Business Intelligence

Treasury Bills, Treasury Bonds and Infrastructure Bonds: What are they?
Eric Ombok
Published: 19-JUL-07

John Ngumi who is the Executive Director for Investment Banking at Stanbic Investment Bank in Kenya says the role of the government in making infrastructure bonds a reality is limited to making the necessary regulatory changes to the Capital Markets Authority (CMA) Act.

Ngumi says the CMA should allow newly established companies without a track record to debt paper. However, he says that unlike corporate bonds, infrastructure bonds do not require CMA approval.

He says the single most important regulatory change is for the Retirements Benefits Authority (RBA) Act to be amended to allow pension funds, who are custodians of the largest amounts of long term money, to invest in infrastructure bonds. He says currently the RBA Act does not allow pension funds to lend money. �Underlying all this, is the fact that there are no projects. You cannot issue bonds in a vacuum,� Ngumi says.

He says the infrastructure bonds market becomes active when the private sector knows that there is a project in the pipeline that needs funding. �The bonds sector is going to boom when we have the infrastructure bonds and more appreciation about what companies can do with regards to raising funds from the capital markets,� Sterling Securities Chairman, Stanley Ngaine says. Ngaine says infrastructure bonds were initially developed as a form of public-private partnership. The government wanted to involve the private sector in raising funds to be used to roll out infrastructure projects that are costly, particularly roads. He says such projects can also include airports, ports and telecommunication among others.

In the case of corporate bonds, Ngumi says the process involves a company�s financial advisors convincing the client that they need to raise money through bonds. Once this is done the two parties sign an agreement after which various advisors, brokers and reporting accountants are appointed to work on an information memorandum that is based on legal due diligence, financial due diligence and due diligence on the company�s management and history.

While the information memorandum is being compiled, the team of consultants informally gets the opinions of the market on the upcoming bond. This information is also used to structure the information memorandum, which is then submitted to the CMA for approval.

Thereafter marketing of the bond begins by getting commitments or pledges of how much institutional investors are willing to lend to the company issuing the bond. The whole process takes an average of 90 days to 120 days. �The corporate bonds market in Africa is still tiny. In developed economies the bonds market outweighs the equities market by far,� Ngumi says. Legislative issues aside, Ngumi says investment banks and CMA should make it simpler for companies to raise money through bonds than through bank loans. �As long as liquidity is high and the Capital Markets Authority remains a process driven institution, buyers will remain in the loans market,� he says.

�The corporate bond sector is not active. There has been no new issue this year but until June the government has raised $571,32mn (Ksh38bn) from Treasury Bonds,� Ngaine says. �There has not been a lot of uptake because banks have a lot of liquidity that they can lend at good rates�. He says that in the second half of this year, the government could raise slightly more money through Treasury Bonds. �I expect Treasury Bonds to raise more money because there is more demand for resources,� Ngaine says. Apart from the rigorous process of preparing a corporate bond, Ngaine says, �Depending on the credit rating of the issuer, the pricing could be based on the Treasury Bill rate plus one or two percent�.

He says that in coming months, the government could issue more non tradable bonds. In June this year, the government has converted $300,74mn (Ksh20bn) owed to National Bank of Kenya by state corporations into long-term non tradable bonds, effectively paying off the bad debts. The largest bond was worth $90,14mn (Ksh6bn) with a yield of 14,5 percent. There were two bonds worth $75,12mn (Ksh5bn) each with a yield of 13 percent and 11.5 percent respectively. The final bond, worth $60,08mn (Ksh4bn) had a yield of 9,5 percent.

All the four bonds are dated 1st June 2007 and interest repayment will be made twice a year. For Treasury Bonds and Treasury Bills, which are issued by the Central Bank of Kenya (CBK) on behalf of the government, they are a form of the state bridging its budget deficit by borrowing money from the general public, through the stock exchange.

CBK advertises new issues of Treasury Bills and Treasury Bonds on a weekly basis. Treasury Bills are short term, usually 91 days and 182 days, while Treasury Bonds are long term, ranging from one year to 15 years. Ngumi says the perception that Treasury Bills and Treasury Bonds are the preserve of institutional investors is not correct because anyone with $752 (Ksh50,000) can lend money to the government. �It is a matter of knowledge and financial costs,� he says. Ngumi adds that for individuals seeking to invest in Treasury Bills and Treasury Bonds, it will be more cost effective to do so collectively. Ngaine says there is good momentum to develop the Treasury Bonds market this year because the yield on Treasury Bills and Treasury Bonds are higher than they were four years back when they were below two percent. He says low yields do not provide sufficient incentive for investors to put their money in bonds. Ngaine says the yield curve for Treasury Bonds is now well developed because there are bonds which are much longer term. He says the CBK consults commercial Banks and Fund Managers on issuance of bonds since they are the largest investors in bonds.

He says the role of brokers is giving the government technical advice on structuring the bonds so that the subscription rate is higher. He says having a secondary market (selling the bonds to a third party before maturity) will increase the uptake of bonds.

�A lot of institutions, especially insurance companies and pension funds buy and hold but that is changing now,� Ngaine says. He says that since all bonds that have been issued recently have been oversubscribed the problem of what to do with the surplus funds can be solved by having an active secondary market. He says banks, pension funds and insurance companies respectively are the largest investors in Treasury Bonds because they have a higher yield compared to Treasury Bills.

Old Mutual Asset Managers (OMAM) says it expects Treasury Bill rates to be within the six percent to eight percent range in the third quarter of this year. �The high liquidity position in the banking sector should dampen the potential for any significant rise in rates in the short and medium term,� the second quarter economic analysis from OMAM says.

�Yields may trend higher, shifting the yield curve upwards, as investors factor in risks associated with the need to tame the money supply growth due to inflation concerns and the political risk deriving from the general election later in the year,� OMAM says.

During the year ending 30th June 2007, the government issued more of long term bonds than short dated bonds. �The strategy aims at raising the maturity profile, thereby reducing financial strain on Treasury. Treasury bonds now constitute 73,4 percent of total government domestic debts compared to 69,5 percent a year earlier; and the maturity profile of domestic debts increased from 2,22 years in June 2006 to 2,85 years in June 2007,� OMAM says. Ngaine says one area that has not been fully exploited is issuance of bonds by local authorities. �Municipal bonds should be developed but considering the strength of local authorities the bonds should be for specific projects,� he says. �Municipalities have been left without reasonable investments, especially in water. The bonds can be tied to the forecast cash flow of those projects. There are funds available in this country for that,� Ngaine says.

-Business in Africa Online

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