DMO hedges against cost in bond auction

The Debt Management Office (DMO) last week hedged against escalating borrowing costs by selling 76 percent less bond on offer at its monthly debt auction, as most bids came above its interest rate cut off point.

The DMO is expected to continue with such cautionary debt management steps, according to analysts, amid growing debt service payments which have spiked from below N200 billion a year in 2007 to over N550 billion in 2012.

“It appears that the authorities were reluctant to lock such high yields amid the recent correction in emerging market debt rates,” Samir Gadio, an emerging markets strategist at Standard Bank, London, said by e-mail.

“Given that FGN bond rates have now declined in the secondary market to sub-13 percent levels, there was certainly no point in issuing bonds in the primary market at substantially higher yields.”

The DMO offered N85.0 billion worth of five-year (N60 billion) and 20-year (N25 billion) bonds, while a total of N20.81 billion was sold. All auctioned securities were reopening of existing benchmark bonds.

The sell off in emerging market debt that began on May 22 has led to an unwind of the carry trade on the naira, as investors unnerved by the potential end to Quantitative Easing QE in the United States, exited emerging market assets, leading to losses in the Nigerian bond market and a reduced bid for naira assets.

Total subscription levels by banks and investors at the auction amounted to N157 billion, 185 percent higher than the amount on offer, however, the range of bids indicated that investors sought to optimise returns by submitting relatively high bids, analysts say.

The initial cut-off for the April 15s was 17.4 percent, before the DMO decided to under-allocate the auction, which was eventually issued at 12.25 percent.

The proposed cut-off yields for the April 17 and July 30 bonds were also elevated, at 14.4 percent and 15.0 percent.

The bids ranged from 12.2500 percent – 17.4450 percent for the 5-year April 2015, 12.0 percent – 17.4900 percent for the 5-year April 2017 and 11.0000 percent – 18.2500 percent for the 20-year July 2030, while the securities were allotted at marginal rates of 12.25 percent, 13.00 percent and 13.50 percent, respectively, according to DMO data.

“This suggests that while investors sought higher returns, the DMO was only willing to issue the bonds at the lower end of the bid range, hence the ‘high subscription-low-allotment’ situation at the auction”, Jide Nwaogwugwu, analyst at investment firm, Dunn Loren Merrifield, said in a fixed income update, released on Tuesday.

Even though the decision not to fill the auction is unusual in Nigeria’s market history, it is however, an approach that has episodically been used by other selected African countries such as Kenya in the past, to contain the government’s funding cost, analysts say.

The National Bureau of Statistics (NBS) said on Monday that Nigeria’s inflation rate fell to 9 percent in May, down slightly from 9.1 percent in April, which may help to ease the rise in bond yields.

Yields on Nigerian benchmark 10-year debt due 2022 are down 170 basis points since their highs of last week. The yield on the 16.35 percent January 2022 closed at

13.05 percent on the secondary market on Monday.

The naira strengthened by 1.6 percent on Monday to N160 per dollar on the inter-bank market. The naira is down 2.4 percent versus the dollar year-to-date.

The DMO will try to bridge the domestic financing shortfall over the next auctions as market conditions normalise, according to Gadio.

“I would not call it a failed auction in the sense that the DMO acted appropriately by rejecting excessive bids,” Gadio said.

FGN bonds made up 61.44 percent of the domestic debt stock of N6.5 trillion at the end of 2012.

Nigeria’s budget deficit is forecast at about 2.17 percent of gross domestic product (GDP) in 2013, down from 2.85 percent in 2012.Total debt may reach 14.8 percent of GDP this year.