Nigeria – Fixed Income Weekly

The week that was (August 7-11) – Finance Minister announces NTB refinancing plan

  • Tight liquidity conditions push benchmark NTB yields higher: Liquidity conditions were tight last week with OBB/ON rates closing at 55.8-59% from 22-22.5% in the prior week. As in prior weeks, CBN continued its assault on system liquidity with net OMO issuances of N83.4bn which heaped pressure at the short dated Nigerian Treasury Bill (NTB) yields up: 91-day (up 120bps to 20.2%) & 182-day (up 120bps to 20.5%) while the 364-day slid  50bps to 22.3%.
  • Finance Minister announces a US$3bn NTB ‘switch’ plan: On Wednesday night, the finance minister, Kemi Adeosun, announced that the FGN, after its FEC meeting, had approved a plan to refinance about  US$3bn (N900bn-N1.1trn) worth of NTBs via the issuance of 3-year US$3bn bonds in 2018. Effectively, the plan would seek to reduce outstanding NTB maturities (Q1 2017: N3.6trn) by roughly 30% and is aimed at reducing interest burden. In Q1 2017, FGN paid N474bn to service domestic debt outstanding of N11.9trn using data from the CBN which implies an annualized interest rate of 16%. Though the bulls briefly gained ascendancy on Thursday morning with yields dipping across the yield curve, prices corrected as markets continued to expect the impact of elevated paper supply from the CBN to continue to offset the impact of shrinking FGN debt issuance.
  • Bond bears maintain ascendancy: As the bond market continues to recover from the settlement system issues, traders are waking up to the realization that thinning liquidity (read demand) at the deep end of the yield curve is here to stay. The low demand for longer dated instruments, amid higher interest rates at the short end, and a bull run in equities continued to underpin bearish sentiments in bonds. Thus, bond yields rose on average 8-10bps driven by sell-offs at the 7&10-year (where yields climbed 24bps) and  15-20-year(up 15bps).

In summary, in a quiet week, CBN induced liquidity crunch induced higher yields at the short end while low demand for bonds worked to push the yield curve higher.

The week ahead (August 14-18 ) – Muted impact on yields from NTB refinancing plan  

  • In the week ahead, the FGN would seek to rollover N62bn at the Wednesday NTB auction and there is no OMO maturities. In terms of events, the NBS has announced that it would delay the release of inflation data for July to late August. The release would be accompanied with Q2 17 GDP numbers which according to the NBS should show Nigeria out of recession.
  • How will the refinancing plan impact yields? The key to dimensioning impact is to note that the plan seeks to reduce 30% of outstanding NTBs. Now NTBs on average account for 30% of total debt service costs (2016: 26%, Q1 2017: 20%). In Q1 2017, NTB debt service payments amounted to N102bn (2016: N336bn). Now assume all things remain the same over the rest of 2017, the proposed 30% cut implies a N31bn slash in quarterly NTB debt service and by extension N93bn per annum. Now the FGN would refinance this with a US$3bn bond issue in 2018 at 7-8% which translates to extra debt service costs of US$225m per annum (N69b using N305/US$). Assuming one uses the current interbank rate N366/US$, an event which is likely in 2018 as nearly every single FX rate now hovers between N360-370US$, the incremental debt service cost rises to N82bn. So effectively depending on which exchange rate is applicable over 2018, the plan saves only N11-22bn (1-2% of budgeted 2017 debt service cost). In summary, the savings from the NTB refinancing plan are negligible.
  • This reason behind the minuscule nature of the gain from the finance ministry’s plan is that it does not address the two elephants in the room. Firstly, the plan does not tackle FGN bonds which account for over half of debt service costs (2010-16 avg: 51%, Q1 2017: 68%) without which it’s hard to lower debt service costs. In addition, CBN’s record paper issuance in the last two years has underpinned much of the rise along the yield curve.  In 2017, the CBN has net issued N1.95trn OMO bills alongside N1.1trn in Stabilization Securities relative to net FGN borrowings (NTB and bonds) of N1.58trn.

Therefore, in the absence of a switch to dovish monetary policy which would see the CBN turn from net issuer to net re-payer status, thin system liquidity is going to keep NTB yields stuck in the 19-23% range while bond yields are likely going to test new highs. I leave with a chart below on average rates the FGN pays on NTBs, FGN bonds and US$ debt.  

Estimated Interest rates on FGN debt components

Estimated Interest rates on FGN debt components

Source: DMO, CBN *Q1 2017 annualized

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