Investors’ demand for utility bonds exceeds supply

The infrastructure bond worth Sh14.5 billion was concluded last Wednesday having been heavily subscribed as many institutional investors came in with hefty bids after weeks of keeping away from the short-term, low-return treasury bills.

Because of appreciating the fact that demand was quite high many investors quoted low expecting that others would quote even lower. The subscription finally hit 243 per cent.

The average return on the bond will now be 9.6 per cent which is lower than the annual interest income of 9.75 per cent – indicating that the price the investors will obtain the instrument at will be quite high thereby leading to a lower final return.

Indeed, due to demand from institutions in the past year, interest (or coupon) rates offered on primary bonds has gone down and the eight-year bond offering 9.75 per cent annual interest income on outstanding amount which is three percentage points below another eight-year bond issued in 2007.

A 2006 bond of the same maturity was issued at 13.25 per cent coupon (interest) rate, an indication that interest rates on bonds have been coming down in the past four years.

Although the two bonds were similar in the length of their maturity -- eight years, they were not infrastructure types which are issued without investors being required to pay withholding or income tax meaning that the return (or yield) is higher – somewhat compensating for the lower coupon rate.

Except for last week, the T-bill is being avoided – considering its consistently low subscription rate – because the returns are currently hovering between 6.2 per cent for the 91-day and 7.3 per cent for the 364-day paper against interest rates in excess of nine per cent annually for most of the treasury bonds.

The government offered the latest bond after seeing the success with the first infrastructure bond.

Central Bank’s debt department said in the invitation for subscription in the new offer: “Building on the market confidence in Government securities and public goodwill in supporting infrastructure development, the Government proposed to raise Sh32.9 billion in the financial year 2009/10 through Infrastructure Bonds issuance to fund targeted projects in Roads, Energy and Water sectors.”

Many analysts and investment banks had advised their clients that the bond was a good buy even before it officially came into the market.

One such was Dry Associates Investment Bank which extolled the tax-free advantage of the bond.

It asked its clients to buy the bond noting that it was also tradable at the stock market thereby providing liquidity.

“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,” said a note from the investment bank.

Mr Fred Mweni, chairman of the Bond Dealers Association, said earlier that he expected the results to show an oversubscription because of the demand on the instrument as was the case with previous bonds.

The bond was floated recently by the government as a way to raise funds for major projects that could not be adequately using tax revenue.

The proceeds will be utilised as follows such that Sh3.5 billion (or 24.14 per cent) towards arid and semi-arid areas (ASAL) flood control and irrigation, Sh8 billion (or 55.17 per cent) towards ongoing construction of new roads, overhaul of civil works and purchase of plant equipment; and Sh3 billion (or 20.69 per cent) to finance ongoing projects in Geothermal Resources Exploration and Rural Electrification in the Energy sector.

Because of the demand for fixed-income instruments, their prices has shot up thereby pressuring down returns as interest rates on upcoming issues progressively move downwards.

In a research note of last week, Faida Investment Bank revealed that the bond market was experiencing vibrant trading in the longer-term bonds drawing attention to the fact that the benchmark 15-year bond turning over Sh3.4 billion ($44 million) against Sh2.7 billion ($34 million) the previous week, representing a 26 per cent rise.