Opportunities for bond investors in 2016

Financial Article 418 by Edward Rizzo - Jan 21, 2016

During 2015, there were relatively few opportunities for bond investors as most of the new corporate bonds listed on the Malta Stock Exchange were all targeted at existing bondholders or shareholders of the respective companies, namely International Hotel Investments plc, Mediterranean Investments Holding plc and 6pm Holdings plc. Furthermore, the bond issue of Izola Bank plc was placed with a few financial intermediaries and the subordinated bond issue by Bank of Valletta plc in November was not easily available to the public at large since it was classified as a complex financial instrument and the application process for investors wishing to apply for less than €25,000 was more cumbersome than usual and included a question and answer section to test the knowledge of applicants on these riskier instruments.

It is therefore not surprising that the only new corporate bond available to the general public at large was met with elevated enthusiasm. In fact, the €37 million bond issue of Hili Properties at a rate of 4.5% per annum attracted over 9,000 investors who applied for over €230 million worth of bonds. There was never such a high level of demand for a corporate bond issue in Malta.

Moreover, the lack of opportunities on the primary market, resulted in a surge in trading activity on the secondary market. Over the past 12 months, a record €59.8 million worth of corporate bonds traded on the secondary market, representing an increase of 38% over the previous year. Prices of most corporate bonds surged reflecting the decline in yields across sovereign bonds. Despite the increased activity across the secondary market, most retail investors are still generally averse to buying bonds at a price above 100% and they are therefore constantly seeking new opportunities on the primary market at par value.

The difficulty for retail investors to obtain access to the corporate bond market was once again evident in the most recent offering by Medserv plc. Their bond was structured as a ‘non-retail’ issue with minimum subscriptions of €50,000 and/or USD55,000. Additionally, if a bondholder wishes to dispose of any bonds once these are admitted to the Official List of the Malta Stock Exchange, they will need to retain a minimum holding of USD55,000 or €50,000 unless as a result of the sale of bonds, the bondholder would have disposed of his/her entire holding.

Although the €30 million Medserv bond issue was also over-subscribed as disclosed by the company last Friday, the wider retail investor base who may not have the liquidity to invest a minimum of €50,000 is still in dire need of new investment opportunities.

Will some become available throughout the course of 2016?

On 7 January, the Treasury published its 2016 indicative issuance calendar for Malta Government Stocks. The Treasury announced that this year, total issuance will not exceed €600 million and these will be utilized to finance: (i) the government’s budget deficit estimated at €196 million; (ii) the redemption of four MGS issues amounting to €417.77 million; and (iii) the repayment of a bank loan of €56.38 million. Similar to previous years, the Treasury will be issuing two different types of securities – the conventional fixed rate MGS’s as well as Floating rate MGS’s linked to the 6-month Euribor, which are primarily aimed at institutional investors. The first MGS issue is expected to take place next month. It is worth highlighting that the total issuance for 2016 at €600 million is €100 million above the total amount issued in 2015. However, it is still below the €650 million issued in each of the two previous years.

Nonetheless, given the sharp decline in yields during the past 18 months (despite the wide degree of volatility from May 2015 onwards), investors cannot expect the interest rate of the new MGS being issued in the coming weeks to be higher than 3% unless the Treasury opts to issue a new 30-year bond (i.e. maturiting in 2046).

Retail investors must understand that the interest rate and corresponding yield to maturity of new MGS’s need to be in line with the yields on other MGS at the time of issuance. As such, for example, if the Treasury opts to issue a 15-year bond (i.e a bond with a maturity in 2031), the yield to maturity has to be in the region of 2.05%, which is equivalent to the present yield on the 5.2% MGS 2031. In theory, investors should be indifferent in investing in the 5.2% MGS 2031 at a price of say 142% which gives a yield to maturity of 2.05% per annum or say a new issuance of 2.05% MGS 2031 at par (100%).

Naturally, investors would prefer investing at par rather than at a 40% premium to par value. However, it is important for retail investors to understand that as the price of the 5.2% MGS 2031 may fall below 142% if yields across Europe rise, so can a hypothetical new bond issued at 100% fall below par. This has in fact been the case for a brief period at the end of June 2015 in the 2.3% MGS 2029 following the institutional offering on the primary market.

So if yields on MGS’s are expected to remain low, what about new opportunities in the corporate bond market?

The Malta Stock Exchange has not yet issued an indicative listing calendar this year showing possible corporate bond issues that may take place in the months ahead. In February 2015, the MSE had indicated that up to €172 million in new corporate bonds had been expected during the first six months of 2015. However, these did not  materialise and some may have spilled over into the second half of the year such as the bond issue of Hili Properties plc and of Bank of Valletta plc. Disappointingly, following the publication of the indicative calendar in February 2015, no further update has since been issued by the MSE.

After the recent bond issue by Medserv plc, the next bond issuer could very well be Bank of Valletta plc with the second tranche of its €150 million debt issuance programme. The ex-CEO of BOV had indicated last October that the Bank’s intention was to conclude their debt issuance programme by the first quarter of 2016 and the focus will then shift to the issuance of Tier 1 capital, i.e. equity.

Furthermore, a number of bond issuers may opt for an early redemption this year and given the prevailing low interest rate environment, such issuers may either decide to carry out a full repayment to bondholders or seek re-financing via a new bond issue. Corinthia Finance plc has a €40 million bond which may be redeemed as from 23 September 2016, Mizzi Organisation Finance plc has a €30 million bond which may be redeemed as from 30 November 2016 and MIDI plc has two bonds in issue totaling the equivalent of around €40 million which may be redeemed as from 15 December 2016. Moreover, Mediterranean Investments Holding plc has three bonds in issue totaling the equivalent of circa €40 million which, since July last year, may be redeemed at any time prior to July 2017 when full redemption must take place.

Although these may all be likely contenders to hit the bond market in the months ahead, should any of these companies refinance via a new bond issue, these will presumably be structured as a bond exchange offer giving preference to existing holders to roll-over their existing bonds. Therefore, such issues will not offer any sizeable new opportunities for retail investors waiting to invest their idle investible funds.

Hopefully, other new issuers are considering the use of the bond market to raise the necessary funds for their respective needs. As an example, a number of the upcoming sizeable property projects could also seek to use the bond market as a way of diversifying their debt funding alternatives.

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