Switch Auction Fuels Record Spread as S. Africa Extends Debt
South Africa’s plan to extend the maturity of its debt is driving the yield premium on its longest-dated bonds to the highest on record.
The South African Reserve Bank announced the terms today of an offer to swap as much as 71 billion rand ($8.9 billion) of two-year bonds for longer-dated, higher-yielding notes through a series of so-called switch auctions starting on May 17. The offering would be almost twice the size of the 37.9 billion rand exchanged through the auctions last year, according to the Treasury’s data.
The auctions and new bond sales will lengthen the maturity of South Africa’s debt to an average of 12.5 years from 10.1 years, helping to ease pressure on short-term repayments, according to Michael Grobler, an analyst at Afrifocus Securities in Cape Town. Investors anticipating an increased supply of longer bonds lifted the extra yield on 2031 debt over notes due in 2014 by 18 basis points in the past month to 318 today, the widest premium since the 2031 notes were first issued in 2010, data compiled by Bloomberg show.
“This is already a very steep curve, and in that sense it is attractive,” Leon Myburgh, a Johannesburg-based analyst at Citigroup Inc., said in a phone interview.
The yield on 7.5 percent notes due 2014, one of the securities the Treasury is offering to swap, has dropped 41 basis points, or 0.41 percentage point, this year to 5.64 percent, while the rate on the 2031 notes declined 15 basis points to 8.77 percent. The spread has widened from 260 basis points in February, when the government announced its switch auction program. The comparable spread for Polish bonds is 85 basis points, data compiled by Bloomberg show.
“Essentially, you’re selling a bond yielding 5.6 percent and replacing it with an asset yielding 8.7 percent -- that is quite a yield sweetener,” said Myburgh.
In the first auction on May 17, the Treasury is offering to replace 7.5 percent bonds due in 2014. The so-called destination bonds are 13.5 percent bonds due 2015, 8 percent notes due 2018 and 10.5 percent securities due 2026, the central bank announced on Bloomberg.
Destination bonds in future auctions, which will be held twice a month through November, are likely to include notes maturing in 2031, 2036 and 2041, Myburgh said.
Investors are concerned long-term yields will rise as the switch auctions together with planned new bond issuance flood the market with longer-dated paper, Grobler said. In addition to the switch auctions, the Treasury plans to sell new benchmark fixed-rate bonds maturing in 2023 and 2049 this year and inflation-linked securities due in 2025, 2038 and 2051.
“That will be in the back of the market’s mind,” Grobler said in a phone interview yesterday. “That’s stock that the market will have to absorb at the long end, and the curve will steepen more. It is a concern.”
Switch auctions are an alternative to raising cash through new bond sales to repay maturing debt, the Treasury said in its budget review in February.
“You want to avoid a Greek situation, with a lot of debt coming due in the short term,” Monale Ratsoma, an official in the Treasury’s asset and liability management division, said in an interview in Cape Town in February. “You want to smooth out your refinancing risk and develop your yield curve.”
Africa’s biggest economy is cutting domestic bond sales by 2.5 percent this fiscal year to 151.4 billion rand, according to the Treasury’s budget plan released in February.
South Africa is reining in debt after Moody’s Investors Service and Fitch Ratings lowered their outlooks for its credit rating to negative since November. Standard & Poor’s cut its outlook to negative in March citing slower economic growth and a risk the government may exceed its spending plans.
The nation will cut its budget deficit to 4.6 percent of gross domestic product in the year through March 2013, below the government’s earlier forecast of 5.2 percent in October, Finance Minister Pravin Gordhan told lawmakers in February.
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