High yields on domestic bonds a ticking time bomb - experts

Rates on bonds and Treasury Bills are averaging 18 and 16.6%

In Summary
  • This month, domestic debt service obligations—maturities plus coupon payments—are estimated at Sh280.9 billion.
  • By mid-last year, lenders had recorded bond revaluation losses on two- and 20-year Treasury bonds of Sh103 billion.
National Treasury building
TREASURY: National Treasury building
Image: FILE

Yields on local bonds are at a record high, an aspect that is worrying money market experts who fear that the value of bonds might go down, shrinking bondholders’ wealth. 

The latest data from the Central Bank of Kenya (CBK) shows that rates on bonds are averaging 18 percent while those of Treasury Bills are at 16.6 percent. 

Pundits are afraid that this is likely to hurt bankers the most since they account for over 70 percent of the local debt. According to the Capital Markets Authority (CMA), commercial banks account for Sh1.6 trillion worth of treasury bonds. 

By mid-last year, lenders had recorded bond revaluation losses on two- and 20-year Treasury bonds of Sh103 billion.

The regulator estimates that if the average bond yields increase to 18.6 percent and 19.9 percent, under moderate and severe scenarios, banks will record unrealized bond valuation losses of Sh155 billion under the moderate scenario and Sh210 billion under the severe scenario.

This is against the baseline estimates of Sh96 billion. 

Money markets expert Maxwell Nthiga says on the surface, high bond yields might look attractive for investors but they eventually trigger a loss of value. 

According to him, the change in bond values only relates to a bond's price on the open market, meaning if the bond is sold before maturity, the seller will obtain a higher or lower price for the bond compared to its face value, depending on current interest rates.

"It is simple. Bond prices move inversely to interest rates, reflecting an important bond investing consideration known as interest rate risk. If bond yields decline, the value of bonds already on the market moves higher. If bond yields rise, existing bonds lose value,'' Nthiga told the Star. 

While agreeing with Nthiga, Hellen Masero, a career investment banker fears that the rising lending rates might devalue bond rates, causing immediate pain to fixed-income investors. 

She argues that investors must focus more on the quality of the bond rather than high yields. 

"Higher-quality bonds generally have a lower yield than non-investment grade because they are considered more likely to make all of their scheduled interest payments. Conversely, high-yield bonds pay higher coupon rates because there is a greater possibility that the issuer could default and fail to make payments,'' Masero said. 

He pokes holes in the current high-yield rate curve on Kenya's government papers, cautioning that a ''possible default has never been more likely than ever.''

This month, domestic debt service obligations—maturities plus coupon payments—are estimated at Sh280.9 billion, nearly half of which lies on maturities of the 91-day Treasury bill.

Overall, in the current financial year, domestic debt service comprising interests and redemption expenditures is projected at Sh1.03 trillion. Interests alone stand at Sh628.3 billion.

The report of the Public Debt Committee on consolidated fund service expenditures for 2023/24 notes that a further increase in domestic interest is forecasted over the medium term, with domestic debt service expenditures forecasted to hit Sh730 billion in 2025/26, representing 62per cent of total debt service. 

"This is not good for the economy as it is likely to hurt lending to the private sector,'' Masero said. 

In a past interview with a regional paper, Prof XN Iraki of the University of Nairobi’s Faculty of Business and Management Sciences insisted on diversification of investments.

"We hope that, with more taxes, there will be less appetite for debt and this will bring down the interest rates and the value of the bonds can go up,” he said. 

He added that rising interest rates affect bond values through mark-to-market unrealized valuation losses for bonds held for trading and available for sale, which are charged on the banks’ capital.

“Therefore, the banking sector is exposed to the government securities in terms of assets and liquidity.''

Jared Otieno of Capital Plus Investments registered in Mauritius is concerned by the unusual shape of the yield curve representing different bond maturities, a phenomenon that developed in 2022 and continues in 2024 

According to him, under normal circumstances, bonds with longer maturity dates yield more, represented by an upward-sloping yield curve.

"It logically reflects that investors normally demand a return premium for the greater uncertainty inherent in lending money over a longer time. Unfortunately, many yield curve pairs using various maturities have been inverted since late 2022,'' Otieno explains. 

He attributes this scenario to rate hikes, which have the greatest direct impact on short-term bond yields.

This has seen investors gravitate toward short-term bonds in Kenya, with the latest 8.5-year infrastructure bond worth Sh70 billion attracting Sh288 billion in receipts. 

The National Treasury seems to be alive to this reality if the recent statement by PS Chris Kiptoo is anything to go by. 

He told the Budget and Appropriations Committee that the government is betting on long-tenure Treasury Bonds to refinance the maturing domestic debt in its medium-term debt management strategy. 

The high borrowing by the state has sent Capital market players into panic mode, with the Association of Pension Trustees and Administrators of Kenya (APTAK) saying they are piling unnecessary pressure on an already bloated public debt.

In an interview with the Star, the lobby's chairperson Hosea Kili said APTAK members are working on a module that will see domestic capital fuel the growth of public equities in Kenya and shaping a prosperous financial landscape. 

''We are advocating for 'patriotic investment'. The current yields on domestic bonds and T-Bills are not sustainable. We want to create a sound environment where our investments will add value to our economy,'' Kili said. 

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