Lower bond price leaves mixed signals in market

Unveiling KenGen’s public infrastructure bond: Large investors have shown an appetite for offerings on the bond market. Photo/CHRIS OJOW

The Central Bank has shrugged off a recent decline of investor interest in government debt to price the latest issue of infrastructure bond at six per cent, making it the largest and cheapest bond ever in the market.

The Sh31 billion nine-year bond, which comes with a three per cent discount for early exit, marked yet another signal of the CBK’s preference for lower lending rates and is expected to become the benchmark for upcoming corporate bond issues in the coming months.

By pricing the bond at six per cent, the CBK is hoping that the latest offer will renew investor interest in government paper after nearly four weeks of waning take up even as it leaves room for the state to raise cheap cash to finance its budget.

Success of the government’s largest fund raising initiative will however depend on the level of liquidity in the market and the existence of attractive options in the near term.

Discount and interest payments for the nine-year amortized bond, with a 6.0 per cent coupon are tax exempt.

And at six per cent, the latest infrastructure bond is priced at half the 12.5 per cent rate that the government offered buyers of a similar bond last year.

Tax exemptions that come with the infrastructure bond are expected to add a sweetener to the offer but the jury is still out as to whether investors will be willing to pump cash into the bond or hold on to it in wait for upcoming corporate issues.

“Based on the current yield curve, this infrastructure bond might be well priced. However interest rates have fallen to record seven-year lows and the market is beginning to demand higher premiums from the government,” said a fund manager who cannot be named because he buys government bonds.

The deep cut in the pricing of the bond comes after nearly a month-long steady decline in subscription rate for government paper that dropped to a new low in the run up to last week’s vote.

The government’s ability to cherry-pick whose money to accept in the first six months of the year has pulled down the market’s indicative rate substantially, forcing the banks to respond with cuts in deposit and lending rates.

CBK data, however, shows that in the past four weeks, investors have been showing signs of low yields fatigue and have slowed their participation in debt paper auctions — causing a steady decline in the volume of subscriptions.

The government attained a 61 per cent or Sh3.6 billion subscription rate for the 182-day Treasury bill against a target of Sh6 billion during last week’s auction – the first under subscription in 20 months.

Investor interest in the 91-day T-bill was much better at 101 per cent subscription rate that netted Sh5.1 billion against a target of Sh5 billion.

The take-up rate was however less than half the 338 per cent realised in the first week of June.

These low yields for short and medium term securities are expected to make lending to government less attractive for commercial banks intensify the drive for private sector and household lending where the returns are much higher.

Although the CBK has stayed on the expansionary monetary policy path aiming to make credit affordable to a larger segment of the population, analysts warned it could turn into a double edged sword by making it for government to realise its borrowing targets.

The government plans to borrow Sh109 billion from the domestic market this year but the low rates are expected to push banks – the biggest fixed income investors – to seek out higher yielding investments in alternative segments of the market.

The recent decline in subscription rates has been seen as signalling a tightening of liquidity in the market that can only accelerate with the infrastructure bond auction and trigger upward movement of interest rates.

Benchmark offer

Performance of the infrastructure bond is expected to offer clear signals on the investor appetite for long term debt and serve as a pricing benchmark for similar private sector debt in the coming months.

Should the ongoing decline in subscription rate continue, analysts said the CBK will have to pump more money into the market or adjust its pricing upwards triggering a rise in the pricing of private sector bonds, a rise in bank deposits rates and ultimately higher lending rates.

“The CBK might need to pump liquidity into the market to ensure that this offer is fully taken up,” said Resa Imbuye, the head of research at Co-op Trust Investment Services Ltd.

Mortgage financier Housing Finance (HF) is expected to float a Sh10 billion bond next month — the first corporate bond of the year.

Safaricom is also expected to float Sh7 billion in the second tranche of its corporate bond while hotel chain TPS Serena will add another Sh1.2 billion later in the year.

Pricing of these bonds are yet to be finalised but it has become clear the arrangers of the offers will be keenly watching the take up of the latest infrastructure bond to gauge the market’s appetite for longer dated fixed income securities and more importantly; the price.

A decline in cost of funds (deposit rates) has been the main driver of the recent cuts in lending rates contrary to the common belief that they are responding to the Central Bank’s signal as expressed through the CBR cuts.

Last month, the CBK slashed the CBR by 75 basis points from 6.75 per cent to 6 per cent staying with its long held fight for lower lending rates.

Official statistics show that banks have been gradually cutting the deposit rates for the headroom they need to cut lending rates in the fight for the loans market with ongoing economic recovery.

In the short term, low interest rates should also erode the huge gains that cash rich companies such as Safaricom and East Africa Breweries made from interest incomes when banks offered their corporate customers deposit rates of between 10 and 11 per cent.

Last week, the bench mark 91-day Treasury Bill rate dropped to 1.69 per cent from 7.3 per cent last December pushed by heavy oversubscription of the auctions.

That also helped the average deposit rate fall from five per cent in January to 4.54 per cent in the first week of August, according the Central Bank of Kenya.

Banking executives however said the deposit rate dropped to below four per cent with the aggressive cuts in lending rates since April.

Compared to last year when Kenya’s capital markets generated a Sh36 billion investment opportunity for those with cash through corporate bonds, only a private placement by cement maker Athi River Mining of Sh1.2 billion came through in the first half on 2010.

PAYE Tax Calculator

Note: The results are not exact but very close to the actual.