Next FGN Bond Auction

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1 FGN Bond Auction Scheduled 20 January, 2016 Summary of Bond Auction 15.54% FGN FEB 2020 Auction Date 20/01/16 Settlement Date 22/01/16 Advised Yield % Maturity Date 13/02/2020 Coupon 15.54% Next Coupon Date 13/02/16 Clean Price NGN FGN JAN 2026 Auction Date 20/01/16 Settlement Date 22/01/16 Advised Yield % Issue on Offer/Summary The Federal Government of Nigeria (FGN) through the Debt Management Office (DMO) will be conducting a bond auction on Wednesday 20 th of January, Two major instruments; FGN 5-year and 10-year bonds are to be auctioned as scheduled, for a total amount of NGN80bn % FGN FEB 2020 (5-Yr Re-opening) NGN40, 000,000,000 FGN JAN 2026 (10-Yr NEW) NGN40, 000,000,000 Given our analysis of the current yield environment vis-à-vis our bond valuation models, we present below our advised bid rates: Instrument Advised Yield 15.54% FGN FEB % % Current Yield Analysis FGN JAN % % The Nigerian bond market has had a weak outing since the last bond auction on the 9 th of December, The Treasury bond yields across instruments advanced by 1.79% on the average, pushing the average bond yield to 11.39% as at 18 th January, There was noticeably weaker demand on the shorter-termed instruments, with the APR-2017 (+2.98%), JUL-2017 (+2.90%), AUG-2017 (+2.83%) and MAY-2018 (+2.31%) instruments recording the highest yield increases. The frail demand in the bond space in our opinion is partly due to the waning trend in the financial system liquidity value which in the period under consideration declined from NGN682.99bn on the 9 th December 2015 to NGN126.95bn as at 13 th January 2016 (last updated date by the CBN). Furthermore, the lingering uncertainties in the general economy, especially as regarding the decisions of the MPC at their next meeting on the 25 th and 26 th of January 2016 have continued to exacerbate fears on the part of investors, as calls for a devaluation of the domestic currency from various quarters have seemingly intensified, even as rising inflation levels (9.60% as at December 2015) continue to pressure real returns in the low yield environment. Considering the bullish pre-auction rally witnessed in the treasury bonds space at the secondary market on the 18 th January 2016, where average bond yield pared by 0.28% to 1 P a g e

2 11.39%, we anticipate the bond auction will be well subscribed, and as such, yields might be further tempered in the short term. We believe the Nigerian sovereign yield curve (which shows the current yield for fixed income instruments of different maturities) reflects an appropriate measure for pricing the different bonds. Our methodology adopts the iteration process in determining the suitable discounting factor for the different streams of cash flows for the instruments considered. This forms the basis for our valuation of the 5-year and 10-year instruments discounting the stream of coupons (cash inflows) by the iterated yields and summing the present value of the future cash flows to arrive at our intrinsic price. Bond Absolute and Relative Valuation We valued the 15.54% FGN FEB 2020 re-opening using the current yield curve as the basis for discounting. We arrived at fair value of NGN121.85, implying a yield of 9.00%. Instrument Fair Value Implied Yield IRR 15.54% FGN FEB % 6.18% We analyzed the issues on offer given the current yield environment, market liquidity, as well as a review of the recent past auctions, whilst also introducing market sentiment factor into our valuation, on which we advise bid yield ranges for both issues on offer. 2 P a g e

3 About Bonds A bond is a fixed income debt instrument issued by the government (federal or state government) or corporate institutions with a definite date of maturity and a fixed interest payment (known as coupon) payable either semi-annually or annually. Unlike equities, bonds are issued with a guarantee of the initial investment and can have tenors as long as 20 years. A treasury note refers to a government bond instrument with a term to maturity of 1 to 10 years while a treasury bond has a maturity of 10 years and above. Bonds issued by state governments of a country are referred to as municipal bonds while those issued by organizations are corporate bonds. The government usually issue bonds at the primary market to raise domestic funds to meet its fiscal responsibilities. This can be done from time to time as the need arises. Nigerian FGN bond instruments are named by their maturity, coupon, tenor etc. such as 13.05% FGN AUG 2016 instrument. How is Return Determined? Bonds are mostly issued with a coupon otherwise known as, the periodic interest payable. Bond instruments are usually issued at par; that is, N100 or N1, 000 as is the case with Nigerian bonds. A 2-year bond issued at 12% annual coupon with a par value of N1000 implies that the issuer will make 3 semi-annual payments of N60, and a final N1060 on the maturity date. Bonds can be purchased at both the primary and secondary markets, they are either quoted in price or yields. There is an inverse relationship between the price of a bond and its yield to maturity (YTM). At issuance, the yield on a bond instrument is most likely the coupon on that instrument. At the secondary market therefore, an investor can trade bonds by quoting a yield that reflects the variance between the par value and the current price based on the current market dynamics. How does the Auction Process work? Bond instruments are issued through a competitive bidding process at auctions as conducted by the Debt Management Office which serves as the representative of the government. An existing government instrument can be re-issued also at the primary market in which case the DMO re-issues based on the current market yield to maturity. Bonds are auctioned at established rates which determine the return to investors. Purchasing these instruments in the primary market and holding it till maturity would mean that the investor gets a fixed interest payment, however, there is a secondary market in which investors can trade these bonds to meet their immediate liquidity needs. 3 P a g e

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