December 08, 2017 / 6:05 PM /Meristem Research
Issue on Offer/Summary
The Federal Government of Nigeria (FGN), through the Debt Management Office (DMO) is scheduled to hold the last bond auction for the year on the 13th of December, 2017. The amount on offer is expected to be within the range of NGN90bn-NGN110bn. Two (2) instruments which are both re-openings, the FGN JUL-2021 (5-year) and the FGN MAR-2027 (10-year), will be on offer as shown below.
14.50% FGN JULY 2021 (5-Yr Re-opening) NGN45bn-NGN55bn
16.2884% FGN MAR-2027 (10-Yr Re-opening) NGN45bn-NGN55bn
Current Yield Analysis
The Treasury bonds market has remained bullish since the last auction held on the 22nd of November, as the average bond yield declined by 0.25% to close at 14.70% on the 7th of December, 2017. However, investors’ appetite towards the FGN JUN-2019 and FGN OCT-2019 instruments remained bearish, as they were the only instruments to record yield advancements of 0.20% and 0.04% respectively.
During the same period, the National Bureau of Statistics (NBS) released the Q3:2017 GDP result, which showed improved economic growth of 1.40%, driven by increases in crude oil price and production. We note that this growth, coupled with improvements in other macroeconomic variables, has strengthened investor confidence, evidenced in the increased participation in the domestic market.
On Tuesday December 5, the House of Representatives passed the revised Medium Term Expenditure Framework (MTEF) with an increase in the oil benchmark from USD45 to USD47 per barrel and adopted a projected non-oil revenue of NGN5.279trn.
The MTEF provides a long term view of the Federal Government objectives and ensures all plans and policies are in line with the long term goals of the government. We expect this to further improve investor confidence and participation in the Nigerian economy.
Since the absence of the 20-year bond at the primary auctions, the 10 year bond has received significant participation, causing a moderation in the marginal rates across tenors. Given the current liquidity levels in the market, driven by persistent OMO auctions and FX supply, we expect yields to remain around the same levels at this auction.
Bond Absolute and Relative Valuation
Valuing the14.50% FGN JUL 2021 and 16.2884% FGN MAR 2027re-openingswith 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 analyzed 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 both issues on offer.
A bond is a fixed income debt instrument issued by the government (federal or state government) or corporate institutions with a definite date of maturity and a fixed interest payment (known as coupon) payable either semi-annually or annually. Unlike equities, bonds are issued with a guarantee of the initial investment and can have tenors as long as 20 years.
A treasury note refers to a government bond instrument with a term to maturity of 1 to 10 years while a treasury bond has a maturity of 10 years and above. Bonds issued by state governments of a country are referred to as municipal bonds while those issued by organizations are corporate bonds.
The government usually issue bonds at the primary market to raise domestic funds to meet its fiscal responsibilities. This can be done from time to time as the need arises. Nigerian FGN bond instruments are named by their maturity, coupon, tenor etc. such as 13.05% FGN AUG 2016 instrument.
How is Return Determined?
Bonds are mostly issued with a coupon otherwise known as, the periodic interest payable. Bond instruments are usually issued at par; that is, N100 or N1,000 as is the case with Nigerian bonds. A 2-year bond issued at 12% annual coupon with a par value of N1000 implies that the issuer will make 3 semi-annual payments of N60, and a final N1060 on the maturity date.
Bonds can be purchased at both the primary and secondary markets; they are either quoted in price or yields. There is an inverse relationship between the price of a bond and its yield to maturity (YTM). At issuance, the yield on a bond instrument is most likely the coupon on that instrument.
At the secondary market therefore, an investor can trade bonds by quoting a yield that reflects the variance between the par value and the current price based on the current market dynamics.
How does the Auction Process work?
Bond instruments are issued through a competitive bidding process at auctions as conducted by the Debt Management Office which serves as the representative of the government. An existing government instrument can be re-issued also at the primary market in which case the DMO re-issues based on the current market yield to maturity.
Bonds are auctioned at established rates which determine the return to investors. Purchasing these instruments in the primary market and holding it till maturity would mean that the investor gets a fixed interest payment, however, there is a secondary market in which investors can trade these bonds to meet their immediate liquidity needs.