Meristem reports that the Federal Government of Nigeria (FGN), through the Debt Management Office (DMO), will be conducting a bond auction on Wednesday 18th of August 2021. The indicated total amount to be on offer is NGN150bn. All instruments on offer are re-opening issues.
13.98% FGN FEB 2028 NGN50bn.
12.40% FGN MAR 2036 NGN50bn.
12.98% FGN MAR 2050 NGN50bn.
Current Yield Analysis
The Debt Management Office (DMO) held its monthly auction in July 2021 where it offered NGN150bn on the 2028, 2035 and 2050 instruments collectively. The instruments on offer were oversubscribed with bid to cover ratios of 1.13x, 1.47x, and 3.13x across the 13.98% FEB 2028, 12.40% MAR 2036 and 12.98% MAR 2050 instruments respectively. This is reflective of robust investors’ appetite despite persistent high inflation and the consequent
negative real returns.
At the coming auction, we do not expect stop rates to trend higher as we think that the federal government is less inclined (relative to much earlier in the year) to borrow domestically. Our thoughts are based on two main factors.
Firstly, the government’s plan to raise USD6.20bn in Eurobonds implies that c.87% of outstanding deficits (including deficit from the supplementary budget) can be financed with proceeds of the issuance, leaving c.13% to be financed via local borrowing. Furthermore, the ease in production cuts which took effect in August 2021, should translate to higher oil receipts and a generally better revenue outlook over the near to medium term.
Meanwhile, in the secondary market for FGN bonds, average yield moderated to 10.93% on 16
th August 2021 from 11.45% (recorded on the date of the last auction). In our opinion, the bullish streak reflects strong investor demand and liquidity, in addition to a general expectation of sustained decline in interest rates over the near term.
Bond Absolute and Relative Valuation
In valuing the 13.98% FGN FEB 2028, 12.40% FGN MAR 2036 and 12.98% FGN MAR 2050 re-opening offers with the current yield curve as the basis for discounting, we arrived at the following fair value, implied yield and an IRR for the instruments:
Instrument Fair Value Implied Yield IRR
13.98% FGN FEB 2028 109.25 11.90% 5.95%.
12.40% FGN MAR 2036 96.40 12.95% 6.47%.
12.98% FGN MAR 2050 101.33 12.80% 6.40%.
Our valuation gives a fair-trading price ex coupon payment, the expected return on the bond considering its periodic interest payments and the expected return on the bond’s periodic payments. We analysed the issues on offer given the current yield environment, market liquidity, as well as a review of the recent past auctions, whilst also introducing market sentiment factor into our valuation, on which we advise bid yield ranges for the issues on offer.
A bond is a fixed income debt instrument issued by the government (federal or state government) or corporate institutions with a definite date of maturity and a fixed interest payment (known as coupon) payable either semi-annually or annually. Unlike equities, bonds are issued with a guarantee of the initial investment and can have tenors as long as 20 years. A treasury note refers to a government bond instrument with a term to maturity of
1 to 10 years while a treasury bond has a maturity of 10 years and above. Bonds issued by state governments of a country are referred to as municipal bonds while those issued by organizations are corporate bonds.
The government usually issue bonds at the primary market to raise domestic funds to meet its fiscal responsibilities. This can be done from time to time as the need arises. Nigerian FGN bond instruments are named by their maturity, coupon, tenor etc. such as 13.05% FGN AUG 2016 instrument.
How is Return Determined?
Bonds are mostly issued with a coupon otherwise known as the periodic interest payable. Bond instruments are usually issued at par; that is, N100 or N1,000 as is the case with Nigerian bonds. A 2-year bond issued at 12% annual coupon with a par value of N1000 implies that the issuer will make 3 semi-annual payments of N60,
and a final N1060 on the maturity date.
Bonds can be purchased at both the primary and secondary markets, they are either quoted in price or yields. There is an inverse relationship between the price of a bond and its yield to maturity (YTM). At issuance, the yield on a bond instrument is most likely the coupon on that instrument. At the secondary market therefore, an investor can trade bonds by quoting a yield that reflects the variance between the par value and the current price based on the current market dynamics.
How does the Auction Process work?
Bond instruments are issued through a competitive bidding process at auctions as conducted by the Debt Management Office which serves as the representative of the government. An existing government instrument can be re-issued also at the primary market in which case the DMO re-issues based on the current market yield
to maturity. Bonds are auctioned at established rates which determine the return to investors.
Purchasing these instruments in the primary market and holding it till maturity would mean that the investor gets a fixed interest payment, however, there is a secondary market in which investors can trade these bonds to meet their immediate liquidity needs.