Investors shun banks as bond sales boom

By Morris Aron

You want to raise money to expand your business? No problem; just issue a bond at the Nairobi Stock Exchange.

Alternatively, if you are an investor who does not want to meddle around in risky investment alternatives, until the economy bounces back, try Government securities.

This seems to be the new business wisdom as seen in increasing interest in Government and corporate debts in the last couple of months.

Central Bank of Kenya said it recently, the oversubscription of KenGen bond confirmed it and now it is the talk of town as several companies join in the merry-making.

Fixed security dealers say the growing interest is not about to ease soon, unless inflation trends are reversed, banks raise their deposit rates and the cost of borrowing drops significantly in the short-term.

Steady recovery

And so, as the bourse undergoes a slow and painful, but steady, recovery, the bond market is quickly emerging as the new cash cow.

"Investors who had their money with banks for safe keeping as they wait economic recovery have been shocked to learn that they only earn between 2 per cent and 3.5 per cent on their deposits," said Mueni.

"As a result, many are looking for options that can guarantee a fixed and tidy sum of returns on their investments irrespective of how the economy behaves."

Estimates indicate that deposit rates have dropped from five per cent to three per cent since half-year results showed rising non-performing loan book portfolio while piles of idle cash mounts in their vaults.

Investment analysts are also attributing the latest craze to the fact returns from bonds—though normally lower--are fixed over a given time period and as such a good idea when the economy is in shambles.

Other players point to the incentive stemming from Finance Minister Uhuru Kenyatta’s decision to reduce withholding tax from 15 per cent to 10 per cent on bonds with at least a 10-year maturity in order to encourage long-term investment.

And for a while now, the market is responding.

Preliminary results from the KenGen public infrastructure bond offering indicated the power utility firm issue surpassed its target by 33 per cent.

Provisional results from the transaction advisors showed KenGen raked in over Sh20 billion against a target of Sh15 billion.

Following the development, KenGen is looking to lock in the additional Sh5 billion against a target of Sh10 billion it expected to raise under the "green shoe" option.

Green shoe is an underwriting agreement that gives the underwriter the right to sell investors more shares than originally planned by the issuer.

Housing financier Shelter Afrique’s Sh1 billion Bond, which concluded recently, also posted eight per cent oversubscription. Shelter Afrique raised its funds through fixed- and floating-rate notes.

The raw fortunes in the bond market have seen other companies join the fray as a source of development capital.

Telecommunications firm Safaricom has also launched Sh12 billion Bond. Safaricom’s first tranche of Sh12 billion corporate bond was launched last week.

This is the second time Safaricom is coming to bond market after the Sh4 billion note issue in 2001, which the principal was repaid between September 2003 and March 2006.

The joint lead managers and book runners for this issue, which will be issued in tranches are Barclays, ABSA Capital, CFC Stanbic and Kestral Capital. The firm’s Chief Executive Officer Michael Joseph said during the launch last week that the offer for the initial Sh5 billion tranche closes on October 29, while the allocation will be done a day later.

The fixed rate note will have a coupon rate of 12.5 per cent, while the floating rate coupon will be 185 basis points above the prevailing 182- day Treasury bill.

Safaricom is seeking more cash to pump into the 3-G high speed data network, fibre optic cable and Wimax investments as well as put up more base stations.

And banks too are learning from the development. Barclays Bank is also possibly in the queue. Currently, Treasury is the biggest player in the Sh360 billion bonds market, out of which private corporations account for only about three per cent – Sh12 billion - of the outstanding offers.

About 73 treasury bonds and 11 corporate ones are listed at the NSE.

Financial institutions that have cut down on lending to escape loan defaults—are also looking at safer investment options in the name of longer term papers offered by the Government.

Favourite for banks include the Treasury Bills and Treasury Bonds that have witnessed over-subscription in recent months.

"We have seen an increase in demand for longer term papers in the last couple of months as investors look for safe havens," said CBK Governor Njuguna Ndungu.

Reading from the signs, NSE is making the necessary adjustments to increase interest and trade on bonds and fixed securities.

The automated trading system (ATS) will be coming on live by mid this month setting the stage for a possible surge in the average volume of bonds traded at the bourse.

The automation process, which cost Sh15 million will encourage secondary trading of bonds and draw in more retail investors by slashing the number of days a bond transaction is concluded by half.

"Automation will enhance the ability to predict the yields on issues, resulting in a more objective process, ensuring the instruments are correctly priced," said Eddy Njoroge, chairman of NSE.

Bond automation

The automation is expected to result in a transaction period of three days, bringing the exchange closer to global standards.

The current transaction period is six days, but because of inefficiencies dealing with paperwork it usually takes longer.

Lack of liquidity and prolonged settlement periods have been key barriers to growth of the bond market.

But while interest in bonds grows, a number of investment analysts are pointing to details that an investor may need to know about trading in bonds.

"Returns from bonds are generally lower than other investment options as they are mostly below inflation figures," said Mr Mueni.

KenGen bond for example will attract returns of 12.5 per cent against inflation trends that currently average at 18 per cent.

Robert Yawe, an investment analyst with Quadrant Shift reckons that the current structure of bonds where one is paid back the initial amount invested and the interest in instalments over a given period of time means that an investor will have to source for other investment avenues every so often.

Key reforms

There are also concerns over the tax-free interest, which is subject to the continuing finance act. If next year, Mr Uhuru reintroduces tax on infrastructure bonds then the 12.5 per cent earnings will become taxable.

"If tax regimes change then investors will bear the costs," said Mr Yawe. But more worrying to most investors is what is called in financial jargon early redemption option in case of cheaper finance options from elsewhere.

Under the early redemption option, KenGen for example, is only required to issue a one-month notice to pay investors outstanding amounts they invested in the bond before the end of the 10-year period.

It is known that KenGen for example is in talks with a number of international donors to source $500 million to carry out comprehensive infrastructural adjustments.

The talks are, however, hinged on condition that Kenya undertakes a number of reforms, a string that might take time to cut given the pace of some of economic, political and social reforms in the country.

"Despite the various rules that come with trading in fixed income securities, it remains one of the best options during a downturn," said Mr Mueni.

maron@eastandard.net