GLOBAL MARKETS | 23 NOVEMBER 2022 A Different Kind of Debt Instrument Absa | Corporate and Investment Banking > Insights and Events > A Different Kind of Debt Instrument Zine Misani Senior Credit Trader, Absa SHARE The South African government recently issued a new floating-rate note. What does it offer, and what does the market reaction reveal about the state of local credit markets? In mid-2022 the South African government announced the issuance of a floating-rate note (FRN), designed – according to National Treasury – to “support the development of South African debt capital markets through a diversified portfolio of debt instruments”. The subsequent auctions sent ripples through the market, with investors attracted to the note’s low risk and variable interest rate. And, as Zine Misani, Senior Credit Trader at Absa, says, the FRN also offered the market something new and different. “It’s an alternative to what Treasury currently has in its portfolio, in terms of the bond instruments or debt instruments that the government can issue. Their bonds are mostly fixed-rate, while the others are linked to inflation.” The FRN is a different type of debt instrument. “It’s coupon payments are linked to a floating benchmark,” explains Misani. “In this instance the benchmark is the three-month Johannesburg Interbank Average Rate [Jibar], which changes daily.” Reaction to the FRN Because it is a different kind of debt instrument, the FRN attracts a different kind of investor, more amenable to the floating-rate style of instrument than to fixed-rate bonds. “Some of these mandates can hold fixed-rate bonds, but they prefer to hold floating-rate instruments so that they can take advantage of a rise in interest rates, for example,” Misani says. The first auction, in July 2022, was very well received, with a big book. “There were bids worth more than ZAR27 billion from the market,” she says. “The price point was at the three-month Jibar +130, which was about 50 bps wider than the asset swap on the next comparable government bond, which is the R186. At the time, that point was pricing at about 80 bps and was looked at by most investors as the base.” Misani says the general feeling was that the note’s +130 issuance level was quite rich. “Investors found that to be a very valuable level, and by the next day the bond was trading all the way down to about the three-month Jibar +115 – so there was a 15-bps contraction in that spread from the day of issuance to the following day. At the second auction, in August, the issuance level was about Jibar +110, which suggests Treasury were looking to contain that spread instead of just issuing wherever they could get the volumes.” A changed dynamic The market reaction to the FRN reflects the general trend in the South African credit market, which – in terms of pricing – remains driven predominantly by supply/demand dynamics. “There is a lot more cash in the system than there are instruments to invest in,” says Misani. “Credit spreads tend to be tighter than where credit metrics would otherwise dictate, simply because there are fewer assets being chased by a lot of money.” The government’s FRN has also caught the attention of corporate bond issuers. “All of a sudden you have this basis between where the government is issuing versus where the corporate bond market is issuing,” says Misani. “That changes the dynamic. Will we see a shift in investor appetite from the credit-risky notes issued by corporates into this government bond, which is pricing quite attractively? I think some investors would rather hold a risk-free note priced at an attractive level than a risky note issued by a corporate priced at a similar level.” Historically, local credit market investors buy and hold instruments. This FRN presents an attractive alternative. “Now you can sell out of the corporate bonds, take the profits (because the pricing has tightened so aggressively), and while you wait for something better to come along, go and buy the government FRN. It’s at attractive levels, it’s risk-free … and I’m quite sure fund managers won’t be asked too many questions about the position they’re holding there.” That, in turn, speaks to the state of local credit markets, where investors have money to spend, but also want it as de-risked as possible. “From that point of view, the government couldn’t have timed this FRN better,” Misani concludes. Zine MisaniSenior Credit Trader, Absa https://cib.absa.africa/wp-content/uploads/2020/07/file_example_MP3_700KB.mp3 Related Articles RISK MANAGEMENT Liquidity: Easing The Corporate Treasurer’s Pain Points James Stirling, Head of Liquidity Product, Absa CIB and Lumnandi Dambuza, Head of Liquidity: Africa Regional Office, Absa CIB, explore the changing demands on corporate treasurers, and the cash management solutions available. 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