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National Treasury’s new borrowings to bypass debt watchdogs

By Otiato Guguyu | September 4th 2018
By Otiato Guguyu | September 4th 2018
National Treasury building in Nairobi.

Treasury’s move to raise cash via private placement from local investors will take away the pride of banks, which have controlled more than 50 per cent of the local debt market.

Treasury is seeking alternative sources of funds with maturities ranging from 30 years, an option that is not available in bank loans and public bonds, but it could achieve this in private placements of its debt securities.

Although the Capital Markets Authority (CMA) said it has no regulatory powers in private placements, it, however, added that it agreed with the Government’s move to provide a pricing benchmark, add volumes and tenures of private placements, and boost the market for corporate bonds.

However, the use of private placements, insiders warn, could help the Government hide new debt since it does not require disclosure.

While CMA seems to have to bend its rules to okay the deal, the law, according to the CMA Act, requires an issuer to file an information notice with the authority in respect of a restricted public offer of securities, where the minimum amount which may be paid under the offer of securities is not less than such an amount as the Authority may prescribe.

Such disclosure to CMA could provide the public with a glimpse into what the Government is borrowing, but the regulator, answering questions from the Financial Standard, said the Treasury was not under any obligation to seek its approval or make any disclosures, contrary to the requirements prescribed in its Act.

“Going forward, to help understand the level of activity in the private offers market, the authority shall enforce provisions in section 30C of the Act which require that it be notified through information notices by issuers raising funds through private offers (both in commercial paper and equity),” indicated CMA in the Soundness Report for the second quarter last year.

“To this end, the authority is in the process of developing a framework for ensuring that all private offer transactions are made known to the authority.”

However, with CMA appearing to give Treasury a free hand in a private placement, concerns have emerged whether the Government will use the option to push public debt to unmanageable levels.

One major disadvantage of private placements is that bond issuers will frequently have to pay higher interest rates to entice investors. Because privately placed bonds aren’t assigned ratings, it can be trickier for investors to determine their risk. Issuers must, therefore, be prepared to pay investors a premium in exchange for taking on added risk.

In addition, private placement limits the number and variety of investors the issuing party can reach. Further, private-placement issuers could be forced to take extra steps to cater to their investors. For example, potential investors might demand additional security from issuers.

These emerging scenarios could see Treasury take up more debt outside the watchful eyes of Parliament and the public in an already delicate current debt portfolio that is estimated at Sh4.5 trillion as at December 2017.

But for Treasury technocrats, the option would free them from the stronghold of banks who are its biggest lenders in its Nairobi Securities Exchange-listed debt market.

And whenever banks want to loan the country cash, taxpayers subsidise them with a facility fee for making placements before they get paid an interest on the loans.

It is a practice in less liquid markets, yet Kenya has continued to pay banks the unnecessary fee in an example of how financial institutions control State bureaucracy inside and out.

“Licensed placing agents are paid a commission at the rate of 0.15 per cent of actual sales (at cost), net of a 5 per cent withholding tax,” Renaldo D’Souza, an analyst at Sterling Capital said.

Banks control 55 per cent of local debt and have in the past been accused of colluding to keep rates high, especially when the State seems desperate to borrow.

When the rate cap was introduced, banks made Government papers their mainstay business, holding a debt of Sh1.27 trillion in the first half, 11 per cent more than a year earlier, according to the Treasury.

Profits for Kenyan lenders climbed as much as 18 per cent despite an interest-rate cap that pegs commercial lending rates to the benchmark policy rate. But even with this kind of excess supply of cash, Treasury bill rates and bonds have not come down significantly.

Cheaper money

According to the Institute of Economic Affairs Kenya CEO Kwame Owino, unless the Government has a poor credit rating or the borrowing is not for the right purpose, then the State should get cheaper money.

However, he said, this would only happen if there is an objectively designed system. In fact, banks have been trying to push rates up, forcing the Central Bank of Kenya (CBK) to reject bids during several auctions.

CBK Governor Patrick Njoroge said the bank of last resort would turn down high bids by investors seeking to capitalise on the State’s borrowing needs.

“When they put in bids, they were not large and some of the prices were way outside the yield curve. There is a feeling that the Government has an insatiable need to borrow and that is why some of them are bidding on crazy rates,” Dr Njoroge said in January last year.

But while CBK has managed to create a good yield curve by refusing to budge, the empire has struck back by ensuring banks do not buy long-term debt, reducing the average maturity rate to four years.

“Central Bank is concerned about the low uptake of long-term bonds. You will notice that the 20, 25 and 15-year bonds received low subscriptions,” Mr D’Souza said.

But now the Treasury wants to steal banks’ lunch by giving part of the local debt to other investors through the private placement.

Treasury has already flouted Public Finance Management (PFM) thresholds for the size of the debt to Gross Domestic Product, failed to deliver a rate cap repeal promised to the International Monetary Fund (IMF) and is plunging head-first into a Eurobond principle payment in uncertain times.

“The PFM does not set any limits to borrowing per se. It only states that borrowing should be for development spending and cannot be used for recurrent items, such as paying salaries. However, there are thresholds that are set by some international players such as the IMF that even our Government uses as the red-lines,” John Kinuthia, the lead research analyst at International Budget Partnership said.

Against a debt to service ratio threshold of 30 per cent, Kenya hit 35.7 per cent in 2017 and will be at 33.4 per cent by 2019.

The mandarins who manage our debt say they need 20 experienced hands to help restructure payments, arguing that it is not the size of the debt but the rate of servicing it against the money the taxman collects.

They claim part of the reason private placement is so important is to space the dates when debts become due. In a letter sent to fund managers in July, the Treasury mooted the option to the financial sector, hoping to agree on a pricing mechanism for such bonds.

Insurers and pension funds, whose stock of State debt is currently at 6.2 per cent and 26.9 per cent, respectively, could also get tenures that are more aligned to their businesses.

This would offer the benefit of strengthening their balance sheets to carry long-term risk instead of letting each Kenyan carry the risk that makes pension and insurance more expensive. The Central Bank, which earns Sh3 billion in agency fees to place debt for Government, was the first to fight back.

Njoroge warned that the country should be wary of debt sold in private boardrooms, saying it would kill transparency and create products that are hard to resell in the open market.

“The matter is still in a preliminary stage and as the fiscal agents for the Government, we will weigh in when it comes up,” he said at a press briefing in Nairobi.

“What I think is (we need) to find a way in which we borrow without harming the market. What we want is predictability and presenting an instrument that investors understand. There is no point of holding an instrument in the market that you cannot sell.”

Mr Owino, however, said CBK may know something we do not know to take such a stance, adding that Kenyans can only asses the benefits of Treasury’s move if disclosures are made, and that tends not to happen. “Maybe the negotiated rates will seem lower but it is attached to harsh penalties and some guarantees that are not revealed, so unless there is open contracting we may not get the best deal,” he said.

A source told Financial Standard that issues of disclosures are a Pandora’s box given the way the Government deals with Kenyans. The source cited the IMF facility whose terms for some time were not known to the public in terms of the conditions attached, such as public service restructuring, or even the exact wording of the present contracts.

“In a private placement, it is worse. You may get to know about details when you are too late into the contracts, and even keeping track of issues may not be possible,” the source with knowledge of the consultations who did not wish to be named said.

In fact, the Treasury is said to have fast-tracked talks with some players in the local and international market to issue about Sh20 billion by the end of the year with expectations that local debt will become expensive once the rate cap is lifted and banks can finally price Kenya’s true sovereign debt position. 

The IEA boss also said that historically, the Government has tended to find the rationale for new products but the benefits promised do not always materialise. “Look at the Eurobond, they said it would bring local interests down, but in a year they had actually gone up,” he said.

Owino advised that the placement be done in parallel with a public auction for comparison and to choose the best option, with the prospectus made public.

A highly placed source in Government said Treasury is exploring the option of listing the placements, which will offer it the necessary transparency, but it is still jittery about having them traded rather than held before the market adjusts to the new instruments. 

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