• ‘Insufficient’ interest to cut domestic debt cost
• But will better hold ‘reckless’ Gov’ts accountable
• Benefits ‘not overnight’ but transparency greater
By NEIL HARTNELL
Tribune Business Editor
A Bahamas-based investment banker yesterday said “insufficient demand” means the Government is unlikely to lower its domestic debt costs through the launch of competitive bidding for its securities.
Michael Anderson, RF Bank & Trust’s president, told Tribune Business that the “generally negative market sentiment” prevailing towards government debt will also blunt potential benefits from the planned January 2, 2024, launch of reforms to how Bahamas Registered Stock (BRS) bonds are issued to investors.
The Central Bank, which acts as the Government’s agent in issuing/auctioning both bonds and Treasury Bills, confirmed in newspaper advertisements yesterday that so-called “competitive bidding’s” launch had been pushed back from this month to the New Year. This reform, if successful, will effectively allow the market to set the price and interest coupon on all future debt issues, as opposed to these being determined by the Government and Central Bank.
Mr Anderson, though, voiced doubts that the switch to free market mechanisms will result in lower costs and interest rates on both BRS and Treasury Bill issuances at a time when the Government is eager to generate any savings possible on an $11.645bn national debt which, at end-June 2023, was equivalent to almost 85 percent of the country’s economic output or gross domestic product (GDP).
“I think that if there was a competitive bidding market for it the Government could end up pricing its debt at a lower cost if there was sufficient demand, and people bid for more than what was available and pushed the cost of the debt down,” the RF Bank & Trust chief told this newspaper.
“My sense is not enough people will be bidding on the debt. It’s unlikely to push the price down below where the Government prices it through the Central Bank. If there’s big enough demand, the Government could see the cost of its [domestic] debt go down as demand pushes the price down.
“But, if people bid for less than what is offered, the Government could end up paying more for its debt if the Central Bank provides it at a discount.” Mr Anderson added that, should investors offer to acquire BRS bonds and Treasury Bills at a discount to their par value (price), it was likely the Central Bank will still “fill the gap” and ensure there’s no change in price.
“My sense is there’s not sufficient demand in the market to cause a really competitive bid,” he said. “If there was sufficient demand, it makes sense because there’s enough people bidding and the price will drop but, because there’s insufficient demand, it will not make any change in price because the Central Bank will buy what’s left and people will pay the same price.”
Noting that the interest coupon attached to government debt issues would rise if there is insufficient demand from Bahamian institutions and broker/dealers, with such investors only willing to buy-in at a discount such as 95 cents to the dollar, Mr Anderson said in such a scenario the Central Bank will likely step in and ensure both the interest rate and ‘par’ value set by the Government are maintained. That will be little to no change from the present system.
“There’s insufficient demand generally within the market so I don’t see competitive bidding helping the Government on the price or amount issued,” he reiterated to Tribune Business. “Competitive bidding requires more people to be bidding. Auctions don’t work well when there’s insufficient demand.
“Most banks are still buying short-term debt, one-year paper and Treasury Bills, so there’s not a lot of money going into long-term debt. It won’t really change the situation to any great extent. I don’t see it helping the Government much. There’s still generally a negative sentiment across the market around government debt notwithstanding that the Government is doing better with its Budget.”
Interest payments on The Bahamas’ outstanding debts stand at more than $612m, or almost $1 out of every $5 in recurrent spending in the 2023-2024 fiscal year, so the Government’s eagerness to cap or reduce these servicing costs is both clear and understandable.
Larry Gibson, chief operating officer of CG Atlantic Pensions, told Tribune Business yesterday that many institutional investors such as banks, pension funds and insurance companies are close to their prudential and regulatory limits in terms of how much additional government debt they can hold on their balance sheets.
This could further limit demand for BRS bonds and Treasury Bills, and explains why the Government is eager to expand the pool of domestic debt investors to individuals and non-financial companies. However, Mr Gibson praised the Central Bank for driving capital markets modernisation, and argued that the switch to “competitive bidding” will better hold the Government accountable for reckless spending and fiscal policies.
“It also holds the Government’s hands,” he explained of the new mechanism. “If they’re reckless in their spending, reckless in their fiscal management, persons will demand higher interest rates on government paper. It’s very positive from that standpoint because it makes government more accountable too.
“By being a sovereign credit, you have a special ability in that you can issue bonds but, at the same time, with competitive pricing it’s a check and balance because if people don’t have confidence in your ability to service and repay, notwithstanding the Government’s ability to impose new taxes, investors will demand higher interest rates. That’s the way it works in all modern economies.
“Competitive bidding is a positive step in the right direction. It brings us more into line with modern capital markets. There’s transition and education involved that must accompany it. It makes the market more transparent, even the Government more transparent. It should encourage greater long-term confidence and greater participation in the markets. It can work. It’s not going to happen overnight where it’s perfect.”
Besides better pricing and more transparent discovery, Mr Gibson said the reforms should help to create a government debt yield curve that can be used as a benchmark for costing corporate debt issues. “The importance of competitive bidding is you are now moving closer towards a true yield curve where you have the market determine rates and what have you,” he added.
“You now have a yield curve that other financial institutions can use to price debt. If the Government is acting inappropriately, that means the cost of credit goes up for everybody because the benchmark rate goes up. There are still a lot of institutions out there carrying government debt at par.
“If you have a bond with a 4 percent coupon and 20-year maturity, that is priced at par. If you have a bond at 6 percent and 10-year maturity, that’s also priced at par. Anomalies like that essentially fade away with market-driven rates and that’s another positive in the long-term. There will be price distortions for those not pricing government bonds at market rates as they should have been doing.”
Praising the reforms’ intent, Mr Gibson said: “The Central Bank is doing good things in terms of advancing bond trading and capital markets.. It’s a huge step in the modernisation of our domestic financial sector and also catching up to what you would find in any other modern economy. All things taken into their proper context, this is another positive step in developing our capital markets infrastructure.”
John Rolle, the Central Bank’s governor, could not be reached for comment before press time last night. However, in a July 2023 interview, he explained the rationale for competitive bidding as moving away from the current structure where all issues are purchased at “par” or 100 percent of face value and at set interest coupons.
“Bahamas Government Registered Stock (BRS) offers are currently issued on a non-competitive basis. What this means is that investors submit applications to purchase bonds at par value at a set price in the primary market,” Mr Rolle explained. “Under competitive bidding, the investors would have to indicate the price at which they wish to purchase the bonds, given the coupon rates of interest that the Government would set in advance.
“Investors who offer the best or highest price for such bonds on offer would be allowed to purchase the amounts being offered. Investors who do not offer competitive bids could find themselves excluded from an offering. In instances where there is an over-subscription to a bond offering, the bidders who offer the best price could get fully satisfied, while others could be completely shut out.
“This is different from a non-tender process, where the bonds are allocated on a first come, first served basis or all investors get a reduced, prorated amount. The competitive bidding will be done through the Bahamas Government Securities Depository (BGSD) system, same as the Treasury Bill auctions, and would be a transparent and objective process,” he added.
“A tender is a more transparent process for the market to price bonds in line with the level of interest expressed by investors. It should be noted though that each tender process would reserve a fraction of the bonds for non-competitive investors. Rather than submitting a bid, such investors would be consenting in advance to pay the average price obtained from successful competitive bids.”