currency peg was broken in 1997.
Thailand’s GDP growth in the first half of the 90s averaged over 8% to 6% in 96. Foreign investors attracted to the stable baht, high interest rates (vs rates in Eurodollar market) and high growth rate flooded into Thailand. But then the music stopped. Led by a sharp reduction in export growth, economic activity started to slow. The weakness in the financial sector, put pressure on the baht to depreciate.
Just like Thailand, Nigeria showed the signs of an economic boom from 2000s. With GDP growth swinging between 6% and 8% from 2006 to 2014. A somewhat stable currency between 2009 and 2013, depreciating by just under 8% through that period.

 

Fast forward to 2015, following the collapse in oil prices, Nigeria’s current account turned negative for the first time since 2002.

Current account balance

Although oil and gas accounts for 35% of the country’s GDP, petroleum export revenue represents over 90% of total exports revenue. Now not only is the price of oil trading over 50% below 2014 high, but due to oil pipeline vandalism from militants in the Niger-Delta region, Nigeria has also begun to see a reduction in exported barrels of oil per day.
Oil price.

Barrels per day of Nigeria’s oil exports have not been this low since 2009.
Crude oil export.

After over a year of maintaining the Naira’s peg with the US dollar, the Central Bank of Nigeria abandoned this peg. Instead of depleting its FX reserves the bank announced that it will allow the Naira to be market-driven, setting the stage for a devaluation of the currency when the system kicks in on the 20th of June.
My concern is that Nigeria tends to pass through high import costs as its currency falls. A falling currency will easily force inflation higher, as the country is already suffering from its highest inflation rate in 6 years.

The central bank will be forced to raise rates, which will add to the government’s borrowing costs.

Currently, the Nigeria dollar debt is trading at an average yield of 6.5%. It’s not a historical premium, but the highest in 2016. This gives me the impression that for some reason the market has taken a view that the country’s finances are stable and relatively safe.

The local government bond now trading at negative real yields.

In my opinon, the market is yet to fully adjust to the fact that the numbers in Nigeria have changed; Nigeria is still reliant on a commodity story that has also changed-suffering price and export reductions, it’s currency now floating will naturally devalue and add inflationary pressure on an economy that’s already seeing high numbers due to bad policy. I also see the market adjusting to an increase in government borrowing costs.
At the end for Thailand, policymakers had no easy choices once pressures on the exchange rate emerged, as defending the peg or allowing the currency to depreciate both involved significant costs. Thanks to the power of hindsight, it’s obvious to us that this dilemma could have been avoided by allowing the currency to freely float earlier than they did. It is saddening that the Central bank of Nigeria had not learned this lesson. I think we hold tight and enjoy the ride.

Quick ChartS-Food for thought-FBN 2021 V SEVEN ENERGY 2021

Interesting chart I just came across- First bank’s 2021 USD bond now trading at a higher yield than Seven Energy 2021…

FBN 2021

 

 

 

 

 

Seven Energy 2021

 

 

 

 

 

For those who do not know, Seven Energy is a Nigerian upstream oil and gas company,  with interests  in the south-east of Nigeria. Seven Energy had a few issues in the past with former director Kola Aluko and some assets-but that’s not what this post is about. I just find it interesting that the country’s largest bank-by assets is trading at or near to an oil and gas company.

Perhaps a reflection of things to come?

We need to talk about Zambia -The short case for Zambia 2027

I’ve always thought that it never makes sense to get bullish unless you can see that the drivers of the bear market are breaking down. Hence the recent rally in Zambia USD paper has caught my attention. Especially the 2027USD bond.

This year we’ve seen the bond rally over 20% from trading at low 60’s to 80.

 

A rally across the curve has caused a downward shift.

 

It looks like what the market is forgetting about Zambia is copper. After reaching peak copper production in 2013, thanks to tax increases and power cuts, Zambia has struggled to hit production targets, so much so that it is seeing a flat line in copper production.

 

The chart shows the spread in yield between USD bonds issued by Zambia (average of 2022,2024 and 2027) and the US treasuries and the copper price. What’s important to me is that copper is trading around a 6 year low and it trades together with Zambia USD spreads.

 

The trading pattern of the curve has also been interesting to me. As you can see below, the rally ended in April, especially for the 2022 and 2024 paper, but not for the 2027. There seems to be lag, a bearish hump has now formed across the curve.

 

Tightening in the spread between the 2022 and 2027 this year.

 

 

The 2027 paper is now more expensive and trading higher than the 2024. Relatively the most expensive it’s been since issued in August last year.

 

 

In February this year, the country announced that the IMF were on the ground, the market reaction was very positive. But the fundamental facts still hold in my view-the bearish drivers Zambia struggled with have not changed, lower copper prices and slowing copper production, however for some reason the market is yet to price this in the 2027 paper. In my view the bond is now looking very attractive to short.