Subdued Month for Rates

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1 August 2014 September, 2013 Monthly Fixed Income Report P a g e 1 Subdued Month for Rates...Naira strengthens against the greenback Fixed Income Update Executive Summary Macroeconomic Variables Inflation Rate 8.20% MPR 12.00% GDP Growth 6.21% Current Bond Metrics Average TB yield 10.77% Average Coupon 11.26% Average YTM 11.58% Average Clean price Average MD 3.71 Average Convexity 0.28 Meristem Bond Index Index Level 1, YtD Return 5.92% QtD Return 0.32% MtD Return 0.03% WtD Return 0.00% The fixed income market performed well from the start of the year to the end of July, as measured by our MERI-BOND index which returned 6.03% (vs. Equities return of 1.86%). Though we expect the impact of reduced participation to be more acute in later period of H2:2014, we expect that yields may start to trend upwards in the new month and find a level marginally higher than the current market rate. The average rate for NIBOR advanced by 0.19% during the month partly reversing the average decline in the preceding month (0.36%), to peg the average rate at 13.28%. The Naira strengthened against the greenback in July appreciating by 0.63% to bring the Ytd depreciation to 0.81% as the CBN sold USD2.526bn from USD2.700bn offered at an average marginal rate of NGN in defence of the currency at RDAS auctions held during the month. The effects of US QE tapering have been forgotten as yield seeking money still flooded the Nigerian financial markets, the biggest signal of which was the declining yields in the fixed income market witnessed in the early parts of The impact of political pressures on capital inflows is a major reason for our assessment about the direction of rates in H2:2014. Reduced inflows from other countries may be the factor that amplifies the full impact of the ending of the US Fed s QE program. Due to the correlation between MPR and yields on bonds and T-Bills, we expect that when rates are cut after the 2015 elections, yields on investments in the fixed income asset class may decline markedly (dependent on the magnitude of cut). Based on our assessment of the market direction of yields, we advise that investors go overweight on issues when rates start to rise, for capital appreciation purposes in Also, we advise that investors widen their appetite beyond FGN bond in 2015 to boost income.

2 P a g e 2 Muted Month as yields pare marginally The fixed income market performed well from the start of the year to the end of July as measured by our MERI-BOND index which returned 6.03% (vs. Equities return of 1.86%). From the chart below, it can also be seen that the equities index has trailed the fixed income market for most part of 2014, though the spread has narrowed recently. In July, the bond index returned 0.29% as market demand for bonds eased from the highs in the preceding month resulting in a marginal decline in bond yields of 0.11% across instruments. The decline in yields for T-Bill instruments closely mirrored those of bonds, as the yields on TB instruments across tenors pared by 0.19%. Chart 1: Year-to-date Returns of MERI-BOND index vs. NSEASI Chart 2: Average yield on treasury bonds and bills in July 8% 6% CHANGE IN BOND INDEX LEVEL CHANGE IN EQUITIES INDEX LEVEL Avg TB Yield Avg Bond Yield 4% 2% 0% 2-Jan 2-Feb 2-Mar 2-Apr 2-May 2-Jun -2% -4% -6% -8% -10% -12% Jun 7-Jul 14-Jul 21-Jul 28-Jul Source: Bloomberg, FMDQOTC, Meristem Research The easing market demand may be an early signal of a decline in foreign participation in the fixed income market, which we opine will happen in H2:2014. Though we expect the impact of reduced participation to be more acute in later period of H2:2014, we expect that yields may start to trend upwards in the new month and find a level marginally higher than the current market rate for both Bonds and T-Bills, though we expect some downward pressure to be exerted by position taking as the yields in the market become more attractive.

3 P a g e 3 Cost of funding for banks rises as Market takes shorter term view The average rate for NIBOR advanced by 0.19% during the month, partly reversing the average decline in the preceding month (0.36%), to peg the average rate at 13.28%. The largest increase was observed in the Call (Overnight O/N) tenor which advanced by 1.13%, while the 1M, 3M and 6M tenors advanced by 0.84%, 0.79%, and 0.49% respectively. Though we expect the ebb and flow of the NIBOR market as banks position to meet their obligations as they come due, we may relate the higher cost of funding precipitated by higher rates to the weakened demand as major players in the market would have had to limit their participation in the market. Chart 3: Interbank Rates for all tenors Chart 4: Nigerian Sovereign Yield curve; May July O/N 1M 3M 6M 14% 13% 13% May-14 Jun-14 Jul % 10 12% 11% 8 11% Jun 7-Jul 14-Jul 21-Jul 28-Jul 10% 10% 9% 1M 2M 3M 6M 9M 1Y 3Y 5Y 7Y 10Y 20Y Source: Bloomberg, FMDQOTC, Meristem Research There was a relatively parallel downward shift in the sovereign yield curve for most tenors, while there was upward pressure at the short end of the curve as can be gleaned from the chart above. We opine that investors caution about the impact of headwinds expected in H2, as well as a desire to free up funds for the expected higher yields towards the start of Q4:2014 is the major reason for the observed movement. We expect this to persist for the month before upward pressure is exerted at the long end of the curve due to position taking for 2014.

4 P a g e 4 Naira Strong relative to peers The Naira strengthened against the greenback in July, appreciating by 0.63% to bring the Ytd depreciation to 0.81%, as the CBN sold a sum of USD2.526bn from USD2.700bn offered at an average marginal rate of NGN in defence of the currency at RDAS auction held during the month. We opine that this is one of the major factors that explains why Nigeria remains an attractive investment destination, as exchange rate risk is fairly tempered. From the African peers selected, only Egypt recorded an appreciation as the Egyptian Pound advanced marginally by 0.04%. Ghana, South Africa, and Kenya all recorded currency depreciations of 9.89%, 0.66% and 0.23% respectively during the period. From the peer BRICS economies, China was the only country to record an appreciation of 0.47%, while Russia pressured by sanctions due the ongoing conflict in Ukraine pared by 5.02%. Brazil (2.23%) and India (0.62%) also depreciated against the greenback in the period under review. Chart 5: Naira performance vs. peers (BRICS; African) Chart 6: NGN vs. USD for July, % % 5.02% % 0.66% % 0.23% % -0.47% % -2.00% 0.00% 2.00% 4.00% 6.00% 8.00% 10.00% 12.00% Jun 7-Jul 14-Jul 21-Jul 28-Jul Source: Bloomberg, FMDQOTC, Meristem Research We opine that the NGN/USD pair has fared well as the net inflow of capital into the Nigerian economy has stayed fairly consistent with the effects of the further retrenchment of the US Fed s quantitative easing program to USD25bn offset by easy monetary policies from other Central banks. We expect currency depreciation in 2014 to be capped at 1.65% due to positive global liquidity conditions and relative strength of the Nigerian economy.

5 P a g e 5 Global recovery, the foe The effects of US QE tapering (which is now USD25bn/month, reduced at the last FOMC meeting held; July, 2014) have been forgotten as yield seeking funds still flooded the Nigerian financial markets, the biggest signal of which was the declining yields in the fixed income market. We opine that the BoE s (UK central bank) QE program (though significantly smaller than the US program), and the European Union s stimulus driving monetary policies might be behind the tempered impact. The Bank of England (BoE) has a QE program (bond buying program) which has bought GBP325bn (USD546bn) between March 2009 and July 2014, which was further increase by GBP50bn (USD84bn) at their MPC meeting held in July, While the European Central Bank (ECB) reduced its benchmark rates to record lows in June, effectively punishing banks for not lending to the real economy, with expectations that continued sluggish growth might lead to the ECB s own QE program. The impact of easy money in those developed financial markets is much the same as it was in the US, which is signalled by the capital importation statistics from the apex bank, which shows that the level of inflows from the US, UK and the EU (excluding the UK) was USD1.17, USD5.22bn, and USD990mn respectively, with the total inflows from the start of the year to May recorded at USD8.18bn. Chart 7: Capital Importation into the Nigerian Economy Chart 8: Portfolio investment in Nigerian Capital Markets Millions 3,000 2,500 EUROPE EX-UK UNITED KINGDOM UNITED STATES TOTAL Millions 2,500 2,000 Equity Markets Fixed Income Instruments Total Portfolio Investment Poly. (Total Portfolio Investment ) 2,000 1,500 1,500 1,000 1, January February March April May 0 Jan Feb Mar Apr May Source: CBN, Meristem Research We expect that the level of inflows from these countries will retain the same composition for the rest of The major threat to these inflows

6 P a g e 6 however, is the level of global recovery which determines the continuation of the easy monetary policies of these Central banks, and so we may expect strong capital inflows as long as global recovery lags expectations. No country for falling rates The impact of political pressures on capital inflows is a major reason for our assessment about the direction of rates for in H2:2014. Reduced inflows from other countries may be the factor that amplifies the full impact of the end of the US Fed s QE, which may be decided in the FOMC meeting held on the th September, In the absence of QE, and with yield seeking money averted by political pressure (even without net outflows) we expect upward pressure on rates. We measured in our monthly report for June that the correlation between MPR and rates on bonds and T-Bills was 0.86 and 0.83 respectively, showing a positive relationship between MPR and yields on fixed income assets. And so, we expect that when rates are cut in the New Year, after the 2015 elections (as pronounced by the new CBN governor), that yields on investments in the fixed income asset class may decline markedly (dependent on the magnitude of cut). We advise that investors take advantage of the impending high yielding environment, investing in what is sure to be some of the last high yielding instruments for a while. There is expected to be one more new bond issue in 2014, and likely only 1 other before the end of the 2015 elections. We advise investor to partake in these final auctions which given our expectations from yields may likely have attractive coupon rates (and consequently, yields) which would have the added advantage of price appreciation in 2014 (given the inverse relationship with rates). The downside of a declining rates environment is definitely lower rates from traditional fixed income instruments (T-Bills and Bonds), however, we are expectant that the lower rate environment might encourage more issuance of Naira denominated debt by both Nigerian and foreign firms, as well as increased Federal Government issuances due to the reduced cost of borrowing. We opine that this would be the beginning of the deepening of the Nigerian fixed income market, leading to more exotic instruments from securitization et al. Were such a scenario to play out, then investors would be able to offset the declining yield from Federal government securities by investing in corporate issues which would be offered to the market at the risk free rate plus a risk spread. This would be one avenue of boosting income that investors should

7 P a g e 7 take advantage of. However, we add a caveat, that investor be wary of the liquidity issues that may be associated with investing in corporate issues i.e. holding to maturity may be necessitated by the fact that selling if the need arises may be challenging. Also, the credit quality of the company should be accessed on a case by case basis, as well as periodically reassessing any investment already made as corporates come with significantly more risk. Investment Case: Diversification will be key Also we advise diversifying across fixed income sectors, including in state, investment grade corporates, and high yield (lower grade corporates etc.) as well as other emerging markets, to manage portfolio sensitivity to changing interest rates while providing additional income. However, we cannot stress enough the importance of engaging a manager when adding riskier bonds to your portfolio as the risks of investing in these instruments are greater than investment in government instruments (riskfree instruments) making professional advice a necessity in navigating these threats.

8 P a g e 8 FGN BONDS Issuer Description Issue Date Maturity Date Price YTM FEDERAL GOVT SEP Oct Oct % FEDERAL GOVT APR Dec Dec % FEDERAL GOVT AUG Apr Dec % FEDERAL GOVT APR Aug Aug % FEDERAL GOVT JUL Dec Dec % FEDERAL GOVT AUG Jan Jan % FEDERAL GOVT MAY Sep Sep % FEDERAL GOVT JUN Oct Oct % FEDERAL GOVT OCT Sep Sep % FEDERAL GOVT JAN Nov Nov % FEDERAL GOVT MAR Apr Apr % FEDERAL GOVT NOV Sep Sep % FEDERAL GOVT MAY Sep Sep % FEDERAL GOVT NOV Sep Sep % FEDERAL GOVT JUL Oct Oct % FEDERAL GOVT JUL Feb Feb % SUPRANATIONAL BONDS Issuer Description Issue Date Maturity Date Price YTM IFC IFC 11-FEB Feb Feb % STATE GOVERNMENT BONDS Issuer Description Issue Date Maturity Date Price YTM NIGER NIGER 15-OCT Oct Oct % KADUNA KADUNA 31-AUG Aug Aug % EBONYI EBONYI 30-SEP Sep Sep % BENUE BENUE 30-JUN Jun Jun % IMO IMO 30-JUN Jun Jun % LAGOS LAGOS 19-APR Apr Apr % BAYELSA BAYELSA 30-JUN Jun Jun % EDO EDO 31-DEC Dec Dec % DELTA DELTA 30-SEP Sep Sep % NIGER NIGER II 4-OCT Oct Oct % EKITI EKITI 09-DEC Dec Dec % NIGER NIGER III 12-DEC Dec Dec % ONDO ONDO 14-FEB Feb Feb % GOMBE GOMBE 02-OCT Oct Oct % LAGOS LAGOS 22-NOV Nov Nov % OSUN OSUN 12-DEC Dec Dec % OSUN OSUN II 30-SEP Sep Sep % LAGOS LAGOS IV 27-NOV Nov Nov % KOGI KOGI 31-DEC Dec Dec % EKITI EKITI II 31-DEC Dec Dec % NASARAWA NASARAWA 06-JAN Jan Jan % CORPORATE BONDS Issuer Description Issue Date Maturity Date Price YTM LAFARGE WAPCO LAFARGE WAPCO 7-OCT Oct Oct % GTB GUARANTY TRUST 18-DEC Dec Dec % NGC NGC 31-DEC Apr Dec % UPDC UPDC 17-AUG Aug Aug % FLOURMILLS FLOURMILLS 9-DEC Dec Dec % CHELLARAMS CHELLARAMS 06-JAN Jan Jan % NAHCO NAHCO 29-SEP Sep Sep % FSDH FSDH 25-OCT Oct Oct % UBA UBA 30-SEP Sep Sep % C & I LEASING C&I LEASING 30-NOV Nov Nov % DANA MPR+7.00 DANA 9-APR Apr Apr % TOWER I MPR+7.00 TOWER 9-SEP Sep Sep % TOWER II MPR+5.25 TOWER 9-SEP Sep Sep % UBA UBA II 22-SEP Sep Sep % LA CASERA LA CASERA 18-OCT Oct Oct % CHELLARAMS MPR+5.00 CHELLARAMS II 17-FEB Feb Feb % DANA DANA II 1-APR Apr Apr % NAHCO NAHCO II 14-NOV Nov Nov % Source: FMDQOTC, Meristem Research

9 P a g e 9 Contact Information Brokerage Services gbadunolasokunbi@meristemng.com ( ) Investment Banking/Corporate Finance adejumokeawolumate@meristemng.com ( ) michaelogun@meristemng.com ( ) Wealth Management sulaimanadedokun@meristemwealth.com ( ) damilolahassan@meristemng.com ( ) Tel: Registrars muboolasoko@meristemregistrars.com ( ) Tel: Trustees yinkaadegbola@meristemng.com ( ) Tel: Client Services tounomonaiye@meristemng.com ( ) Investment Advisory ifeomaogalue@meristemng.com ( ) Investment Research saheedbashir@mersitemng.com ( ) kemiakinde@meristemng.com ( ) research@meristemng.com Tel: Corporate websites: Meristem Research can also be accessed on the following platforms: Meristem Research portal: meristem.com.ng/rhub Bloomberg: MERI <GO> Capital IQ: ISI Emerging Markets: Reuters: FactSet:

10 P a g e 10 IMPORTANT INFORMATION: DISCLAIMER Meristem Securities Limited ( Meristem ) fixed-income reports and its attendant recommendations are prepared based on publicly available information and are meant for general information purposes only and it may not be reproduced or distributed to any other person. All reasonable care has been taken to ensure that the information contained herein is not misleading or untrue at the time of publication; Meristem can neither guarantee its accuracy nor completeness as they are an expression of our analysts views and opinions. Meristem and any of its associated or subsidiary companies or the employees thereof cannot be held responsible for any loss suffered by relying on the said information as this information as earlier stated, is based on publicly available information, analysts estimates and opinions and is meant for general information purposes and should not be construed as an offer to buy or sell or a solicitation of an offer to buy or sell securities or any financial instruments. The value of any investment is subject to fluctuations, i.e. may fall and rise. Past performance is no guide to the future. The rate of exchange between currencies may cause the value of investment to increase or diminish. Hence investors may not get back the full value of their original investment. Meristem Securities is registered with the Securities and Exchange (SEC) and is also a member of The Nigerian Stock Exchange (The NSE). Meristem Securities registered office is at 124 Norman Williams Street, South West, Ikoyi, Lagos, Nigeria. Website: research@meristemng.com. Meristem Securities Limited 2014.