The government of every country is renowned as the most credible issuer within the boundaries of its jurisdiction. Indeed, as a sovereign authority, debt notes issued in local currencies by the government or any of its institutions are referred to as “risk-free” instruments, believing that the government cannot default on any obligation in its local currency. After all, the worst that can happen is for the government to order its Central Bank to print money in extreme circumstances, even so.
Economists have over time warned of the consequences of frivolous printing of currencies without a corresponding increase in productivity. This capacity of the government to raise money through taxes and levies and in the extreme case by printing currencies is the main reason why the government-issued debt notes, including bonds and treasury bills, are priced at lower yields and higher prices, compared to equivalent debt securities issued by corporates and other institutions.
In fact, investors often use the price and/or yield of a government bond as the benchmark or basis for pricing a corporate bond, by adding a spread on the yield on a government bond to compensate for the presumably higher risk of investing in corporate debt securities.
Whether it is in Europe, the Americas, Asia, or Africa, government-issued debt securities are priced at a higher price and lower yields compared to those issued by companies in those countries, based on the age-long philosophy that the government is more creditworthy. Interestingly, rating agencies often assign “AAA” to all government-issued securities to the extent that those securities are in local currencies, which the government has control over. In the case of foreign-currency-denominated debt securities, rating agencies often ensure that no company operating or domiciled in a country has a higher credit rating than the government because it is believed that the government is the last resort that can bail out companies in the event of bankruptcy, a philosophy which global rating agencies such as Fitch, S&P and Moody’s refer to as “Sovereign Support”.
So, theoretically, a company’s bond cannot be assigned a credit rating better than the rating of the government that is believed would offer support, in the event that the company runs bankrupt or is unable to meet its obligations to creditors and investors. For instance, a month ago, Fitch Ratings affirmed Nigeria’s Long-Term Foreign-Currency Issuer Default Rating (LTFC IDR) at ‘B’ with a Stable Outlook.
With this rating, no Nigerian company is assigned a rating better than “B”, which is the ceiling for all Nigerian corporates and their securities issued in foreign currency. The exemption to this rule is for multinational companies with subsidiaries in Nigeria, as such entities may ride on demonstrated support from their parent companies in developed markets, especially when such a parent company has a credit rating higher than that of the Nigerian government.
However, investors may be ready to change the theory and define a new narrative, as the market pricing of Nigerian Eurobonds has defied the logic that the Nigerian government is more credible than the companies operating in the country. Notably, in an email note sent by First Bank subsidiary in the United Kingdom to clients, the Nigerian Government-issued Eurobond which matures in November 2025 is priced at a discount, as reflected in the bond price of $90.75 and a yield to maturity of 10.88%, whereas, the Eurobond of Firstbank Nigeria, which has similar tenor and matures in October 2025 is priced at $97.5 or yield of 9.49%, reinforcing the appetite of investors to buy Firstbank Eurobond at a price higher than that of the Federal Government.
Quite interestingly, it is not an isolated case. UBA’s five-year Eurobond issued last year, with November 2026 maturity is priced at $92.5 or 9.25% yield, reinforcing the reality that investors are willing to take a lower return on Nigerian corporate Eurobonds, compared to those issued by the government.
Speaking on the development, Abiola Rasaq, a financial analyst, and former Economist at United Bank for Africa noted that “it’s a new reality that challenges theory and age-long market practice, where corporate securities are priced at a higher yield to compensate for presumably higher risks, compared to sovereign issues. While this development is still remote and not generic to other markets at this time, it may influence the pricing of other Sovereign and corporate debt notes from other emerging markets in the near future, as investors reassess the reality of Sovereign fiscal positions vis-à-vis the corporate entities’ capabilities to meet their credit obligations.”
According to him, while many Sovereigns are highly geared, with obstinately high fiscal deficits and debt service burden, most African corporates, especially those in Nigeria, have relatively low leverage ratios and strong cashflows, reinforcing their ability to meet obligations and demystifying the perception that they may be bailed out by the government should they require support.
“I believe rating agencies may have to revisit their practice of ceiling the ratings of corporates at the Sovereign rating, especially when considering foreign currency issuer default ratings. Some companies, especially Nigerian banks, have strong foreign currency balance sheets, including foreign currency support from offshore subsidiary operations,” Rasaq noted.
Whilst unforeseen foreign currency scarcity and pressured foreign-currency liquidity in the local banking system could limit the capacity of corporates to outflow funds and meet their obligations, just as macro pressures or policies in the country may undermine the ability of corporates to meet foreign currency payments, it is undoubted that comparatively, the fundamentals of some corporates may be stronger than that of the government, in fulfilling their financial obligations, he further observed. “Hence, rating agencies may want to critically reassess the practice of keeping the Sovereign rating as a ceiling for local corporates, as this may be unduly punitive, especially for international debt issues, where corporates with fewer fundamentals from other emerging markets with better Sovereign ratings are rated higher than Nigerian companies for no better reason other than the fact that Nigerian Sovereign is poorly rated and hence the subdued rating of entities operating in the country.”, Rasaq added.
Notably, Fitch last week downgraded the rating of the Sri Lankan government to “Restricted Default,” following the expiration of the 30-day grace period given to the government to pay the coupon that was due on 18 April 18 2022 on two of its Eurobonds. The reality is that while the government has announced the suspension of debt service on all foreign currency loans, including those issued on the international capital market since 13 April 2022, some corporates in Sri Lanka are still able to meet their obligations as and when due.
So, it may be better to assess companies on their merit and sovereign support should rather be a rating positive factor. In fact, this is not the first time we would have a Sovereign default when corporations are still able to survive the storm. This is not the first time a Sovereign would default. Lebanon did in March 2020 and there are concerns one or two African countries may fall into the same pit in the near term, as the post-COVID reality of fiscal position continues to hunt African Sovereigns, many of which require diligent restructuring of fiscal expenditure frameworks if they are to resolve the high debt overhang.
Commenting on the development, a bond trader said: “The rise in the yields on Sovereign bonds that has characterised the bonds of sub-Saharan Africa has continued with the corresponding fall in the prices”. On Wednesday, May 18, 2022, Nigeria’s Eurobond due in November 2025 had a yielding (asking) of 9.64 percent, with a price of USD94.125. It has a coupon of 7.625 percent. On the same day, a bond of First Bank of Nigeria, with a coupon of 8.625 percent and maturing in October of 2025, had a yield of 8.79 percent and a price of USD99.5.
On Thursday, May 19, 2022, the spike in the yield of the government Eurobonds continued, with the 2025 bond’s yield rising to 10.51 percent and its price falling to USD91.75 percent. On the same day, FBN’s 2025 bond retained it yield at 8.97 percent and while the price fell marginally to USD99.
Interestingly, the gap between the yield on Federal Government’s Naira denominated bonds and Eurobonds continues to converge, thus raising concerns of many analysts about whether or not the government should be bullish on Eurobond offerings at this time, especially when the impact of probable Naira depreciation over the tenor of the bonds is put in perspective. “Except for other benefits such as using the Eurobond as a source of foreign currency inflow for the country, it’s really somewhat punitive for a country like Nigeria to be paying a double-digit interest rate on a dollarized loan,” the trader said.
Notwithstanding the rising global interest rate environment, Nigeria should not be paying as much credit spread of over 900 basis points on its 30-year Eurobond, which is priced at a yield of 12.24% based on the bid price on Thursday, 19 May 2022, as against the equivalent US Treasury yield of 2.99%.
Indeed, the yields on Naira and dollar-denominated FGN Bonds are also converging, with the FGN 30-year benchmark Naira-denominated bond trading at barely 70basis points higher yield compared to the Nigerian Sovereign Eurobond. This is, again, another reality that goes against theory given the inflation rate differential between Nigeria and the United States. Again, it’s a new reality that defies theory, the inflation rate differential between Nigeria and the United States is over 900bps, despite the fact that the US inflation is at decades high.
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