Bonds Bondage, Sanusi On Point!!

Yesterday, the CBN Governor cautioned on the likely threats the FGN Bonds possess on the banking system. To put this into perspective, interest rates are closely related to bond yields and as such will remain high just as bond prices tank.

Sanusi’s worry is that the plethora FGN Bonds with seemingly cheap coupon rates that fall below the inflation rates is a recipe for disaster for the Nations banks as they are not real.

Here is how it works, a Government can issues Bond notes of N1b denominated in 1m N1,000 notes. Each N1,000 notes will carry a coupon of 6.5% (as is with the 10-20 year bond Series). So any bank that possess a Bond note expects to receive N65 per annum. However, just like stocks, bond holders do not expect to hold this bonds till maturity meaning(20 years) they are traded in the bond market everyday. So if a Bank holds a note that pays 6.5% and knows the inflation rate is 13.5% automatically the interest of 6.5% is eroded by the inflation rate and is only worth 0.87% (6.5% * 13.5%). What happens next is that the price of the bonds drop as holders realize it’s worthless. Consequently, it increases the Bond yield considering that it has to match or be above inflation to break even. Thus for the yield on the bond to be at par with inflation the price of a Bond will have to be N481.

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Now imagine a bank that has N1b of this Bonds, it will automatically be worth just N481m as the market price. Thus loosing about N581m for holding the so called “safe” FGN Bonds. Based on this, the CBN Governor has every right to be worried as this is enough to bring down the entire banking system. Already it is said that the banks hold close to N1 trillion of Bonds, which is about 59% of their combined capital.

The red flag is out there and Sanusi is on point this time to sound the warning.