Last week we provided you with an overview of the 2018 NIF IPO…today we’re going to dig even deeper! There’s a lot to discuss (this is a long one) – so brew your coffee – and if you’re one of those who like to know how the book ends before you start, skip down to the ‘Recommendations’ section.
Okay, let’s get cracking. This review will be examining:
We’ll then wrap up this feature by supplying a discounted cash flow valuation along with suitability recommendations.
The Consumer Price Index (CPI) is driven by food prices. Headline inflation is often unpredictable. High (demand for) food imports denote key effects by international food prices, although research finds medium-term trends, but ultimately non-stationary relationships in said prices’ impact lag and intensity using the Food and Agricultural Organisation (FAO) index. Less critical to the index is that local agriculture is highly vulnerable to adverse weather. Other demand and supply dynamics include VAT on select segments. Historically, recessions and decreases in headline inflation coincided since 1995.
Core inflation adjusts only for transitory food inflation. Energy inflation is not as volatile as in other economies but is manifested in other sub-indexes and measures, such as transport and exports in the economy. For example, GORTT committed to continue to gradually phase out its fuel subsidy. Other high-weight core sub-indexes include housing prices; furnishings, household equipment and routine maintenance; and recreation & culture. The Producers’ Price Index (PPI) is driven by building materials’ prices for many sub-indexes, often cement.
Core inflation was just below 1% as at March 2018. Moody’s and IMF each forecasted CPI above 2% and trending to 3%.
Policy Outlook: Exchange Rate and Interest Rate Expectations
Investments’ attractiveness depend on macroeconomic demand and supply dynamics, which are interrelated with GORTT fiscal policy and monetary policy of the Central Bank of Trinidad & Tobago (CBTT). The following puts depreciatory pressure on the USD-TTD rate: deteriorations in current account flows, debt sustainability and TTD-USD interest rate differentials.
Regarding the current account flows, it’s necessary to recall the energy price shocks in 2014 which slashed exports’ share of GDP from 67% in 2011 to 37% in 2016. CBTT statistics for the current account (CA) balance per GDP as imports are flat or higher while exports fell. Debt sustainability pressure regarded the worsened fiscal and primary balances, as well as debt measure trajectories. In other words, weaker prospects of an economy means a less competitive fair value for its currency.
The IMF estimated in 2016 that the TTD was 21-50% overvalued, meaning that TTD-USD should otherwise trade between TTD 8 and TTD 10. A 2016 UN ECLAC report listed the TTD as the single most overvalued currency in the Caribbean and Latin America. Lastly, in the 2017-2018 World Economic Forum’s Global Competitiveness Index, ‘foreign currency regulation’ surpassed ‘crime and theft’ and became the fourth most problematic factor in doing business in Trinidad & Tobago.
Thirdly, the 3-month TT-US differential reached -74 basis points in May from -18 basis points at 2017 yearend, driven almost entirely by the upward movement of the US 3-month Treasury rate. The US Fed signalled further hikes in the context of solid US growth outlook.
Policy responses to everything above involved fiscal tightening that since slowed, and de facto FX controls and a 25 basis point repo rate rise in late June 2018 on the monetary side.
Given the aforementioned key characteristics, medium-term GORTT positions will probably remain dependent on energy prices and local energy production as well as for benefits of additional budgeted sources of revenue generation to be slow to implement. Thus, despite sufficient impetus to invest externally, there are no significant capital outflows.
We expect the gradual depreciation and CBTT FX intervention to continue (to the above fair value range) via the de facto FX regime in the medium term. As a price-taker in (energy) export markets, it is probable that a cheaper TTD would not materially make exports competitive.
CBTT foreign reserves’ downtrend, in turn, will depend on energy exports’ USD contributions to the economy. Importantly, however, the regime limits capital outflows—it is and will likely remain difficult to exchange TTD for USD to meaningfully invest internationally so long as the regime can be sustained, measured by months of import cover.
The repo rate impact on the TTD interest rate environment regards the CBTT TTD GORTT yield curve, the commercial bank average prime lending rate, the CBTT mortgage reference rate and rates offered by local fixed deposits.
We expected a two- to three-month lagged increase of the same amount in prime and mortgage rates, gradually and stepped, respectively. Previously was a bout of eight (8) repo rate increases from 2.75% to 4.75% between late 2014 and 2015 (that coincided with the energy shock).
The CBTT TTD GORTT yield curve flattened over that period into 2016 via greater basis point changes—and volatility—in the short end of the curve. Fixed deposit market reads were not readily available, but commercial bank deposit rates have remained near zero since 2008.
The June 2018 CBTT rate hike decision regarded the aforementioned US rate hikes, as well as emerging market and domestic growth (the latter was energy led), and private sector credit growth.
In an interview on the Offer, Finance Minister Colm Imbert said (timestamp 25:25) that the crux of that decision was to prevent leakages or capital outflows given the US rate hikes. He also said that the 25 bps on its own will not have a material impact on local rates generally, but multiple increases had a clear impact in the 2014-2015 case.
The following section on local capital markets discusses the GORTT and local corporate fixed income investments; additional repo rate activity will certainly affect the coupon rates and prices of existing and new issues.
As of writing, US-China trade tensions, high US equity valuations and a flatter US yield curve—potentially heading to inversion—rings some alarms for what would have been the first US recession since 2009.
Except for trade uncertainty, against those were that US valuations were ultimately based on strong fundamentals and that the US Fed was far more prudent than in the past: a severe correction was not likely. Both considered, we did not expect as large a CBTT response as in 2014-2015, because the nature of the external shock was less direct to the local economy than before.
The Trinidad & Tobago economy is bank-based, far more than (capital) market-based. This section describes implications of this, relevant to potential investors in the Offer, regarding expectations for an under- or over- subscription.
Local capital markets are characteristically under-developed and illiquid. For example, US stock markets’ turnover is more than 90 times that of the local market, using data from the CBTT and World Bank. Local culture is highly risk averse and lowly educated in investing.
Liquidity risk, thus, is a key consideration of listed investments of and within the Offer. The risks include volatile listing pricing given a low volume threshold, and traders’ wide bid-ask spreads and/or long trade order turnaround. The risk is manifest in the market having too few listings and market participants.
Expected Market Liquidity
Minister Imbert explained a lower CBTT reserve requirement only for the months July and August to coincide with the Offer period. He anticipated increased commercial bank liquidity of some TTD 2 billion to TTD 3 billion in each month: approximately TTD 5 billion in liquidity made available. (The primary reserve requirement was 17% for commercial banks and 9% for non-banks; and 2% was the secondary requirement.) Minister Imbert also described “no contagion effect” from this initiative. This would be the case as Offer proceeds re-enter the banking system and reserves.
This initiative was in response to observations of below-average daily commercial bank excess liquidity of TTD 2.6 billion relative to the last two years. This measure was driven by net domestic fiscal injections (NDFIs) (that benefited from higher energy revenues to GORTT in H1, but also by CBTT open market operations (OMOs).
Expected Liquidity: Financial Market Participants
Demand for the Offer by institutional (and individual) investors will determine each Series’ liquidity.
Minister Imbert (interview timestamp 8:00) expressed surprise at the positive feedback from pension funds, insurance companies and the Credit Union League, particularly for the 20-year Series. This was to be expected for these institutions’ demand for long-duration exposures and management; for context, the last 20-year GORTT issue was in the 1990s.
His conjecture was some TTD 200 million to TTD 300 million in demand from individual investors. Against large institutions’ demand was high sovereign concentrations in the financial system according to the CBTT Financial Stability Report, 2017 (‘sovereign’ included state enterprises).
RFHL owns Republic Bank Limited, Republic Bank (Guyana) Limited, Republic Bank (Barbados) Limited, Republic Bank (Grenada) Limited, Republic Bank (Suriname) Limited, HFC Bank (Ghana), as well as Republic Securities Limited and other subsidiaries.
The RFHL Group was profitable over the last 5 years, with a 10.1% 5-year compound annual growth rate (CAGR) of profit after tax. In FY2017, RFHL recorded a profit after tax (PAT) of TTD 1.3 billion, up 39.7% from the prior year’s outturn.
RFHL recorded total interest income of TTD 3.8 billion in FY2017, an increase of TTD 186.4 million or 5.2% compared to FY2016 as the Group continued to expand its loan and investment portfolios and increase its footprint in the Trinidad and Tobago, Barbados, Suriname, Guyana and Cayman/Eastern Caribbean markets. Despite a TTD 123 million, or 4.7%, increase in total operating expenses, RFHL’s PAT improved by TTD 373.9 million, or 39.7%, in FY2017 compared to FY2016.
RFHL’s dividend pay-out ratio over the past 5 financial years (FY2013 – FY2017) averaged 59.5%, with the average dividend over the period being TTD 693.4 million.
RFHL continued to be well-capitalised with a tangible net worth (TNW) of TTD 9.2 billion as at September 2017, up 6.8% from TTD 8.6 billion one year earlier. RFHL’s TNW is the largest in CariCRIS’ sample of regional banks. The large TNW provides adequate coverage of total assets (adjusted for goodwill, revaluation reserves and intangibles) at 13.4%, above CariCRIS’ sample of regional commercial banks of 11.8%, and good capital coverage of non-performing loans (NPLs) at 11.6 times, up from 9.5 times as at September 2016.
Each subsidiary within the RFHL Group recorded strong capital adequacy ratios (CAR) as at September 2017, well above the CBTT’s minimum requirement for systemically important financial institutions (SIFIs) of 10% and the Group’s minimum requirement of 12%. Republic Bank Limited (RBL), RFHL’s subsidiary in Trinidad and Tobago, was thelargest commercial bank in T&T in terms of assets, with an asset base of TTD 45.3 billion as at September 2017 and was the 2nd largest in CariCRIS’ sample of regional commercial banks.
Supported by its network of 129 automated banking machines (ABMs), the largest in the country, and 41 branches, the Bank maintained its leading market share in 2017. RBL’s share of the market for net loans and advances and for deposits averaged 34.9% and 33.6% respectively over the past 3 years, with RBL having the largest real estate mortgage and credit card portfolios in T&T.
Notably, RBL contributed more than 60% to RFHL’s total income and PAT in FY2017.
TGU owns and operates a 720 Megawatt (MW) net capacity combined-cycle gas-fired power plant in the Union Industrial Estate in La Brea, South Trinidad, which currently is the largest power generation plant in T&T in terms of installed capacity. TGU contributes much to local energy security and improves the fuel efficiency of the entire grid. As at January 2016, the plant accounted for 34% of all power generation in T&T and delivered approximately 45% of the country’s average demand.
In 2017, TGU recorded 255% or a TTD 127.7 million increase in PAT to TTD 177.8 million over the prior year. This improvement, however, was primarily due to a 70.5% decline in tax expense for the year. Operating revenue fell slightly in 2017 to TTD 698.7 million from TTD 716.2 million previously, as finance lease income and capacity revenues fell by TTD 3.4 million and TTD 11.4 million respectively.
These revenue shortfalls were offset by a 25.3% reduction in operating expenses, leading to an operating profit of TTD 563.4 million, in line with that of the prior year. TGU’s dividend pay-out ratio over the past 3 years has averaged 212%, with the average annual dividend paid over the period being TTD 612.9 million.
The discounted cash flow valuation model finds that each series is fairly priced. Given repo rate expectations, explained previously, we expect interest rate risks are unlikely to offset the tax benefit in each Series—especially for corporations. Yes, individuals’ interest income is otherwise taxable; although the average individual may be unaware.
We estimate the tax benefit for each Series to be 5%, 14% and 24%, respectively, relative to theoretically taxable equivalent bonds. We expect that recent Trinidad & Tobago Revenue Authority (TTRA) developments make the Offer very attractive in the long term. Between the above and our capital market analysis—particularly the reserve requirement initiative—we expect at least a High or oversubscription in Series A and Series B as well as short-term volatility in bonds that will trade at a premium value.
The duration of each Series is 4.5, 8.9 and 11.7, respectively. (The Series C measure only seems unintuitive. We recommend that readers and clients consider the time value of money and how distant or heavily discounted the 20 year maturity really is.)
The risk-free rate estimates are within basis points of the June CBTT GORTT yield curve, but the July data due next month would be more appropriate for capturing the June 29, 2018 repo rate increase. Note as well that the estimates are between 75% – 85% of the rate estimate for discounting each Series cash flows.
More robust estimations of credit spreads and a liquidity risk premium above the risk-free rate estimates remain outstanding. We combined the premia to estimate a range from 105 bps and 150 bps: each Series’ value was 1% below the pre-tax offer value at a spread of 120 bps.
Minister Imbert referred to the Prospectus’ widest possible participation policy (a link to the video of Minister Imbert’s interview was provided in the ‘Policy Outlook’ section above…fast forward to 31.50 for his comments on the participation policy) that oversubscribed tranches, namely Series A, will be allocated first to small, individual subscriptions.
The above were general, Offer-specific recommendations — not overall fixed income recommendations. Interested potential investors should discuss alternative asset classes and sub-classes for other fixed income opportunities and how to diversify the remainder of their portfolios. Institutions should have a similar discussion relative to their investment policies, or mandates, or discuss how to improve the effectiveness of their strategy: or even build one!