The Rizzo Farrugia Malta Corporate Bond Index

Article #422 by Edward Rizzo - Published Published Articles

In December 2010, we had launched the ‘Rizzo Farrugia MGS Index’ to assist market practitioners and investors to follow price trends across Malta Government Stocks. Given the lack of a corporate bond index and the increasing popularity of the local corporate bond market, we are now launching the ‘Rizzo Farrugia Malta Corporate Bond Index’.

While the Rizzo Farrugia MGS Index is based on the indicative bid prices quoted by the Central Bank of Malta on a daily basis, due to a lack of a market making mechanism in corporate bonds, the Rizzo Farrugia Malta Corporate Bond Index is based on the closing market prices of each of the bonds listed on the Malta Stock Exchange. Unfortunately, due to the inexistence of market makers in corporate bonds as well as the general ‘buy-to-hold’ strategy by many local retail and institutional investors, many securities do not trade on a daily basis and therefore this limits the movement in the index.

Moreover, since the Rizzo Farrugia MGS Index is based on the daily bid prices quoted by the Central Bank and in turn these prices are dependent on movements in yields across Eurozone bonds markets, the MGS Index is particularly volatile from one day to the next as was very evident again in recent weeks given the renewed turmoil across global markets, the ‘flight to safety’ and the concerns over certain periphery countries.

The Rizzo Farrugia Malta Corporate Bond Index is weighted by the market capitalisation of each bond and therefore the larger bonds in issue (namely the EUR70 million 4.8% Bank of Valletta plc 2020 subordinated bonds and the EUR58.2 million 4.6% HSBC Bank Malta plc 2017 subordinated bonds) have a larger weighting in the index than the smaller bonds such as the recent two bonds in issue of EUR3 million each of Central Business Centres plc and the GBP1.4 million 6% Mediterranean Bank plc 2019-2024 bonds.

Annual Performance of the Rizzo Farrugia Malta Corporate Bond Index

The Rizzo Farrugia Malta Corporate Bond Index is backdated to 31 December 2008 in order to measure the performance across the corporate bond market over the past seven years. Despite the shortcomings across the local corporate bond market, the historic performance on a yearly basis is very indicative of certain individual events and general market movements.

The most vivid example is the sharp decline in the Corporate Bond Index in 2011. In fact, between 4 February 2011 and 23 March 2011, the Rizzo Farrugia Malta Corporate Bond Index declined by 4.6%. This was solely due to the sharp decline in the value of the Corinthia Group bonds (those issued by Corinthia Finance plc, International Hotel Investments plc and Mediterranean Investments Holding plc) as a result of the Libyan revolution. IHI, MIH and Corinthia bonds accounted for circa 26% of the overall index in 2011 and the sharp decline in prices due to the increased credit risk arising from the Libyan revolution negatively impacted the entire Corporate Bond Index. During that 6-week period, the prices of the various bonds issued by these three companies had dropped from above par to below the 75% level in the case of 7.15% MIH 2015/17 bonds. The prices had then recovered back up to parity by October 2011. It is worth noting that since then, given the growth in the overall local corporate bond market, the weighting of Corinthia Group bonds declined to circa 22% at the beginning of February 2016 even after taking into consideration the acquisition of Island Hotels Group Holdings plc last year which has bonds in issue with a market cap of just over €52 million.

Another very interesting observation is the strong performance of the Corporate Bond Index since summer 2014 at the time when the European Central President Bank Mario Draghi announced a decline in interest rates on two occasions from 0.25% to 0.05% and indicated that the ECB could commence a quantitative easing (QE) programme. During the 12-month period between August 2014 and the all-time high of the Corporate Bond Index on 4 August 2015 of 1,097.73 points, the Index had rallied by 5.5%.

 

As a result of the decline in official interest rates in summer 2014 and indications that further monetary stimulus may be adopted in early 2015, sovereign bond markets rallied and likewise the Maltese corporate bond market very much moved in tandem as showed by the sharp upward move in various corporate bond prices between mid-2014 and the first half of 2015. In fact, many of the longer-dated corporate bonds that had been issued earlier in the year, such as the 6% AX Investments plc 2024 bond and the 5.3% Mariner Finance plc 2024, rallied to new highs of over 109%. The increased responsiveness of the corporate bond market was a healthy development and the ‘search for yield’ phenomenon also filtered through the equity market as investors turned to shares for a better yield.

The QE programme, also referred to as the Public Sector Purchase Programme (PSPP), was initially announced to the market by the ECB on 22 January 2015. The programme commenced on 9 March and until early May 2015, MGS prices had rallied in line with the sharp upward movement in Eurozone sovereign bond prices. Many local corporate bonds also performed positively reflecting the decline in yields across the local sovereign market as well as European sovereign and corporate bond markets. Due to the inverse relationship between prices and yields, an increase in the Index represents a decline in yields and vice versa. In fact, several corporate bond prices continued to reach new highs as trading activity in some of the longer-dated corporate bonds was relatively encouraging.

2015 has been the best year for the Rizzo Farrugia Corporate Bond Index with an increase of 2.5%. During the previous 6 years, the positive performances were milder. The only exception was in 2011 when the Corporate Bond Index declined by 1.5% due to the reasons described earlier on. It is interesting to note that the 2.5% increase in the Corporate Bond Index in 2015 is very much in line with the performance of the MGS Index (+2.7%) showing that bond prices moved in tandem over the past 12 months. However, the Corporate Bond Index was much less volatile between May and December 2015 when compared to the wide movements in MGS prices.

On the other hand, however, the Corporate Bond Index very much underperformed the MGS Index in 2014. The MGS Index had rallied by an extraordinary 8.4% while the Corporate Bond Index only edged 1.3% higher. This in part shows the lack of responsiveness and infrequent trading activity that characterized the corporate bond market until early 2015.

In terms of group weightings, while mention has been made of the Corinthia Group companies with an overall weighting of 22%, the single largest issuer is Bank of Valletta plc at 23.3%. This may increase further should the second tranche of subordinated bonds be issued shortly as part of their overall debt issuance programme. The third largest individual group exposure is of the three companies forming part of Hili Ventures (namely Premier Capital plc, PTL Holdings plc and Hili Properties plc) at 8%.

The banking sector has the largest weighting in the Corporate Bond Index at over 35%. This declined from a high of just over 42% in 2012 as a result of the various bonds issued by non-banking entities over recent years.

Since the start of 2016, the local bond markets moved in opposite directions with the Corporate Bond Index declining by 0.3% and the MGS Index adding 0.3%. This could be due to the fact that the prices of a number of callable corporate bonds are declining as they are approaching their possible early redemption dates.

Although the size of the corporate bond market has increased steadily over the past 7 years (the market cap has risen from EUR536 million to EUR1.3 billion), the local financial system remains flushed with liquidity and hopefully many new issuers will tap the market to provide new investment opportunities to retail as well as institutional investors. Various investors tend to prefer exposure to local companies especially given the renewed turmoil across international markets.

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This article was produced by Edward Rizzo, Director at Rizzo Farrugia, which is a company licensed to undertake investment services in Malta by the MFSA under the Investment Services Act, Cap. 370 of the Laws of Malta and a member of the Malta Stock Exchange. The company’s registered address is at Airways House, Fourth Floor, High Street, Sliema SLM 1551, Malta.