Tuesday, 6 March 2012

A tale of 2 City Bankers, an investor and Nigeria

Last week, two bankers who work in the London financial centre (referred to as City) had an interesting e-mail conversation on why Nigerian bonds, despite their high yields, are not being snapped up by foreign investors with an appetite for high yield bonds. Below is an edited version of the conversation that provides an interesting insight into how foreign investors view the Nigerian economy and even its apex regulator.
Sanusi Lamido Sanusi-Central Bank of Nigeria Governor. 

This is the e-mail from Mr R that set up the conversation trail. 

Over to you guys! I have not known Nigeria to default on its debt obligations in the last 10 years. If the Fed Government is offering such lucrative interest rates on Bonds, which is in essence a safe asset, why are we not selling them to the European public, who can only get 1% on their saving in the retail banking sector? Educate and enlighten us please?

Mr H, a banker in City responds.

There is more to bond yields than the objective factors you have mentioned. First of all, on a currency level, the Nigerian Naira is not a “tradable” currency and as such, bonds cannot be issued in Naira for international sales. Most outstanding Nigerian bonds are issued in USD which carries a currency risk (cross-currency factor).

Nigeria is still regarded as a very unstable country so there is the default risk in case of change of government or change of country structure (think about what happened during the break-up of the soviet union and the Balkans), the cost of Nigeria Credit Default Swap (insurance against default) is very high, this has to be priced in and remember, this is not in Naira as well.

Also, Nigeria is mono-product economy with the economy almost dependent on oil, the value of Naira is very dependent on the price of oil and this affects the value of Nigerian bonds (daily bond valuation – Mark-to-market value). Then, there is the independence of the guys that take decisions with regards to fiscal and monetary policies in the country, these guys are not independent. Soludo tried but his ideas were too advanced for the country and the country wasn’t ready for it, Sanusi is just your ordinary Joe who is not independent but suits the environment.

Finally, bond prices, amongst other things depend on the interest rate in the country, theoretically, for money to have value, the cost of borrowing should be less or equal to inflation, inflation is linked to the purchasing power and purchasing power parity and hence value of money and bond prices/yields. Current inflation rate in Nigeria is about 23%, also, the Nigerian Central Bank Base Interest Rate (Risk Free Rate) is about 12%, if you adjust that with other interest rate factors like default, pre-payment, repayment, liquidity and sovereign risk, you can see that the bond rate of 16-17% is not bad.

Mr T, another banker in City also contributes to the conversation.  

I was just getting some information together so I could attach them and send you an email. Almost my sentiments exactly. Things like the independence of the governor, I wouldn’t have known about, but only a suspicion. Also, your inflation rate, I didn’t know the current figure.  But I was going to say exactly what you have mentioned about stability. See attached Bloomberg screen shot; I was very shocked to see how high Nigeria’s Yield is and how low the price is. With Nigeria’s resources, you can mainly put it down to stability and the other factors you have mentioned like independence, which also comes into stability.

Look at Ghana’s yield (December 11) and see how low that is. I thought they will be not that far off Nigeria, but I was really surprised to see what I just saw. I have also attached Greece, Germany (GR) and the UK which were all printed in December to give anyone an idea of where the advanced nations are, and how bad Greece is at the moment, and where we in Ghana and Nigeria fit, to have a judgement on whether we can do better or we are doing Ok, or to judge if one wants to invest.

I still think 16 to 17% is a very healthy return, but if – on a weekly basis – we hear of bombings and unrest and the perception that the government is being overrun, it’s difficult for people to invest in government bonds. However, people will take the risk of doing business that will bring short term and quick bucks. So that’s my opinion.

Mr H responds again.

You had the patience I didn’t have for I couldn’t walk down and print these out. Yes, the yield on German Government bonds is low but I think it should almost be negative like that of the Swiss. This is because Germany is very healthy economically and should be the only AAA country in the world.

As for UK, the low yield is mainly due to them not being members of the Eurozone; the economy is a bit fragile with high debt to GDP ratio. As for Greece, well, International Swaps and Derivatives Association (ISDA) defines default as when either a country cannot pay its debt back on its own or when there is a debt swap (swapping current debt to longer maturities) with that in mind and with the current situation in Greece, I will say that Greece have defaulted and their debts should be worthless.

As for Nigeria vs Ghana, the difference in yield doesn’t tell the whole storey, the notional value of outstanding debt (which Nigeria has more) also plays a role in bond yields.

Also real inflation in Nigeria is actually more than 30% if one gets really academic in calculating it, there is a lot of money in circulation, the central bank has no control on the amount in circulation, there is free money (stolen, drug, bribery, 419, different foreign currencies) everywhere and as such the central bank cannot control money supply, this is a very effective way of controlling inflation and once the central bank loses this, then it is all gone.

 On a final note, Nigeria has no derivative market, there is almost no financial and biometric risk management within the financial (bank and insurance sector), when idiosyncratic risks cannot be managed, then, they are pushed or passed on to the end user hence high inflation, money supply, low purchasing power of money and this ultimately affects  bond yields.

The most dangerous of all especially with Nigeria is that of instability, most Nigerians don’t even know what the map of Nigeria might look like in the next 20 years, well, if you look at that fact and that things like mortgages are price with 30-year bond rates, then you can understand the reason for high yield and low price of Nigerian bonds, the uncertainty risk.

Mr R who sent the initial mail that set up the conversation responds

Thanks for a very interesting insight,  real inflation, control of money supply, outstanding debt levels, mono-cultural economy, Ghana's yield... Though as T concluded, I still would rather invest in Nigerian Bonds than Greece's, considering that nominal outstanding debt to revenue ratio is almost 200%. So, if I was sitting on a million €, where would you advice I invest in, annuities or similar investment? Just planning for when I win the lottery!!! Just Joking!

Mr T responds  
If you want a cautious and decent growth, then invest in Gold. It has gone through the roof and took a hit this week, so not a bad time to get in.

If you want quick aggressive buck,(with the danger of losing a lot) then you can look no further than African mining firms (this includes foreign companies already mining in and those doing exploration in places like Mali, Guinea, central Africa, Burkina etc). Or look at the ZAR (South African Rand). It is an absolute volatile currency which has dropped 13.5% against the $ in a month. It can move back up that quickly again.

Hurry up and win the lottery. In the past month, two people from Nottinghamshire have won over £40m each. Maybe, you better move there and buy your ticket.

End. 

This is a real conversation. It is not made up, just slightly edited. 

Watch this video by CNBC Africa on Nigerian bond yields done as far back as November 2010. 

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