Decent first 2021 auction for DMO, but drive to finance FGN deficit still poses a challenge

By Charles Abuede

• FBN Quest analysts suggest tapping the Eurobond market
• is a faster and less stressful process than local financing

The Debt Management Office (DMO) last Wednesday held its first monthly FGN Bond Auction for 2021, which saw an oversubscription by 59 per cent (N238.28 billion), due to healthy liquidity in the market. The debt office offered N150 billion and canvassed N122 billion which is equivalent to $310 million. Demand was observed across 10-year and 15-year tenors with bid-to-cover ratios for 10-year and 15-year bonds settling at 1.84x and 2.13x respectively, while the bid-to-cover ratio for 25-year bond settled at 0.80x.

The marginal rates on the reopened 15 and 25-year benchmarks ascended for the second month, by 180 basis points and 195 basis points, respectively, as the DMO also reopened the 10-year benchmark, which it had not sold for over one year. But by accepting fewer bids, the DMO would have set lower marginal rates. Meanwhile, in the secondary market, FGN bond yields have been on the rise since the start of the year. This was the background to the first auction of 2021, along with the good judgment that the DMO would front-load its issuance.

However, the federal government of Nigeria has a huge borrowing programme ahead of it in 2021, not least because of the additional hit to revenue collection as a result of the Covid-19 virus. It is understood that the federal government, in its approved FY 2021 budget, projected a deficit of N5.60 trillion, which is to be covered by new borrowing of N4.68 trillion (50/50 split between its domestic and external borrowings through the DMO), multilateral and bilateral loans of N710 billion and privatisation receipts of N200 billion. The deficit was N5.20 trillion in the FGN’s initial proposals but inflated on the intervention of the National Assembly.

On the other hand, the domestic funding target of N2.34 trillion, if established, is highly challenging to the government. Meanwhile, for 2020 the DMO was set the revised target of N1.60 trillion but it grossed N1.66 trillion from FGN bonds over the 12 months, which shows that the reported domestic funding target for this year is highly challenging. Though, the DMO collects minor sums from the issuance of other debt instruments such as N163 billion from the sale of Sukuk in the first half of 2020, but the success of its target hinges upon the FGN bond auctions.

Accordingly, the views of FBN Quest Capital analysts on the DMO’s drive to canvass funds for government’s deficit through the bonds auction suggest that, “The challenge for the DMO requires the usual heavy lifting by domestic institutional investors, principally the PFAs. Their holdings of FGN bonds amounted to N7.38 trillion at end-November, equivalent to 60 per cent of their assets under management (AuM), according to the latest monthly report from their regulator (PenComm). The yields on the bonds narrowed by up to 400 basis points in H2 ’20 yet it remains the case that the pension funds have few investment alternatives with which they feel comfortable. Local money market securities are the only other asset class to account for more than 10 per cent of their total AuM (14.6%).” 

The PFAs are the pivotal investors within the bond market, holding 63 per cent of the entire stock of FGN bonds. They have developed their exposure to domestic equities but there are limited alternative investments channels with which they are comfortable. Though, it was understood that the PFAs were less prominent in the total bid this January, due to the fact that they are reluctant to commit their funds when the trend in yields is again rising.

FBN Quest Capital analysts also posited that the federal government may opt for the reversal of what is seen to be the current 50/50 split between domestic and external borrowing through the DMO in the 2021 budget. The federal finance minister has been quoted as saying that FG will not issue Eurobonds if local financing is more favourable.

Plans would also have to change if the FGN struggled to secure the projected N0.71 trillion in external loans from multilateral/bilateral sources. “To repeat a point dear to us, tapping the Eurobond market is a faster and less stressful process (although more costly) than accessing such loans, particularly if they come with policy strings attached,” they said.

In the perfect world, the DMO and its counterparts like to plan their issuance with fewer global and domestic uncertainties; the direction of the Covid-19 virus and the crude oil price probably top the list of grey areas. But when the sales on a non-competitive basis are added to public bodies, it can be arrived at that, the DMO raised N170 billion from the auction last week.

Conclusively, it is believed that the DMO will at another issuance in future, tempt investors with some new benchmarks and surely create some savings for the federal government as the coupons on its existing FGN bonds range up to 16.50 per cent.