Markets
Why it makes sense for FBN to recall the 8.25% $300m Subordinated Callable Bond
NSE has just been notified that FirstBank intends to exercise its option to redeem the fixed rate Note held by FBN Finance Company BV.
The Nigerian Stock Exchange has just been notified that First Bank of Nigeria, the largest subsidiary of FBN Holdings plc, intends to exercise its option to redeem the fixed rate Note held by FBN Finance Company BV before its maturity date.
In exercising its option, the company intends to call the $300 million 8.25% subordinated Note raised from the international debt markets. The notes which were to mature in 2020, without the call option, will be called and repaid on August 7, 2018. According to the SEC filing, the objective of this corporate action is to manage the company’s liquidity as well as enhancing the efficiency of the bank’s balance sheet.
As a recap, a callable bond is a bond that grants the issuer the option to redeem or repay the principal of the bond before its maturity date. Different factors such as prevailing market rate determine whether an issuer will call a callable bond or not, so it is not always that a callable bond gets called. Now that FBN Holdings has decided to call the bond, the question is, does it make economic sense to do so, if yes, why?
We strongly feel that this corporate action is a smart move on the part of FBN to call the bond and here is why:
Strong Balance Sheet
FBN Holdings has a strong balance sheet and the cashflow to effectively redeem the bond. According to its March 31, 2018 financial statement, FGN Holdings has N1.4 trillion in its cash and cash equivalent at the end of the period which translates into $3.9 billion at a conservative exchange rate of N360/$. This is more than enough to execute the bond redemption and continue to grow the business.
Saving on Interest Expense
This callable bond pays 8.25% annual interest which amounts to about $24.75m annually. Fortunately for the bank, yield has been falling globally with some countries recording negative interest rates.
For example, the yield on the US 10-year Treasury note stood at 2.8327 percent on Friday, July 5th, 2018, although there are projections by analysts in the US that the rate will most likely spike to between 3.5% and 3.75% by the end of the year. There is therefore no gain for FBN to continue to pay 8.25% on the bond when the market interest rate has fallen to around 2.85%. Even if the Holdings Company does not have enough cash to redeem the bond, it makes economic sense to refinance it with another bond that pays far less in coupon interest.
Therefore, by redeeming the bond, FBN will be saving about $24.75m yearly August 8th 2018 to 2020 assuming that there is no alternative investment that would yield more than 8.25% to the company. In addition, having so much money in cash that pays minimal interest while paying 8.25% on callable Notes will have negative impact on the company’s balance sheet and as such, redeeming or calling the Note is quite a smart move.
Pricing Action Suggests Investor Readiness for a call
Ordinarily, as bonds head to maturity or expected call date, they undergo what is usually known as “pull to par or pull to maturity or pull to call”, which is the tendency for prices to trend towards par value unless there is a high likelihood of default, in which case, the price of the bond trades at discount to par. Pricing action for this Note suggests that investors were expecting a call. It may not be a thing of surprise to institutional investors that FBN Holdings is calling the bond as price analysis shows that the bond was being priced very close to par.
According to available pricing information, the bond was priced at 100.1(which is very close to par of 100) on July 5th, 2018 suggesting that institutional investors and analysts were pricing the bond in anticipation of a possible call.
So, on the basis of the above, we feel very strongly that FBN’s decision to call the Note is a decision in the right direction.
Markets
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The market closed beneath expectation as JAPAULGOLD led 15 Gainers, and 20 Losers topped by CUSTODIAN.
Market Views
With rising bond yields and foreign reserves, will the CBN finally tackle inflation?
A flurry of large corporate debt sales is also underway led by MTN and Dangote Cement which could take out NGN200billion.
Bond yields revved up over the last one week driven by sell-offs on auction bonds (in particular the 25-year) where yields crossed 13%. Though the Q2 2021 bond auction calendar points to a modest increase in borrowings by the DMO, the underlying driver of the sell-off appears to be forced liquidations of excess short-money positions from the March 2021 bond auction, amid another short-lived strain in the banking sector liquidity.
Liquidity squeeze across money markets drive money market rates higher: The step-down in OMO maturities over April implied that money markets were heading into a tight liquidity period. Unlike the usual NGN200-300billion weekly maturities, April opened to only NGN49billion in OMO maturities which implied tight funding positions across. Accordingly, interbank lending rates spiked to 30%, and though this subsequently receded, it remained in double digits. Placement rates for large institutions have moved to 7-8% from 0-1% levels at the start of 2021.
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‘Margin calls’ trigger sell-offs on the 25-year, resets curve to December 2019 levels: The steepening along the Naira yield curve resumed last week with an average increase of 41bps (YTD: +439bps) driven by over 120bps jump in the 25-year bond (2045). As I noted in my review following the bond auction, the DMO overallotment meant that everyone who needed a bond got on including speculative bids from short-money accounts (brokers). The overallotment resulted in these short-money winners having more bonds than their leverage financed positions could have permitted implying these excess positions needed to be sold off. Unfortunately, the over-allotment meant limited secondary market demand at current yield levels. Compounding the situation was the funding squeeze across the banks, who now applied pressure on these short-money positions to exit these auction bond positions (a sort of margin call). As consequence, these 2045 bond auction winners soon turned into desperate sellers and flooded the market with offers seeking to hit the bids. Above 13%, demand predictably returned and helped calm markets. Beyond the 2045, there were limited desperate offers on the other tenors which has resulted in a mispricing that should adjust in the coming days. The lesson here is in a tight liquidity environment as we are moving towards, bond auction over-allotments hold the risk of sell-offs by short-money traders.
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Figure 2: NGN Yield Curve
Source: FMDQ, NBS
Q2 2021 Bond calendar: The Debt Management Office (DMO) released the Q2 issuance calendar wherein it will seek to borrow between NGN450-540billion with the upper end pointing to an extra NGN90billion worth of sales. In my opinion, the bond calendars are not indicative of the evolution of actual borrowings as the DMO has shown a pattern of being highly sensitive to market liquidity conditions (with overallotments in coupon heavy months and under allotments during tight spells) while making maximum use of non-competitive bids. For evidence look no further than in Q1 2021 when the DMO sold bonds with face value of NGN637billion well above target of NGN450billion. Perhaps surprising is the planned re-opening of the 2049s at the May auction which looks odd but could indicate the existence of a large non-competitive bidder who wants the tenor.
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FX reserves continue to track higher, Eurobond conversations get underway: Foreign reserves continued to rise, up 0.6% w/w to USD34.9billion which suggests the impact of higher oil prices is starting to feed through. This comes just as news of parties being appointed for a Eurobond sale gathers steam. Depending on the size, and I expect a record sale, near term foreign reserve outlook appears positive. Throw in the upward adjustments in interest rates and moves to cultivate remittance inflows, Naira outlook appears on less shaky footing than in recent times. On this wise, the currency continues to hold around the NGN410/$ handle in the NAFEX window (Friday: NGN409/$) and NGN482/$ at the parallel market.
The Week ahead (April 12-April 16, 2021)
In the week ahead, system inflows are thin comprising OMO bills (NGN10billion) and NTB maturities (NGN70billion). As such there will be an NTB auction on Wednesday and possibly an OMO sale on Thursday. In keeping with the trend in recent auctions, the 1yr will likely take another step closer to parity with the OMO bill with a potential stop rate of 8.5-9%. A flurry of large corporate debt sales is also underway led by MTN and Dangote Cement which could take out NGN200billion. Funding pressures will continue to force banks to reduce trading positions but on a lesser scale than in the prior week. In terms of data releases, the NBS should announce the March inflation numbers.
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Inflation likely accelerated in March to over 18%: The National Bureau of Statistics (NBS) looks set to publish the March 2021 inflation numbers. Though fuel prices have stabilized after Nigerian authorities elected to continue working out a resolution with labour unions, food prices have continued to accelerate over the lean season. Though monthly trends likely remained sticky, the year-on-year comparison still points to over 20% increases in food prices which cover over half of the CPI basket. With this in my mind, my expectation is for the headline print to come in at 18-18.2% with the monthly print at 1.55-1.58%.
Term premiums have started to moderate reflecting the NTB re-pricing but the next big move on interest rates is the May 2021 MPC with the key data point of Q1 2021 GDP. In the event, Nigeria consolidates on the exit from recession with a positive growth read, then I expect the CBN to hike monetary policy rates by 200bps accompanied by an upward adjustment in the 1-year OMO and May 2021 SPEB maturities to at least over 12-13% levels as a first step towards managing inflation expectations.
