Bonds

Outline

In 2015 and 2016 the government was adamant about supporting the value of the Egyptian pound in the face of ongoing currency depreciation pressure, through its successive increases of the Treasury rate. As of October 2016 Treasury bond offerings show the five-year bonds standing at 13.4% after tax, compared with 11.23% in October 2015. While Egypt has always been an inflationary economy, such rates have had a notable negative impact on the corporate bond market, which remains largely illiquid, with the majority of bond holders being banks (which have already been in the business of lending for quite a while) coupled with a limited number of money market funds.

Since 2010 Egypt has only witnessed three corporate bond issuances, of which one was dollar denominated. Only the US dollar corporate bond remains outstanding. The Treasury bill market, meanwhile, has been rather more active. As of October 2016 there were a total of 189 issuances outstanding, with an aggregate value in excess of LE1.5trn ( equivalent to $79.5bn as of December 2016) and an average after-tax yield to maturity of 12.8%. The volume of secondary market trading on such issuances also remains limited, with most lenders, the majority of which are banks and financial institutions, holding the bonds to maturity.

Projection

Despite the above mentioned limitations, the outlook is positive. Keeping the interest rates of 2016 in mind, individuals should be able to lock in much higher returns on the Egyptian pound than what is offered through bank deposits. This, however, still needs to be realised.

Investor education will be needed for the market – especially for less-experienced investors – if the bond market is to be considered as a serious alternative to bank deposits. A first-mover advantage for investors going after corporate bonds offers superior returns due to the inherited liquidity premium.

In early 2016 the Central Bank of Egypt (CBE) lowered the single obligor limit for banks on their loans to corporate clients. Banks typically like lending money to companies that will repay them, as the more trustworthy a company is, the more money it will normally receive. Accordingly, in most cases banks were at their single obligor limit with their best clients. This regulation forced the banks to lower their exposure to their best companies. These companies were then left with a financing gap that they would be looking to cover. Given the right operating framework, the bond market represents a good source to fill in this financing gap.

Starting in the fourth quarter of 2016 the Ministry of Finance and the CBE began taking positive steps to activate the secondary bond market. This is something that any investor, on either the corporate or the lender side, should keep his or her eye on, as it could mark the start of a transformational phase for Egypt’s bond market. Having an active and liquid secondary market will attract more investors and increase corporations’ finance-raising capabilities.

Private pension funds are traditionally managed by one of the beneficiaries, who typically have very limited experience in properly managing the funds. The money usually ends up as a term deposit in one of the banks. The Egyptian Financial Supervisory Authority has recently decided to tackle this issue by ordering that if such funds have assets in excess of LE100m ($5.3m), they must be managed by either internal or external professional fund managers. This is slowly taking effect. Such funds would provide ample liquidity to finance future corporate bond offerings, should the market be properly activated.

Blending all this together, all the pillars are in place to support the targeted market growth the government is aiming for. Given the right support from the regulators, investors will be reaching for their wallets to capitalise on the existing potential.

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The Report: Egypt 2017

Capital Markets chapter from The Report: Egypt 2017