State set to launch eight-year infrastructure bond

Long-term institutional and retail investors have yet another opportunity for tax-free bond offer with an eight-year infrastructure bond scheduled to be rolled out this month.

While investors will also be in a position to diversify their holdings away from other types of investments such as the volatile shares market, they will save 15 per cent withholding tax as well as 30 per cent income tax in the case of institutions thereby raising their individual returns.

A similar bond was offered last December, the second such offer in 2009 following an earlier one in February.

There is a possibility of the coupon (interest) rate on the coming bond being lower because similar rates on the Nairobi bourse have been going down, even though commercial bank lending rates have hardly moved.

In an advisory report, Dry Investment Bank said: “The next tax-free government infrastructure bond is expected in February 2010…We recommend purchase of this bond for current Kenya shilling income. These bonds also trade on the secondary market so investors should be able to exit these bonds relatively easily.”

Mr Timothy Karanja, a senior investment analyst at the Investment Bank, said that he expected the take up to be high given that interest rates on the alternative investment vehicles like Treasury bills that are only up to a year in maturity (occupying the so-called shorter end of the yield curve) are in decline.

“Investors would rather lock their investments in the higher rates of the bonds because the yields on the shorter end are really going down,” said Mr Karanja.

He said that foreign interest in the Kenyan securities market was also likely to be a factor in the subscription enabling higher take up. In the equities market, foreign investors have also been seen as key to the rise in the price of the blue chips.

Going forward, even long-term interest rates such as that of bonds are likely to decline, he explained, making it all the more necessary to grab whatever was currently available in the market.

The market leaders meeting held on Tuesday is said to have approved the issuance of the debt security intended to finance long-term projects.

In an interview before the meeting, the chairman of Bond Traders Association, Mr Fred Mweni, said that it was expected that the coupon rate would be lower given the falling yields at the secondary market in the last few months.

“The interest rates on the secondary market have drastically come down from 13.85 per cent in March 2009 to 12.5 per cent on September 2009 to 9.75 per cent today,” said Mr Mweni.

In the 2008/9 budget, the government removed the 15 per cent withholding tax for investment in government bonds.

A similar incentive was extended to corporates and other institutions doing infrastructure projects such that the tax came down to 10 per cent on interest arising from long-term bonds of 10 years maturity and above.

The expected coupon rate of the coming bond could be as low as 9.75 per cent which is much lower than the 12.0 per cent coupon rate of the second issue.

The second offer itself was also a reduction from 12.5 per cent coupon of February 2009, as the Central Bank of Kenya (CBK) increasingly sought to bring down interest rates.

The first and second infrastructure bonds had maturity period of 12 years.

In terms of a previous offer of the same eight-year duration, the expected rate will be three-percentage points (or 300 basis points) below.

The last eight-year treasury bond was in February 2007 and was issued at 12.75 per cent coupon at a time the government was battling rising long-term interest rates.

The CBK has already expressed its frustration in bringing down commercial bank lending rates even though it has been relatively successful in reducing short-term rates such as T-bills, interbank rates and repo rates.

Hardly any commercial bank has brought their rates significantly down despite the reduction of the Central Bank Rate (CBR) to 7.00 per cent from a high of nine per cent at the end of 2008.

In the past two auctions of the infrastructure bond issues, the government was seeking for Sh18.5 billion in each case but received much more in terms of bids.

In the first offer of February 2009, the government received Sh27 billion worth of bids while in the second offer of December it got Sh44 billion in subscriptions.

In a recent report, Kestrel Capital said that liquidity generated from the reduction of CBR and the cash reserve ratio is “largely responsible for the increased liquidity in the fixed income market… The primary and secondary debt markets have been very liquid especially on the longer end of the market. Longer term bonds are now in “vogue” as funds and banks snap up any long term bond that is available in the market.”

According to Mr Mweni, the coming bond is expected to be the bullet type which means that the principal investment of a minimum of Sh100,000 will only be paid at the end of the period rather than in instalments.

Interest would however be paid either semi-annually on the basis of the outstanding balances like in the previous offers.

This can be contrasted with the first two infrastructure bonds that were amortised in the sense that the principal was paid at intervals.

In the first bond, the first instalment comes in 2015, the next in 2017 and the final one in 2021 while in the second bond, the first instalment is to be paid in 2015, the next in 2018 and the last one in 2021.

The logic of the amortised payment structure is that investors with a medium-term horizon are able to recoup a significant amount of their investment before the expiry of the life of the bond.

Another feature of the bonds is that an investor can go to the CBK and have them rediscounted such that they get repaid the invested amount although at a much lower price – indicating that the investor would get less than would have otherwise been the case if he had waited till maturity.

The investor would seek this opportunity in a situation where he urgently needs liquidity and cannot get a buyer of their bond from the secondary market at the Nairobi Stock Exchange or the price is lower than the rediscount rate.

The CBK offers a rediscount rate of three per cent percentage points above the prevailing secondary market yield meaning that the investor gets a lower price for his asset.