Kenya’s debt market is readying for improved activity after the government introduced controls on lending rates.
This is expected to encourage banks to put more money in Treasury bills and bonds, which are currently offering returns of above 10 per cent, with no risk of default.
But this is not good news for the Nairobi Securities Exchange, which has been struggling to attract companies to raise capital by selling shares to new investors through initial public offerings.
Bonds, which promise investors stated annual returns over a specified period, are more attractive during periods of low interest rates, because the yield (the difference between the price of a bond and the par value, expressed as a percentage) falls to match the lower cost of money, allowing investors to make more on the secondary market.
Low interest rates also attract more issues, because companies offering the notes can sell them at a price closer to the par value, raising more money overall than when interest rates are high.
The drop in lending rates and the rise in deposit rates are expected to squeeze margins for banks, prompting them to look for alternative investments to protect their earnings.
“We anticipate that banks will scramble for any bond on the market, with at least a 14 per cent annual coupon rate (interest payment on the bond). We also anticipate that banks will opt to hold such bonds and those acquired during primary auctions to maturity,” said Edwin Chui, a research analyst at Dyer & Blair Investment Bank.
The Family Bank bond, with a coupon rate (the interest rate paid by the bond issuer to investors every year, usually calculated at half year intervals) of 14 per cent, is offering the highest return at the NSE at the moment.
Last week, the yields on government securities varied from 12.5 per cent on the two-year Treasury bond to 14.5 per cent for a 15-year bond. The yields have been fairly constant over the past year.
About 16 corporate bonds are listed on the NSE, with an average yield of 13.5 per cent. The yield for a three-year bond was at 12.75 per cent last week, compared with 12.25 per cent a year ago.
On Tuesday last week, bonds valued at Ksh1.4 billion ($13.58 million) were traded, compared with Ksh1.6 billion ($15.52 million) on Monday.
In contrast with bonds, share prices surge with high interest rates, as equities compete with fixed-income securities for funds.
“In the short term, we anticipate a panic-driven selloff of listed bank equities in the Nairobi bourse due to uncertainty on the impact the cap will have on banks’ profitability,” he added.
Analysts at Dyer & Blair say increased competition for government paper between commercial banks, pension funds, insurance companies and fund managers will pull the yields downwards, allowing bondholders to demand higher prices.
“We can expect more activity on the secondary market, because banks are going to be motivated to put money in the bond market. However, at some point, because there is too much money being directed to government securities, the yields will start coming down slowly, meaning that those who are holding these bonds in their books will demand higher prices,” said Mr Chui.
Last week, the Central Bank reduced its policy rate by 50 basis points to 10 per cent, from 10.5 per cent, providing further relief to borrowers whose loans will be re-priced from 14.5 per cent to 14 per cent.
With the lending rate capped at 14 per cent, analysts say that lenders will be tempted to shift a key portion of their assets to government securities.
“In the absence of collusion, and assuming banks hold back on lending, they will be stuck with huge cash balances that, if redeployed to government securities, should also push the yields down. In the long term, therefore, government securities may offer no relief,” said Mr Chui.
A high interest-rate regime saw the value of bonds held by top banks wiped out by close to $97.88 million during the nine months to September 20, 2016.
The rates on the 91-day Treasury bill jumped from 8.6 per cent in January 2015 to a high of 22.6 per cent between September and October 2015, prompting the central bank to pursue a tight monetary policy stance to control inflation and stabilise the currency exchange rate. The interbank rate — the rate at which banks borrow from each other overnight — jumped from 7.1 per cent to 25.8 per cent in the same period.
The NSE is facing a difficult period, with only 11 companies having sold shares to the public between 2000 and 2016, raising $688.62 million in new capital. Among these companies were Mumias Sugar Company, Kenya Electricity Generating Company, Scangroup, dry cell maker Eveready East Africa and AccessKenya, which was delisted in 2013. Others were Kenya Reinsurance Corporation , Safaricom, Co-operative Bank, British American Investments Company and the NSE, which self-listed in 2014.
“We are carrying out research to understand the challenges that the potential issuers are facing so that we can encourage more companies to list. This is a key focus area for us,” said Paul Muthaura, Capital Markets Authority chief executive.
Some players, such as industrialist Manu Chandaria, cite over-regulation and the cost of listing as factors that have prevented the 62-year-old bourse, which currently has 66 listed companies, from attracting new listings.
Analysts say that a controlled interest rate regime will hurt the NSE.
Scramble for high returns
YIELDS ON five-year government bonds have dropped to a 14-month low, as commercial banks and corporate investors scramble for the high returns following capping of interest rates. The five-year paper is offering a return of 13.1 per cent, down from 14 per cent during its last auction in July, and a record 16.4 per cent a year earlier.
Investors offered the National Treasury Ksh56 billion ($494 million), more than double the Ksh25 billion ($220 million) that it wanted to raise from the sale of its latest securities.
Analysts expect returns from government bills and bonds to continue dropping, as deep-pocketed banks look to park their cash while they learn how to operate under the new regulatory regime. Corporate investors have also turned to bills and bonds after exiting the bearish NSE, leading to oversubscriptions of government paper.
“There has been oversubscription but the government has kept to the limits it had put out, so there is no sense of ‘because there is demand, we are expanding the borrowing,’” said Central Bank Governor Patrick Njoroge.
Kenya recently capped lending rates, threatening the key revenue source of banks — interest income. Dr Njoroge does not see recourse to government paper as a sustainable haven for investors.
“Once the law was signed, some bankers tried to move their assets to government securities. However, this is not an open door, because there is also a supply constraint driven by the government borrowing limits,” Dr Njoroge said.
A drop in Treasury bill and bond rates offers a silver lining to banks, due to the inverse relationship between interest rates and value of the securities. A drop in interest rates forces investors to go for higher yielding papers in the secondary market, pushing up the value of bills and bonds held by banks.