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Eurobond: A Case Of Onshore-Offshore Arbitrage

Proshare

Sunday, November 12, 2017  /  07:56AM /  Proshare Research 

Preamble
 

Certainly, the ability of Deposit Money Banks (DMBs) to tap into the foreign capital market in a period of growth spells and still enjoy oversubscription evidently reflects strong resilience in a period of growth spells     

Table 1: Deposit Money Banks Issuing Eurobonds as at 2017

Bank

Amount (million $)

Coupon rate (%)

Zenith

500

7.35

Acess

400

7.25

Fidelity

400

10.5

UBA

500

7.75

ETI

400

8.75

Source:  Proshare Research 

The Eurobond provides DMB’s the opportunity to shore up their counter cyclical capital, such fresh capital would offset earlier poor asset quality.  In some peculiar circumstances capital tapped from the Euro market is used to pay off the already existing external debt.
 

However, increase in debt would weaken shareholders margin of safety, given the rise in debt obligation. An occurrence of currency risk could amplify the existing gearing ratio of banks, eventually limiting the banks efficient investment frontier. 
 

Presently, Deposit Money Banks have fragile net foreign asset position; increase in foreign liabilities will further dampen their net foreign asset position. In recent times there have been accusations that bonds issued by DMBs have not been invested into the real sector. Rather DMBs have ploughed the fresh capital into government risk- free instruments. 
 

Fig 1:  Net foreign Asset of Deposit Money Banks 
Proshare Nigeria Pvt. Ltd.
Source: CBN, Proshare Research

Currently, DMBs have favoured financial asset ahead of real asset, in some way creating a more dispersed portfolio. As they limit their exposure to risky asset, in return absorbing more of risk-free asset in their portfolio.
 

Certainly, DMBs are asset oriented and their lending decision should be determined purely by credit analysis. Therefore, certain quarters are strongly opined that a deviation from the norm of real asset creation through lending runs contrary to the initial mandate of Deposit Money Banks.
 


Fig: 3 Deposit Money Banks Hold of Treasury Bills as at 2016
Proshare Nigeria Pvt. Ltd.
Source::CBN, Proshare Research 

For them, the Eurobond market has not only become a channel to raise fresh capital but an avenue for rent seeking. As DMBs use such channel to carry out offshore–onshore arbitraged on the rate anchor. The present horse trading by DMBs has ended up not trading-off risk but productivity. 

Certainly, they are not far from the truth, the Eurobond market or preferably the Euro Dollar market over the years has evolved parallel market to domestic money markets. The market is characterised by high capital mobility and do operates in certain countries like Switzerland and Luxembourg known to be tax havens. The dynamics enhances credit supply, relatively providing cheaper cost of capital.  
 

Financial intermediaries are comfortable operating within a narrow margin in such a market as credit supply of Dollar denominated asset is high and deposit rate on such asset is relatively low.   
 

In response, many on the other aisle are of the opinion that DMBs can exploit the numerous capital market lines at their disposal in order to maximise wealth for their shareholders. After all they owe such responsibility to their shareholders and why not!!  They can borrow from a particular market and lend the capital borrowed into another capital market. Thereby exploiting the premium between the two capital market lines, moreover recent exchange rate is more of a leg wind.
 

The in ability to take advantage of the differentials between such capital market lines could be tagged as a negligence of opportunity on the part of DMBs.  The blame does not lie on those taking onshore- offshore arbitrage, but the very factors that provide such opportunity. The culprit is not opportunity but present state of macro condition fusing the existing policy response to the cycle.  

Macro Condition and Policy Response
 
DMBs are also economic agents, macro- economic condition and the policy response largely dictate the shape of their portfolio. Expectedly, in period of downturn, banks are vulnerable to higher degree of impairment. In such circumstances, Deposit Money Banks become more risk conscious in order to avoid taking on more moral hazards. 

More importantly, DMBs have exhausted substantial part of their counter cyclical lending position. Inflammation in their deposit to lending ratio due to exhaustion in counter cyclical ratio has led to weaker micro prudential. Putting them in a scenario where they were close to running out of ammunition, whereby close to the levels of 2010.
 

Policy response for some time, especially the tight monetary policy has been a dis-incentive to the real sector. Persistent sterilization has affected money supply, expectedly weighing on cash management. Moreover, the high interest rate amplified risk levels as the deposit and lending rates further widened.
 

The combination of amplified risk by monetary policy and heavy cash management forced banks to look for safe assets.  As banks were desperately in need of a ‘’get out of jail card’’, fiscal policy provided more than a get out of jail card.
 

Fig 3: Deposit to Lending Ratio
 Proshare Nigeria Pvt. Ltd.
Source: CBN, Proshare Research

The domineering posture of fiscal policy by frequently sourcing capital in the money market coupled with high interest. Encouraged DMBs to hold more of short term government instrument in their
portfolio. Obviously, an high interest cycle could also be self-inflictive as it cuts both sides. Government instrument acted more of a smoothening agent to sporadic income fluctuations being experienced by banks. Luckily for them it was not just a get out of jail card, “it provided them an even keel in a growth spell cycle’’  

At the same time deposit money banks over the years have maintained a narrow lending position. They have limited credit intervention in sectors, which requires a longer period to break even coupled with higher risk. Commercial banks have largely restricted themselves to safe havens making it herculean for start up to access credit.   
 

Conclusion
 
Holistically, the incidence of running onshore-offshore arbitrage on the rate anchor reflects in the ability of monetary and fiscal policy to arrive at an alignment. The inability to arrive at that alignment created room to take advantage of the differentials in premium between the Euro Dollar Market   and the domestic market. At the same time, it points to how both policy conduit choked out private sector, the other crowded out the private sector.  

DMBs must gradually move out of their narrow lending shell, rescinding within safe havens or narrow lending fails to shield them from negative turnaround nor rid depositors of  the risk of issuers default. Afterall, repeated cycles have shown that save havens might not be as safe as touted.
 

Relatively, improving the quality of credit analysis, asset valuation and increased periodical assessment of asset quality is more important than the white perception of safe havens. At the same time, investing in financial advisory and providing for them is important. 

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