An Introduction to Retail Bond Market - The Nigerian Stock Exchange

January 29, 2013The Role of NSE FIMMs - An Introduction toRetail Bond MarketAn NSE PresentationBySegun GeorgeDunn Loren Merrifield

Outline1• The Nigerian Bond Market2• What is retail bond market trading & fixed income marketmaking (FIMM)3• How do you participate4• Benefit of trading on the Exchange5• ConclusionThe Nigerian Stock Exchange2

THE NIGERIAN BOND MARKET: AN OVERVIEW• Prior to 2002, the management of the country’s debt position was undertaken by the Federal Ministry ofFinance (FMoF) and the Central Bank of Nigeria (CBN)• During this period, the CBN acted as the main issuer of government debt with issues mainly of expensive shorttenured securities in the form of treasury bills, which translated into a high cost of refinancing and frequentrollovers as open market securities were used to finance long-term government needs. Effectively a financingmis-match• Following a restructuring of the domestic debt markets, the Debt Management Office (DMO), which wasoriginally established in 2000 to centrally coordinate the management of Nigeria’s debt, resumed the issuanceof longer tenured bonds in 2003 which resuscitated the bond market while CBN was mandated to act as theIssuing House and the Registrar• This recorded significant success as there was a paradigm shift away from short-term Treasury Bills to longertenor instruments with maturities of up to 20 years. Principally, maturing short term treasury bills wererefinanced into longer term bonds starting from 2 to 3 years; then, 5, 7, 10 and 20 years. Nigeria now has a 20-year yield curve• The appointment of Primary Dealer Market Makers (PDMMs) further developed the primary and secondarymarket for FGN bonds in providing liquidity to on-the-run bonds across the curve• The Nigerian bond market has witnessed significant growth over the years to emerge as one of the most liquidbond markets in Sub-Sahara Africa (SSA) – ex. South Africa, supported by a considerable increase in marketcapitalization and turnover

THE NIGERIAN BOND MARKET: FOOTPRINTS IN TIME20032006200820102012-Failed offer(variousdocumentedreasons)- callable bonds:3Y, 5Y, 7Y &10Y bonds-15 PDsappointed- 5Y & 7Yissues-Issuance of20Y bondsRelease ofnew guidelinesfor the FGNBond MarketAddition ofFGN Bondsto the JPMorgan’s &Barclays EMBond IndexDMOestablished(4 th Oct, 2000)Smaller issues of2Y &3Y- Regular monthlyissuance ofoption-free bonds- 5 additionalPDs appointed-1st re-opening ofexisting bond- Re-appearanceof 10Y bonds1 st recordedmarket shutdown due toprice volatilityIssuance of the$500m Eurobond(For internationalPrice Discovery):current yield is3.65%(11/01/13)20002005 2007200920114

THE NIGERIAN BOND MARKET: MAJOR EVENTSNIGERIA: COMPOSITION OF GOVERNMENT DEBT – 2001 VS. 20122002: c.N5.1 trillion 2012 (Sept.): c.N6.3 trillion #Treasurybonds*, 36%FGN bonds, 61%Others, 20%LT stock, 1%Treasury bills, 34%Treasury bills,44%Treasury bonds, 5%#The growth in actual new issuance is c.N1.2trillion as most of the issuance was to refinance existing T-bills.* Nigeria’s sovereign bonds (debt) have been in existence since the 1970s. However, the Treasury bonds are federalgovernment securities issued pre-2003. They are illiquid and redeemable only to the Central Bank of Nigeria (CBN) uponmaturity.5

Feb-06Aug-06Feb-07Aug-07Feb-08Aug-08Feb-09Aug-09Feb-10Aug-10Feb-11Aug-11Feb-12Aug-12THE NIGERIAN BOND MARKET: BONDMARKETNIGERIA: COMPOSITIONSIZINGOF BOND MARKETFGN,86.0%States,10.6%Corporates,3.4%The federal government is theprimary issuer of debt. Thecurrent portions for States andCorporates was achieved undera favourable interest rateregime when primary marketactivities for these tiers ofcredit issuers was beginning togain traction.NIGERIA: BOND MARKET TURNOVER, N’TRILLIONS3.02.52.01.51.00.50.0Trend lineHistorically, volumes had asteep upward trajectory giventhe dearth of investiblesecurities in Nigeria,particularly after the equitymeltdown of 2008. Followingthe subsequent bond marketcorrection of 2010, volumeshave been on the increasewhile the overall trend ispositive (see Trend line)7

Sub-Nationals (State Bonds)IssuerIssueSize(N’bn)RatingMaturityOriginalTenorSub-NationalsTTM/ Av. LifeCoupon(%)Mid-Price Yield (%)Lagos-1 (S1) 50.00 A+, AA, Feb-14 5 1.06 13.00 100.64 12.32Kwara 17.00 A Aug-14 5 1.54 14.00 101.16 13.13Niger # 6.00 A- Oct-15 5 1.83 14.00 100.59 13.61Ebonyi # 16.50 A Sep-15 5 2.50 13.00 99.74 13.26Kaduna 8.50 A+ Aug-15 5 2.61 12.50 97.95 13.44Imo # 18.50 A+ Jun-16 7 2.50 15.50 104.43 12.81Benue # 13.00 A- Jun-16 5 2.50 14.00 100.64 13.64Bayelsa # 50.00 A- Jun-17 7 3.17 13.75 101.75 12.89Ekiti # 20.00 A Dec-18 7 3.83 14.50 103.53 13.06Delta # 50.00 A+ Sep-18 7 4.17 14.00 103.51 12.50Lagos-1(S2) 57.00 A+ Apr-17 7 4.25 10.00 92.49 12.31Ondo # 27.00 A/A- Feb-19 7 4.75 15.50 108.36 12.65Niger (S1) 9.00 A- Oct-18 7 4.83 14.00 103.08 13.20Gombe # 20.00 A/A- Oct-19 7 4.83 15.50 107.15 12.75Edo 25.00 A Dec-17 7 4.95 14.00 101.89 13.46Lagos-2 (S1) 80.00 Aa+/A+ Nov-19 7 6.84 14.50 109.48 12.40Osun# 30.00 A/A- Dec-19 7 6.90 14.75 104.63 13.25Source: DLM Research

CorporatesIssuerIssueSize(N’bn)RatingMaturityOriginalTTenorTTM/Av. LifeCoupon(%)Mid-PriceYield, (%)Lafarge 11.80 A+/AA- Oct-14 3 1.72 11.50 96.31 13.96GT Bank 13.17 AA Dec-14 5 1.91 13.50 100.49 13.19Chellarams # 1.50 BBB- Jan-16 5 2.17 14.00 98.31 15.21UPDC # 15.00 BBB Aug-15 5 2.83 10.00 94.96 14.54Flourmills # 37.50 A Dec-15 5 3.50 12.00 97.92 13.54NAHCO 2.15 AA/A- Sep-16 5 3.70 13.00 96.58 14.20*Tower (S1 Tr. A) # 3.63 A-/A- Sep-18 7 4.17 18.00 109.09 14.44*Tower ( S1 Tr.B)#*Dana# 8.011.00 AAA/AA- Sep-18 7 4.17 16.00 106.67 13.44BB+/BBB+Apr-18 7 4.50 16.00 102.50 14.94UBA (S1) 20.00 A+ Sep-17 7 4.70 13.00 98.64 13.39C&I Leasing# 0.94 BBB- Oct-17 5 4.78 18.00 106.77 14.88*Chellarams (S2)#0.54 BBB- Feb-19 7 4.83 17.00 105.14 15.06UBA (S2) 35.00 A/A Sep-18 7 5.70 14.00 102.52 13.34

The Nigerian Bond Market: Volatility (%)16.39% FGN Jan 2022Point of inclusion into JPMorgan indexMPC DatesNote the volatility build-up around the announcement dates for the MPC meetings, inclusion in the JP Morgan EM Bond Indexadded to market expectations and a new support for this bond’s price.

RETAIL BOND TRADING AND FIXED INCOME MARKETMAKER(F) • Retail bond trading is a platform which the Nigerian Stock Exchange has made available totrade the sovereign bonds in smaller units. This was brought about in a bid to afford the retailinvestor an opportunity to participate in the fixed income market on both the buy and sellside.• In order to carry this out efficiently 6 Fixed Income Market Makers where appointed on theexchange. They give both binding buy (bid) and sell (offer) prices on the same quote throughthe Exchange’s Automated Trading Systems. (ATS)•Capital Bancorp•Cordros Capital•ESS/Dunn Loren Merrifield•FSDH Securities•Greenwich Trust•Investment One• On the exchange a FIMM is obligated to give quotes on which he is willing to buy and sell if acounterparty is interested. When selling the Bonds, the same process will be followed i.e. theinvestor notifies the trader of the intention to sell, the trader sells and the total amount fromthe sale is credited to the investor's cash account.• The FIMM is obligated to give quotes both on which he is willing to buy and sell if thecounterparty should indicate interest.11

HOW DO I PARTICIPATE• The TWO simple steps:i. Appoint a house as your Fixed Income Broker/Dealer.ii. A CSCS account is opened for you (the CSCS is the central depository for all securities inNigeria) if you do not have one.• Discuss and get appropriate advice on the Bonds to invest in.• Once the investment is agreed, a trade can then take place which is a very simple process. Itworks as follows:-i.Transfer the funds required to buy the Bond to your broker or the custodianii. Once the payment is confirmed in the custody account, the client’s CSCS account will becredited with the Bonds purchased.• When selling the Bonds, the same process will be followed i.e. the investor notifies the traderof the intention to sell, the trader sells and the total amount from the sale is credited to theinvestor's cash account.• If the investor does not want to sell his Bond, he/she will collect interest payment two times ayear from the issuer. Interest paid will be determined by the Interest rate on the Bond.12

HOW DO I PARTICIPATEInvestorappoints aFixed Incomebroker/dealerWhere required –Dealer opens cash& securities a/cwith custodianInvestorsinterest inbonds, termsare agreed anddeal is sealedBroker buys agreedsecurities intoinvestor’s a/c; andinvestor is debitedfor naira value,Investorreceives a/cstatement orconfirmationfrom brokeron executedtransactions13

BENEFITS OF TRADING ON THE EXCHANGE• Retail investors have direct access to the market• There are 6 FIMM and other brokers as against having few players in the market• Minimal transaction cost• Create further price discovery as the exchange will create a transparent platform• Price level for each trading bond will be determined by the market• Retail Investors can invest as low as N10,000 face value• The default risk on delivery is non existent as its an exchange traded product.14

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