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Friday, March 08, 2019 02.48AM / By Teslim Shitta-Bey Managing Editor, Proshare / Header Image Credit: Visionscape
As at the close of business at 5pm on March 07,
2019 the Lagos State Government, in breach of the terms of a N4.85bn 15.75%
Series 1, Tranche B Secured Rate Medium Term Note due in 2022 and Issued by a
private company, Municipality Waste Management Contractors Limited, is yet to
pay the due incomes to investors in the Fixed Interest Rate Medium Term Note (‘The Municipality Note’).
Since Proshare
broke the story on March 5, 2019; a couple of narratives have emerged in main
stream and social media which has created more emotion than clarity on the
issues; including the narrow interpretation of which entity is in default or
the nature of the default. An
interrogation of these matters, outside of political considerations around the
transaction will reveal a lot of teachable moments that serves up improvement
needs for the development of the private sector-led bond market.
In furtherance of our remit - professional
obligation to offer clarity on market developments in the interest of capital
market stability, integrity, and in fairness to the State
Government/stakeholders involved in the transaction (especially the investing
public), we highlight below the salient issues concerning the reported payment
default on the 15.75% Series 1 Fixed Rate Note issued by Municipality Waste
Management Contractors Limited (“MWMCL”) and secured by an Irrevocable Standing
Payment Order (ISPO) of the Lagos State Government.
The intervention covers there major elements:
1. Who is in default and does this qualify as a technical default?
2. What lessons can be extracted about the default as it relates to risks related to bonds and the importance/place of ratings in investment grades; and
3. The sanctity of contracts and the place/role of Guarantees.
The third point which basically addresses the return of capital vs. return on capital issue will be a matter for a future deep-dive which should offer some illuminating perspectives on what is possible and how we can reinforce safety measures in the all-important fixed income/bond market.
Sticking to the Facts
Background To
Note
To complement the Federal National Environmental
Standards and Regulations Enforcement Agency (Establishment) Act, 2007
(“NESREA”), various States passed their Environmental Laws and Regulations as
advancements to this law.
Lagos State was one of such states, when in
March 2017, it passed into Law the Lagos State Environmental Management
Protection Law, 2017 (“EMPL 2017”). This Law consolidated all the Laws
and Regulations applicable to the management, protection and sustainable
development of the environment in Lagos State.
Though the EMPL 2017 has fourteen (14) parts,
with 526 Sections, various Schedules and is 239 pages long, this Law
considerably attempts to delve into more modern cosmopolitan environmental
issues like waste management, litter, dumping of untreated toxic and or
radioactive material into public drains; sanitation, street trading and
hawking; obstruction to drainage systems, water generation, effluents, noise,
signage, advertisement, gardens and parks, etc.
The Government of Lagos State through the
Ministry of the Environment introduced the Cleaner Lagos Initiative (CLI)
backed by a recently passed Environmental Management and Protection Law (EMPL
2017).
Lagos State Government then awarded contracts to
the Visionscape Sanitations Solutions
Limited and its strategic partners for deployment of appropriately scaled
waste management infrastructure.
Visionscape Group executed a
Memorandum of Understanding on February 23, 2017 authorising the incorporation
of a Special Purpose Vehicle (“SPV”)
– the Municipality Waste Management
Contractors Limited for the purpose of issuing Medium Term Notes (bonds) to
finance implementation of the CLI.
Further to this, the Lagos State Executive
Council at a meeting held on March 21, 2017 passed a resolution to secure the financing structure adopted by
the Consortium to raise funds for the project via issuance of an Irrevocable
Standing Payment Order (ISPO) as a charge on the State Internally Generated
Revenue account/ Environmental Trust Fund.
The Note
In early 2018, Municipality Waste Management Contractors Limited approached the
capital market through registered and authorized technical parties to raise N4.85bn for the mobilization of assets
for residential and general waste collection under the Cleaner Lagos Initiative of the Lagos State Ministry of
Environment.
The Offer, with a nominal face value of N1, 000
per unit, opened on February 26, 2018 and closed on February 28, 2018. The Issue price was 100% of par value and
promised a coupon of 15.75% or N157.50 per unit.
The Note has the following additional features:
The Note is part of a larger N50bln Medium Term
Note Programme designed to raise money to address the environmental challenges
of Lagos State which presently generates an official average of 13,000 tonnes of solid waste daily.
Rating Agency, Agusto & Co noted in its
extracts of the Rating Report published in the Note’s Offer document that,
among other things, “the series 1 Note
Issuance is fully guaranteed by the Lagos State Government (“LASG” or “the
State”) in form of a duly executed Irrevocable Standing Payment Order (ISPO)
authorizing monthly deductions of N715. 7m from the State’s internally
generated revenue for the repayment of the entire series 1 Note obligation. The
assigned series 1 Tranche B rating (which is the same “A+” rating issued to
series 1 Notes by Agusto & Co in June 2017) therefore reflects the strong
financial condition of the Lagos State Government” (see extract image
below).
Figure 1: Extract of Agusto & Co’s Rating Report for
the Note
Source: Supplemental Information Memorandum, Municipality Waste Management Contractors Ltd
The Agusto Credit Rating report further goes on
to note that”
“In our
view, the Series 1 Note has a low credit
risk profile and strong capacity to pay coupon and principal in a timely manner
mainly supported by the continuous fulfillment of monthly ISPO deductions of
approved amounts by the Lagos State Government for the repayment of the
series 1 Note obligation”.
Legal Basis
According to Michael Orimobi in his September
29, 2011 published overview in Proshare titled “The Issuance of State
Government Bonds in Nigeria”, he avers that:
“The power of
State Governments to issue registered bonds (and promissory notes) is enshrined
in Section 223 of the Investment and Securities Act 2007 (“ISA”).
In issuing a
State Government bond, the requirements for obtaining the SEC’s approval are
provided for in Section 224 of the ISA and Rule 307 of the Securities and
Exchange Commission’s Rules and Regulations (“SEC Rules”) made pursuant to the
ISA. Section 224(3)(a) of the ISA provides that an application to the SEC by a
State Government to raise funds from the capital market shall be accompanied by
such documents as may be prescribed by the SEC, from time to time, and shall
include:
1. a Law
authorizing the bond issuance exercise and creating a sinking fund to be fully
funded from the consolidated revenue fund account of the issuer;
2.
a Rating
Report by an accredited Rating Agency registered with the SEC; and
3. an
Irrevocable Letter of Authority (ILoA) from the Accountant General of the
State, authorising the Accountant General of the Federation to deduct payment
obligations due on the bond from the issuer’s statutory allocations in the
event of a default by the Sub-national.
The Sinking
Fund simply refers to a fund into which an issuer sets aside monies with a view
to liquidating its debt instruments. The Sinking Fund can be funded through the
Irrevocable Standing Payment Order (ISPO) and or any other source of repayment
as discussed in the offer documents (in this case, the Bond Prospectus and the
Trust Deed). The ISPO established by reason of the ILoA is a credit enhancement
tool as it is backed by the full faith and credit of the Federal Government of
Nigeria. In other words, it improves the credit rating of the instrument and
enhances the attractiveness of the instrument to prospective investors.
However,
under Rule 107(6) of the SEC Rules, a State Government bond can be approved by
the SEC without an ILoA/ISPO E.g. the Lagos State N57.5bn Series II Fixed Rate
Bonds issued in April 2010 under the N275bn Debt Issuance Programme of the
State Government, was issued via a book building process to investors without
an ISPO. A fastidious examination of the provisions of Section 224(3)(a) of the
ISA creates an impression that deductions from the statutory allocation (ISPO)
should only crystallize when there is a default by the Sub-national in
liquidating the bonds from other sources of repayment. In practice, this isn’t
entirely correct. In fact, for most Sub-national bonds (if not all) that have
hit the Nigerian capital market in the recent past, the ISPO is the only or
major source of repayment. In other words, deductions from the statutory
allocation of the State kick-off immediately the offer hits the market and in
some cases, even before the offer hits the market.
In addition,
the Resolutions of the State Government’s Executive Council and Legislative
Assembly authorising the issuance of the bonds and published in the Official
Gazette of the State and the Feasibility Reports on the projects to be funded
by the proceeds of the bond issue are part of the documents that are sine qua
non for the SEC’s approval to be obtained. Moreover, the funding from the bond
issuance exercise and utilization of same should be captured in the provisions
of the state’s yearly budget during the bond’s tenor.”
Noteworthy must be the fact that this particular
bond was not approved by the SEC as it
was not presented to it. The transaction was considered a private
initiative and is equally permissible.
This is where it gets interesting and opens the
doors for governance issues around risks, pricing in defaults from ratings and
the window for an unwilling issuer to distort the market intent.
More importantly, and as we briefly show below,
the role/status of trustees as gatekeepers become crucial i.e. to be able to:
1. recognize the
place of guarantee on the Lagos State Govt revenue by being able to distinguish
between the use of FAAC vs. IGR as protection for investors; and
2. The sanctity
of contracts or recourse in the case of a contract dispute; if the bond was
‘condition precedent’ on a contract.
Matters Arising
The most important asset traded in financial
markets is trust. A financial transaction is priced and agreed on the basis of
trust concerning the underlying quality of the asset.
To establish that quality and to ensure a
credible metric by which an asset can be traded, especially if the Issuer of
the asset lacks a credible borrowing history, a Credit Rating Agency serves as
an assessor of the default risk of a debt instrument such as the MWMCL Fixed
Rate Note. Agusto’s ‘A+’ Rating of the Offer made the MWMCL Note eligible for
Institutional Investors such as Pension Funds to invest in.
It naturally therefore brings to the fore, a number of critical market governance issues:
Further, in a
letter dated 20th April 2017, and signed by the Director of Treasury Operations
and Permanent Secretary/Accountant General of the Government of Lagos State;
and addressed to Municipality Waste Management Contractors Limited, it was
stated that:
“Pursuant to the Lagos State Executive
Council Resolution (Ref. No.SSG/CO/S.126/VOL.XVI/60) passed on the Provision of
a Guarantee for the above mentioned contract, and following the execution of
State wide Residential and General Waste Collection Agreement between
Visionscape Sanitation Solutions Limited, and the Lagos State Government, and
under which Agreement the LASG is required to issue to the Contractor a
guarantee, I am directed to convey the approval for an Irrevocable Standing
Payment Order (ISPO) in respect of the above referenced Contract Agreement.”
The letter
goes on to read : “Consequent upon the
above, this office would implement the monthly remittance of the gross sum of
Seven Hundred and Thirteen Million, Seven Hundred Thousand Naira Only
(NGN713,700,000) as a first line charge from the revenue account of Lagos State
Government which is to commence in June 2017 and terminate in June 2027.”
The information memorandum (issued in lieu of a prospectus for private placements) sent out to prospective investors had included an excerpt from Agusto & Co (as indicated above) that relied on this comfort/guarantee wherein it stated that:
“We estimate that the duly executed ISPO on Lagos State’s revenue account constitutes sufficient security for the issue as the remittances…will be adequate to cover the cumulative obligations (coupon payments and principal repayments) of the Series 1 Note 1.03 times.”
AMORTISATION SCHEDULE | |||||
Period | Beginning Balance | Payment | Interest | Principal | Ending Balance |
0 | | | | | 4,850,000,000 |
1 | 4,850,000,000 | 772,355,741 | 381,937,500 | 390,418,241 | 4,459,581,759 |
2 | 4,459,581,759 | 772,355,741 | 351,192,064 | 421,163,678 | 4,038,418,081 |
3 | 4,038,418,081 | 772,355,741 | 318,025,424 | 454,330,317 | 3,584,087,764 |
4 | 3,584,087,764 | 772,355,741 | 282,246,911 | 490,108,830 | 3,093,978,934 |
5 | 3,093,978,934 | 772,355,741 | 243,650,841 | 528,704,900 | 2,565,274,034 |
6 | 2,565,274,034 | 772,355,741 | 202,015,330 | 570,340,411 | 1,994,933,623 |
7 | 1,994,933,623 | 772,355,741 | 157,101,023 | 615,254,718 | 1,379,678,905 |
8 | 1,379,678,905 | 772,355,741 | 108,649,714 | 663,706,027 | 715,972,877 |
9 | 715,972,877 | 772,355,741 | 56,382,864 | 715,972,877 | 0 |
Source: Supplemental Information Memorandum, Municipality Waste Management Contractors Ltd
Making Sense of Market Terms – Technical Default / Green Bond Debunked
Technical
Default or Delay
A few analysts making comments on the state’s
default of the March 5, 2019 Note payment that fell due had suggested that the
default was merely “technical”. This is a strange contrivance.
A Fixed Income Debt Issue usually requires that
the Issuing House draws up a debt amortization schedule. This schedule forms
the basis of the Trustees to the Offer paying coupon and principal sums at a
pre-agreed series of dates which in this instance is March 5 and September 5 of
each of the years up until the maturity of the Note on September 5, 2022.
A default on a Fixed Income Debt instrument
occurs when on due payment dates, the Issuer or Guarantor of an Offer cannot
meet up with the payments agreed in the Offers Amortization schedule agreed to
by all parties and to which investors were advised at the time of allotment of
units of the Note or Bond as the case may be. This is quite different from a “technical default” which according to Investopedia is: “a deficiency in a loan agreement that arises from a failure to uphold
certain aspects of the loan terms other than the regularly scheduled payments.
Technical default indicates that the borrower may be in financial
trouble, and can trigger an increase in a loan's interest rate,
foreclosure or other negative events”.
In other words a “Technical default” is no less
worrisome than a default in scheduled payments.
The safe middle is to look at this therefore as
a delay; as the issuing house may have the public believe.
We aver that the concept of payment delay is alien to the Fixed Income market. One would
immediately ask if the ‘potential delay’ was factored into the ‘A+’ rating of
the Municipality Note? Besides, how would investors calculate Bond or Note
yields in a market where yield dates are uncertain?
The NPV basis for Bond or Note pricing is basic
arithmetic and does not build payment delays into the equation. The
Municipality Note is not adjustable for coupons to compensate for payment
delays. It would therefore be interesting to know / hear the Issuing House’s
explanation of a structured payment delay
When is a
Bond or Note ‘Green’?
Green Bonds or Notes are typically debt
instruments raised to address issues related to the environment. Again
according to Investopedia a green
Bond is, “a bond
specifically earmarked to be used for climate and environmental projects. These bonds are typically asset-linked and
backed by the issuer's balance sheet, and are also referred to as climate bonds”.
The financial Note raised to clean Lagos under
the State’s Cleaner Lagos Initiative (CLI) is
a Municipality Note and NOT a Green Note.
Statistics on Green Bond Issuance in 2017 showed
a total global bond value of $155bn and somewhere above $250bn by 2018. The
green bond initiative is undoubtedly growing exponentially around the world.
The problem with the Lagos Note is not about the concept, its fit or
description but the execution of the natural intent.
Once the model built to
support the sinking fund was upended; the early signals kicked in with the
suspension of payments from the Lagos State Government into the sinking fund
after the September 5, 2018 payments to date; a figure we estimate at slightly
above N1.1bn.
Keeping the Market Safe
Nigeria’s Fixed Income Investment market is the
most plausible route to speedily redress Nigeria’s infrastructure gap.
It holds a lot of promise and it is in this
context that it has become uncompromisingly important for market participants
from operators to regulators, investors, governments and financial media
practitioners to ensure that the Fixed Income trading space remains a bastion
of transparency, integrity, efficiency and trust.
According to an operator close to the Note
Issue, but who requested for anonymity, “we
cannot allow the Fixed Income market’s ethics get kicked about like a rubber
ball. For the market to achieve its development goals it must be treated with
decorum. An Issuers word must not only be law; it must be the Holy Grail”,
and we agree totally.
It may be in this regards that feelers from our
follow-up investigations on the MWMCL Note default situation suggest that the Lagos State Government will fund the
Sinking Fund Account by Monday 11, March 2019 and that Note investors will begin
to receive payments from next week.
We hold out the belief that this will be
discharged as intended and that parties meet thereafter to address the fallout
and take steps to get back on track.
You can follow our coverage and data records on State Bonds via Proshare MARKET’s Bond.
For further details about this story, kindly
send an e-mail to content@proshareng.com or/and info@proshareng.com
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