Signs of liquidity drying up in the bond market for South Africa’s beleaugered parastatals is becoming a reality following the results of the Transnet bond auction on Monday.
The state-owned utility, which has been mired in controversy surrounding its business dealings with the Guptas, tried to issue R200 million worth of bonds on May 8. The company received only two bids amounting to R40 million and agreed to issue only R10 million.
Bonds of parastatals are priced in relation to the yield of government bonds for instruments of the same maturity.
Transnet was auctioning two long-dated issues that mature in 2030 and 2040 respectively. With South Africa’s equivalent government bond yields trading at 9.60%, the R10 million of bonds that were auctioned were priced at a spread of 198 basis points (1.98%), translating to a yield of 11.58%.
Transnet has a very well run calendar that it releases to the public, whereby the company attempts to raise amounts of R200 million every two weeks via public auctions that are held on Mondays. (Public auctions invite bids from investors directly who submit the quantum of the bonds they would like to subscribe for along with the price – or yield – they are prepared to pay. Transnet then selects the bonds they are prepared to issue based on the competitive bids in front of them.)
Even by recent standards, Transnet’s auction on Monday was very poor (see graph).
As can be seen from the graph, there has been a strong deterioration in the amount of liquidity the market has been prepared to provide Transnet in the wake of Pravin Gordhan’s dismissal and the credit downgrades. Of the R600 million the company has sought to raise in the three auctions after the dismissal of the finance minister, it has raised just R55 million – or 9%. So, why is this?
Looking at Transnet in isolation may not be illuminating by itself. Other parastatals like the Landbank have had successful issues recently, raising R655 million in unsecured floating rate notes last month, albeit in a different format. The Landbank conducted its bond issue via a private placement, so Transnet’s travails may not be a more general problem with SOEs.
Nor are private companies struggling to raise money. On the same day (Monday) Barloworld successfully issued R582 million of senior unsecured floating rate paper with a maturity of three years, quite different to what Transnet was trying to get away.
“There is much stronger demand for shorter-dated floating rate debt instead of longer-dated fixed bonds of the kind Transnet was auctioning,” says Rand Merchant Bank credit analyst, Elena Ilkova. “So the modest investor interest in Transnet’s recent offering is not just Transnet specific, it’s also about the preference of investors in times of uncertainty. The other reason may have to do with where the market sees South Africa’s long-term interest rates heading.”
If investors expect interest rates to rise over the long term, buying a long-dated fixed rate bond, in which the interest received is a fixed amount, is not a good place to invest if the price is not adequately compensating investors for the risk of holding it. This is because as interest rates rise, the value of the bond falls, and that means a greater risk of incurring capital losses. (Floating rate bonds, by contrast, adjust for higher rates without affecting the value of the bond – and hence are more desirable than fixed rate paper in a rising interest rate environment.)
Transnet is in the process of compiling its annual results for the year ending March 2017, and while these should reflect the generally suppressed economic conditions, Ilkova expects no material deterioration in the company’s credit quality. Transnet’s credit rating is in line with South Africa’s sovereign rating.
But perhaps the market is taking a dim view of governance too… “It was one of the worst auctions in recent memory, there were just no buyers out there,” says a bond manager familiar with the auction, but who wanted to speak on conditions of anonymity due to the sensitive relationships at stake. “Of course the downgrade has hit confidence, but there is real concern about how the SOEs are being run and how viable they are.”
Transnet is in a much better financial position than the likes of Eskom, but both have serious questions regarding corporate governance, which would dictate investors be more circumspect in an environment where the public has declining trust in government.
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