By NBF News
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Since the capital market crash, many investors have since found a new investment haven in the fixed income market. And as of now, the market players say that the equity market has shrunk so much that it has reduced to just a mere fraction of the existing bond market in the country.

Painting the evolving scenario, Mr Ike Chioke, the Managing Director of Afrinvest (West Africa) Ltd, said: 'with all the noise we had heard about the equity market, 'NSE has gone up by N75 billion today, NSE has gone down N25 billion tomorrow', equity market is just a fraction of the existing bond market that we have.

I will give you an example. In all of November 2009, the equity market recorded a total value of N85 billion, total volume, everything traded in November was N85 billion. In the same month of November, the bond market recorded a total volume of N2 trillion.

That is not all about that, its capital preservation is so much bigger that there is so much money for the ordinary investors who consider this market.' Chioke's assertion could point to only one direction, there is an overwhelming switch-over from the equity market, which has ballooned to an over-subscription, particularly in the federal and state government bonds. But, as they say, one man's gain is another man's loss, the latest development tends to be choking out other instruments in the fixed income market as our findings reveal.

The shift
Recovering from the price meltdown at the stock market, the Nigerian investors shifted their attention to the bond market. This marks the era of 'flight to safety' by investors. But despite the spate of oversubscriptions that have trailed both the federal and state government bonds in the primary fixed income market, the secondary segment, particularly the private and corporate bonds, lack that type of depth. The renewed appetite for bonds and increased activities in the market, though in line with the regulators' aspirations, has been a source of concern to most industry watchers, potential investors, the equity market, even as its transmission effect is being felt in the macro-economic environment.

The Director General of the Securities and Exchange Commission (SEC), Ms Arunma Oteh, is of the opinion that now is the time for the capital market to be diversified if it is to fulfil its role of fostering entrepreneurship in the larger economy for development.

According to her, we must focus more on the fixed income market which has somehow become the last resort for investors due to the capital market crash. Giving reasons for this, the SEC boss said: 'Over the last few years, we have created sovereign debt market. The Debt Management Office (DMO) has done very well in ensuring that we have this because that is one of the building blocks of the fixed income market. If you have got the sovereign debt market, it is a benchmark that, henceforth, you are going to allow state governments or corporate bodies to price your transactions up.

We have seen a lot of entries from state governments. Lagos State is taking the lead in that regard. So, having a vibrant bond market and fixed income market is extremely important. But that fixed income market needs to be developed with risk management and products so that dealers can focus on what they can do well, this is intermediation, that they can hedge their positions. We need to ensure that the future market develops in our country. Also, we need to look at most importantly the things that target the ordinary investor''.

Similarly, Ms Razia Khan, the Regional head of Research for Africa/ head of Macroeconomics, Standard Chartered Bank, UK, observed that the FGN bonds have been the key safe-haven beneficiary of uncertainty in Nigerian markets in recent years. According to her, the recent developments like the switch from equities to bonds as the sell- off pre-crisis, the easing of monetary policy in response to the global economic crisis in the midst of Nigeria's own banking crisis, and the injection of N620 billion ($ 4.1billion) of Tier 2 capital into rescued banks last year, have all played a role in encouraging flows into Nigeria's bond market.

She added: ''With banks understandably reluctant to lend, following the record write-down of losses last year, much of the excess liquidity created has found its way into FGN bonds. However, following the recent market dislocation and the sell-off in bonds, unrealised losses at Nigerian financial institutions were estimated to be in the region of $1billion.Yields have now largely corrected, but the risks were made clear'' said Khan.

In its 2010 market outlook, Afrinvest, a research and investment company, highlighted the market's preference for safety; and how it expected money market instruments, government treasuries and sovereign bonds to receive heavier weightings in investor portfolios. This translated into an increase in the volumes traded by 35.7 per cent to N5.7trillion in the first quarter of the year up from N4.2 trillion traded in a similar period in 2009 (dominated by FGN bonds).

Bond market update
The Nigerian Stock Exchange(NSE) recently listed the 7th FGN Bond 2015 series 2, worth N45 billion on its daily official list. This has increased the number of listed FGN bonds and securities to 38 and 262 respectively.

The recent Monetary Policy Committee (MPC) meeting recognized the dominance of FGN bonds in the market and noted that credit to government, which grew by 28.4 per cent, was the major contributor to the growth in aggregate credit in March as credit to the private sector declined by 1.7 per cent.

This trend, MPC noted, is crowding out the private sector. The Federal Government's action through the CBN to help in the development of the corporate bond market by making investment income derived from the instrument tax free; in order to encourage issuance at competitive coupon rates is a step in the right direction. But the corporate segment of the market is yet to record high levels of subscriptions.

Commenting on the increase in the demand for bond issues and turnover on the secondary market, Dr Abraham Nwankwo, the director general of DMO said the organisation has been able to develop bonds into new attractive alternative investments, which has further deepened the Nigerian capital market hitherto dominated by equities. He noted that the FGN bonds have been heavily oversubscribed since its introduction, hitting an all time high of 89.14 per cent in 2009.As at April 30,2010, the value of the total outstanding (FGN) bonds was put at N2.248 trillion.

The DMO, through domestic bond issues, according to Nwankwo, has been the major source of financing budget deficit since 2003, pointing out that the development of domestic bond in recent years has forestalled the previous practice of using the CBN's ways and means to finance deficits. He was confident that the organization would meet over N876 billion target set for it as part of its contribution towards funding the deficit in the 2010 budget, stressing that it raised N524 billion to fund the 2009 budget.

The state governments were equally not left out of bond issuance as many of them have besieged the capital market since the second quarter of last year. Imo state government's bond which closed on Tuesday, June 30, 2009 hit the market with N18.5 billion bonds that attracted 15.5 per cent fixed rate at N1000 per unit, expected to mature in 2016. The bond attracted 22 valid applications which were accepted, processed and it was 100 per cent subscribed. The first Kebbi State Government N3.5 billion revenue bond 2006/2009 has been fully redeemed by payment of the principal and interest as at December 2009. Kaduna is planning to debut N10 billion bond issue to help finance infrastructure projects, including a water treatment plant and specialist hospital.

Other states that approached the market are: Ogun, N50billion; Bauchi, N40billion; Kano, N17 billion; Kwara, N17 billion and Niger State, N6 billion respectively.

The Lagos State Government on last April 19, (2010) held the Completion Board Meeting of the N57.5 billion, Lagos State Fixed Rate Bond (series 2) 2010/2017, issued under the N275 billion state debt issuance programme with the application receiving bids in excess of 249 per cent.

Speaking at the verification of questionnaire and signing of the documents for the bonds, the state Governor, Babatunde Fashola, represented by his deputy, Mrs Sarah Sosan, said the second series of the N275 billion bonds has recorded the highest level of participation in any bond issue in the capital market. 'This is the second such gathering in the tenure of this administration.

When a similar meeting was convened on December 24th, 2008 for the purpose of signing the documentation for the Tranche issuance, there was much anticipation in our financial markets. That public offer received a tremendous response from investors both individuals and institutional, and recorded an unprecedented 117.93 per cent level of subscription,' the governor said.

Away from local scene, the Federal Government's decision to raise US$500 billion from the Euro Dollar Market is likely to open a window through which companies and lower tiers of government will access the international bond market. According to Ini Ebong, the head of Fixed Income Market of Renaissance Capital, the Federal Government could have successfully borrowed the money locally, even at cheaper rate, but the opportunity it would create for other issuers made the effort worth the while.

Corporate bonds
A company may issue a bond in order to raise capital for the purposes of building a new plant, purchasing equipment, funding acquisitions or expanding its business. Sometimes corporate bonds embraces all bonds except those issued by governments in their own currencies ( this is called sovereign bonds).

The CBN at the last quarter of 2009 removed the 10 per cent cap earlier placed on bank's participation in sub-national and corporate bond offers.

The move made good the earlier promise by Sanusi Lamido Sanusi, the apex bank governor, to collaborate with other relevant authorities towards resuscitating and increasing participation in the nation's market so as to create atmosphere for long term investment and especially complement the capital market facing downturn. Entering second quarter of 2010, investors are yet to embrace sub-national and corporate bonds as much as that of FGN.

Lamenting the situation, the former acting Director General of SEC, Ms Daisy Ekineh, that as the federal and state governments have been very actively involved in providing viable alternative investment outlets through the bond market, the corporate segment has recorded virtually no activity. She initiated a number of measures whose effects are yet to be fully felt.

On why there has not been remarkable improvement in the corporate bond market, analysts maintain that after the value erosion of the shares of these companies, investors' confidence is yet to be restored, and corporate goodwill has waned. But Mr Ike Chioke, the managing director of Afrinvest (West Africa) Ltd observed that the appetite for corporate bonds may have been grossly overestimated.

According to him, the results of Guaranty Trust Bank's bond offering in which the company sought to raise N50 billion via a five-year tenured instrument and a 13 per cent coupon but succeeded in attracting only N13 billion suggest overestimation of the corporate bond segment of the market.This, he said, justifies the argument in favour of higher returns on corporate bonds given the risk profile of issuers in this assets class.

While Access Bank already has a N13.5 billion bond that ended in 2009, other banks leading the way are: First Bank and UBA, each issuing N500 billion, GTbank and Diamond are issuing N200 billion worth of bonds. Industry watchers and shareholders of corporations are worried about the interest that most companies have shown in raising debt instrument as a result of the boom in the primary market.

The worry stems from the fact that considering the priority that the debt enjoyed over equity during payment, the poor risk management strategies and the poor investment decisions demonstrated by Nigerian Banks, slow economic activities, slow growth and development, civil unrest and lack of skilled personnel to handle the complex nature of bonds; the introduction of bonds as another financial product will surely increase corporate leverage unjustly.

According to a shareholder with Access bank, Mr Ademola Taiwo, increased corporate leverage will in turn post more danger to the growth of profit after tax (PAT) and interests. A decrease in profit after tax and interests will automatically affect dividend payment and capital formation, which are the main returns on equity investment and the major fundamental of share price and market value of a company. There will be increase in the gearing ratio ( that is debt/ equity ratio). A highly geared company is bad for equity shareholders as the debt obligation will have to be met first before dividend is considered.

A case in point is Access bank noted above. The bank reported loss after tax of N4.194 billion in its financial year results which ended last December against profit after tax of N21.034 billion in 2008. It managed to reward investors with a bonus of one for 10 shares. Apparently, This is to placate them for leaving their money for the bank to trade with.

Recently, UBA made available to the Nigerian Stock Exchange its results showing that the financial institution's PAT went down by 94 per cent from N40.8 billion to N2.4 billion. The bank managed to pay 10 kobo per share and a bonus of one for five shares. The situation is the same with Diamond Bank, Skye Bank and others.

According to Omodara Oladipupo, a financial analyst, since bond issuance simply means leverage level (debt), more earnings is expected to be set aside for interest payment as well as for final maturity payment from the company's earnings. The implication is that dividend, which is the main fundamental of equity will suffer more as earnings after tax and interest tends to shrink further; resulting from higher earnings involved in servicing of debt instruments.

Business intelligence experts also share the view that caution should be exercised by corporate bond issuers until economic fundamentals that encourage wealth creation are put in place. Toe this line is the Managing Director of NEM insurance Plc., Mr. Tope Smart, who cautioned both bond issuers and subscribers about the investment decisions they take in the bond market. According to him, the capital market had over the years been characterized by bandwagon effect.

Yet, Smart added, ''I don't believe that the market would crash. But I strongly advise that people should exercise caution in going to the bond market: Whether corporate organisations, governments, and even investors. I think we all need to exercise caution in taking advantage of the market. This is because by the time it also gets saturated, it would definitely have its own effect'.

Although, he argued that if well structured, equity holders in quoted companies would not suffer any depreciation in their investment, but stressed that when faced with operating challenges, an organization would be more committed to its bondholders.

'But I would maintain that if a bond issue is properly structured, all the stakeholders should benefit, whether you are a bondholder, a preference shareholder or an ordinary shareholder. 'The advantage for a shareholder is simply that, if utilized, the issuer is able to utilise that instrument very well and the company was able to make good profit, such profit can be transformed to dividend which is payable to shareholders. So every bond issuer must have done its feasibility study to analyze the type of profit it is likely going to take and of course, there could be a value it is going to add to shareholders'' the insurance expert submitted.

Smart further said that corporate organizations now believe that if they come to the market with equities, the investing public may not subscribe. Because of the experience they have had, they now view the market as being too risky. But he still believes that like Warren Buffet, this is the proper time to invest in equities.

According to him 'I can assure you that at the prevailing price of some of these equities, if they come under public offer, it would be more attractive to investors.'

This is because there still have to be a lot of marketing sensitisation for the bond market to maintain its level of success or grow wider. The goodwill of a company that is floating a bond ought to be very strong. However, Smart added that government bonds are supposed to be the best because they are zero risk investments given the fact that government is a going concern.

Other analysts favoured corporate bonds because it can serve as an instrument for increasing a company's competitiveness and can create a competitive advantage or economies of scale. When a large number of creditors provide funding, it has the consequence of a risk distribution, result in a lower costs alternative in comparison to bank loans under a certain debt level condition. A significant advantage also rests in the fact that returns on corporate bonds represent a tax base and in the case of a company's profitability, an interest tax shield can be used. Issuing a well- subscribed corporate bond is considered by bond managers as a prestigious thing, helping the company to gain respect of the investing public, capital market and business partners.

Why issue bonds.
Giving the reasons for issuing bonds, the DMO boss said: ''there might be other sources of revenue that are peculiar to other countries like royalties from oil and all that. But governments find out, historically, that tax revenue is not always sufficient for them to fund their immediate expenditures that are needed to bring about transformation in the living standards of their people and achieving other objectives. Therefore they need to borrow to close the gap. So that is where public borrowing comes in so as to augment tax revenue. With borrowed funds, then you have portfolio with which you can find the totality of your planned expenditures for the period under consideration.''

Other reasons advanced by the Nwankwo are to provide infrastructure, such as power, roads, water and healthcare facilities, necessary for the development of the economy; to increase the range of instruments available to the public for investment purposes; to provide a safe investment opportunity into which long term funds can be channeled. To support the growth of the domestic bond markets in order to promote economic growth and to enable the Federal Government effectively support the growth of the financial markets as part of the requirements for achieving vision 2020.

Bonds, Nwankwo stated, 'are tax exempt, implying bigger income in the hands of the investors; the bonds provide an alternative investment to equities, real estate and bank deposits; bonds can be used as collateral for borrowing from banks and discount houses and bonds can be sold either through any of the 21 Primary Dealer's Market Makers (PDMMs) licensed by the DMO or on the floor of the NSE'.

Given the spate of oversubscriptions trailing these bond issues, analyst believed that proceeds are not being used for purposes for which they are issued. If the proceeds were being properly utilized, infrastructural deficits as we have in Nigeria would have been rectified to a large extent. They also argue that the proceeds not properly channeled, poses danger of incurring debt for the future generation instead of accelerating development.

Agreeing with the above argument , Managing Director, Securities Solutions Limited, Mr. Joel Okafor said there is nothing wrong in issuing bonds but the most important thing is that the proceeds must be of economic benefit.

He said, 'I think a bond taken by a state Government or whoever should be such that the proceeds from its utilization should be sufficient to service both the principal and the interest. But if you are taking a bond hoping that the repayment will be from some other source, it will be a clear case of robbing peter to pay Paul.'

The Lagos State Government bond is justifiable according to him, because we expect that things like tolls and rents from some of the roads and market construction will be realized. ''those money will eventually come back to support the repayment process. The future generation will be better off because they will not be looking for money to invest in such projects again,' Okafor assured.

He decried a situation where some states will take the bonds and five years down the line, they have not come out of that. 'Whoever is taking bond should in the name of God, ensure that the proceeds are applied for the economic benefit of the state for which it is taken,' the stockbroker pleaded. He further called on the budget office to enforce compliance regulation on bond issuers.

Analysts with Afrinvest share the same opinion. They noted that ''greater emphasis must be placed on the efficient use of proceeds as a true measure of the success of these capital raising exercises. ''We are still of the opinion that regulatory agencies need to enforce strict adherence to financial disclosure by intending issuers.''

Defending the use of FBN bond proceeds, the DMO DG said, 'You are aware for example, that there is an initiative for the revitalization and modernization of the rail services in Nigeria and that locomotives are being brought to resuscitate rail transportation.

I can tell you definitely that part of the funds being used for this rail transportation revitalization were sourced and borrowed funds from the domestic capital market through the issuance of Federal Government bonds. Through the concerted effort of the Central Bank of Nigeria and the Ministry of Agriculture and Water Resources, about N200 billion is being made available for commercial agriculture. This N200 billion long term money was raised by issuing FGN bonds and debt instruments for this purpose.'

He further pointed out that the government has a grand plan of developing and modernizing the cotton, textile and garment sector. The volume of economic activities it will create in the agricultural sector, in the industrial sector and in the export sector according to Nwankwo, would be tremendous. But suffice it to say that the N100 billion being part of this programme is being provided by the DMO by issuing FGN bonds. ''I am only giving you some few examples of how you can use borrowed resources positively to stimulate the economy, particularly the real sector. This is not just a question of having direct impact on the lives of the people' Nwankwo said.

Dwelling on the impacts of FBN bonds he further maintained that reviving the cotton growing, garment and textile sector means there would be employment. ' If you are talking about rail transportation, you are talking of giving access to everybody because you know that rail transportation is usually an affordable populist, mass transit transportation channel; opening up the rural areas, giving access to rural farmers, making it possible for them to evacuate their produce, be able to move the product of artisan activities to other parts of the country: especially to the city, so that they can earn good income from produce and products.

So this is how borrowed money translates to the real sector and translates to the well-being of the individual citizen,' the DMO boss explained. On compliance and accountability he said there are now unlike in the past, new institutions like DMO, new laws like the Fiscal Responsibility Act, and new processes like the Due Process and Public Procurement arrangement as well as various laws that govern bond issuance and its utilization.

Corroborating bonds utilization, Lagos State governor explained that different projects are being undertaken with the bond proceeds, the major one being the upgrading of the Lagos- Badagry expressway into 10-lane highway featuring pedestrians' walkways, bus routes and a rail line which is already at an advanced stage. This developmental project is expected to touch lives economically.

Again, capping his explanation on the rational for bond issuance, Nwankwo submitted that 'instead of you to wait for the next 10, 20 years to provide for yourself the needed services, you borrow now so you begin to derive the benefit from such a service, from such a project while using the cash flows you would have saved to eventually service and repay the loan. That is the simple logic, simple arithmetic or if you like, the common sense of public borrowing.'

He maintained that one of the most significant developments in the domestic bond market was the introduction of the PDMM which was meant to provide liquidity for FGN bonds and to ensure the success of the auctions. Similarly, under recent state government bonds, the states in question have signed up to their own fiscal responsibility Act and set up their own Debt management offices.

In his address at a workshop on the 'FGN bond market: Safe haven in times of crisis,' Dr. Nwankwo stated that bonds serve the interest of both the investor and the issuer at all times but even more in periods of crisis. For the investor, bonds unlike equities typically offer a guaranteed return and are a good instrument for diversifying their investment portfolio. For the issuer, it provides an opportunity to diversify their funding base and to source long-term, relatively cheaper capital.

According to him, ''If the sovereign bond market had not been resuscitated in 2003 and sufficiently developed as at 2008, in the face of the global financial and economic crisis as well as the crisis in the Nigerian equities market, the down-spin in our stock market could have hit a deeper bottom; the quake and dislocation in the financial system could have been more traumatic; and, the deceleration of economic activities could have been more intense.''