The week that was (August 14-18) – Liquidity reprieve drives downward retracement in yields
- Improved system liquidity post FX sales auction sends NTB yields lower: A bit of a rollercoaster week for debt markets as the tight liquidity conditions at the close of prior week continued into the week resulting in OBB/Overnight rates climbing to nearly 100%. The liquidity strain largely reflected the impact of banks prefunding for a wholesale ($100m) & retail SMIS auction ($264m) in the prior week. Following release of auction results on the SMIS during the week, the released funds reignited buying across the yield curve with the biggest declines across benchmark tenors on the 91-day bill (down 210bps to 18.1%) while the other tenors were flat to lower: 182-day (flat at 20.48%) and 364-day (down 20bps to 22.17%) . As is now customary, the CBN issued OMO issuances of N203billion over the week.
- No surprises NTB auction: At the NTB primary auction on Wednesday, where the FGN had NGN62billion to refinance in 91-day and 182-day tenors, the wide gap between primary and secondary market yields persisted as both papers were issued at discount rates of 13.35% (effective: 13.81%) and 17.35% (effective 18.99%) respectively. The FG, aided by the ‘greater fools’ at the primary auction, have succeeded in driving the 91-day bill lower from a discount rate of 14% at the start of 2017 even though rates of have climbed in the secondary market over 2017 for the paper.
- A bargain debt sale for Lagos? Lagos State announced results of its planned bond sale wherein it filled 85% of its planned N100billion issue (much improved from a 78% pass rate at its N60billion 7-year debt sale in December 2016). The issue was done via book building and was split into two tranches likely to ensure a bigger haul: 7-year and 10-year. On the 7-year, though the cost on the issue rose 25bps to 16.75% from its December issue, Lagos paid only 40bps credit spread on a similar dated sovereign paper (vs 80bps in December) and raised N46billion. In a similar vein despite being a debut non-sovereign issue on the 10-year, pricing came in at 70bps over similar dated sovereign. Basically, despite thinning demand for long dated instruments, Lagos appears to have sold its debt under favourable terms. (I have used yields on the 11th of August for comparison). Given that Lagos had N57.5billion worth of bonds mature in April 2017, the state on a net basis raised N27billion in 2017.
- Bond bears remain in the driving seat: As with the short end, bonds sold off at the start of the week due to the tight liquidity strain with some tenors hitting 17%. However, yields retraced post the release of SMIS auction results and fresh offshore buying interest which induced a short-lived bullish frenzy. However, once that liquidity dissipated, the bears regained control and we closed the week roughly unchanged from the end of the last week.
In summary, improved system liquidity following the release of funds from the SMIS auctions and OMO maturities heaped downward pressure at the short end of the curve but had a short-lived impact at the deep end where thin demand continued to stoke bearish trends in bonds.
The week ahead (August 21-25) – Sideways trading at the secondary market but primary rates to nudge higher
- In the week ahead, the FGN would seek to sell N135billion at the monthly bond auction on Wednesday and there is about N96billion worth of OMO bills maturating on Thursday.
- How to play the FGN bond auction? As at the July bond sale, the amount on offer is split across the 5-year (N35billion), 10-year (N50billion) and 20-year (N50billion). Largely reflecting thinning demand, yields on the three tenors have climbed between 10-25bps from July end levels to 16.41-16.55%. This backdrop pre-supposes that marginal rates should close higher than the 16.25% at the July debt sale. That said, the last tranche of the FGN 2017 bond of N100billion matures on the 31st of August.
- A bit of mixer here, starting in May 2017, pension funds administrators (PFAs) are now required to migrate to IFRS reporting by the end of 2017 as both the industry regulator and Financial Reporting Council have finally aligned. Speaking to industry sources, most PFAs appear to have marked their fixed income portfolios in late 2015 so impact is likely to be minimal. Nonetheless, going forward the IFRS requirement that PFAs justify their decisions to adopt a held-to-maturity or otherwise using a business model assumption implies changes to how investments take place going forward. This could explain recent lackluster appetite for bonds and thinning demand at the segment. Though the August maturity level is low relative to April’s deluge, my suspicion is that these funds are likely to be deployed into HTM portfolio to meet the business model requirements of IFRS as PFAs seek to match long term liabilities.
- How to bid? The low coupon on the 5-year (14.25%) implies subscription is likely to be low, as in past auctions so the marginal rate should close in line with the average marginal rate of the 10-year and 20-year whose coupons are 16.24% and 16.29% respectively. Now, the FGN has been sounding a bit concerned about rising debt levels but they still need to borrow. My guess is that given the upward drift in yields they should be willing to concede on borrowing cost but no more than 5-10bps from July so I’m shooting for a successful big range between 16.25-16.30% on the other two tenors. In summary, please see below my advice is to spread bids between 16.25-16.3% as that is where the margin of safety is likely to be. Should the auction close higher, markets would take it to mean that having played not-desperate at recent auctions, the FG revenue position is now back in a dire state.
As for the rest of the week, CBN is likely to keep up its attack on NGN liquidity leaving rates stuck between 18-23% for NTBs while depending on how the auction goes, bond yields are likely to trade sideways over the week. The chart of the week shows the annual average allotment ratio, bid-cover ratio and marginal clearing rate at bond auctions since 2009. Monetary tightening by Sanusi pushed yields to a new level starting in 2011 as is evident while the tightening in 2017 has taken borrowing costs to fresh highs.
Average Allotment ratio, Bid-cover ratio and Marginal clearing rate at bond auctions
Source: DMO * January-July average