Tuesday, April 20,
2021 / 06:04PM / by
Meristem Research / Header Image Credit: Economic Times
Issue on Offer/Summary
The Federal Government of Nigeria (FGN), through the Debt Management Office (DMO), will be conducting a bond auction on Wednesday 21 st of April 2021. The indicated total amount to be on offer is NGN150bn. All instruments on offer are re-opening issues.
16.2884% FGN MAR 2027 NGN50bn
12.5000% FGN MAR 2035 NGN50bn
9.8000% FGN JUL 2045 NGN50bn
Current Yield Analysis
As expected, the DMO at the last bond auction in March 2021 offered higher rates to investors across all tenors. Marginal rates on the 2027 and 2035 instruments increased by 50bps each to 10.50% and 11.50% respectively, while that of the 2045 instrument increased by 20bps to 12.00%. While we note that the increase in rates is consistent with prevailing economic realities particularly with regards to inflation, we think there is yet room for improvement given the current rate of inflation (18.17% in March 2021) and its implication for real returns.
On the other hand, the government is constrained in terms of revenue generation and we are concerned that government is increasingly borrowing just to refinance preexisting obligations. With less revenue available for government to engage in real value creating activities (which should ultimately expand its earning base), inflationary pressures will only continue to build up, causing real returns to remain negative and depressed. Nevertheless, we expect further uptick in rates over the near term, supported by relatively stable oil receipts. Meanwhile, investor interest has remained strong -especially towards the longer end of the curve as overall bid-to-cover ratio increased to 2.22x from 1.26x at the last auction.
In the secondary market, the direction of yields continues to be influenced by the need to minimize capital losses especially on mark-to-market portfolios. Since the last auction date, average bond yield has risen by 176.00bps to 11.31% on 19th April 2021. Given our expectation for PMA rates over the near term, we do not expect selloffsin the secondary market to taper anytime soon.
Bond Absolute and Relative Valuation
In valuing the 16.2884% FGN MAR 2027, 12.5000% FGN MAR 2035 and 9.8000% FGN JUL 2045 re-opening offers with the current yield curve as the basis for discounting, we arrived at the following fair value, implied yield and an IRR for the instruments:
Our valuation gives a fair-trading price ex coupon payment, the expected return on the bond considering its periodic interest payments and the expected return on the bond's periodic payments. We analysed the issues on offer given the current yield environment, market liquidity, as well as a review of the recent past auctions, whilst also introducing market sentiment factor into our valuation, on which we advise bid yield ranges for the issues on offer.