In December 2010, we launched the Rizzo Farrugia MGS Index to assist market practitioners and investors follow price trends across Malta Government Stocks. Given the lack of a corporate bond index and the increasing popularity of the local corporate bond market, we are now launching the Rizzo Farrugia Malta Corporate Bond Index.
While the Rizzo Farrugia MGS Index is based on the indicative bid prices quoted by the Central Bank of Malta on a daily basis, due to a lack of a market-making mechanism in corporate bonds, the Rizzo Farrugia Malta Corporate Bond Index is based on the closing market prices of each of the bonds listed on the Malta Stock Exchange.
Unfortunately, due to the absence of market makers in corporate bonds as well as the general ‘buy-to-hold’ strategy by many local retail and institutional investors, many securities do not trade on a daily basis and therefore this limits the movement in the index.
Moreover, since the Rizzo Farrugia MGS Index is based on the daily bid prices quoted by the Central Bank and in turn these prices are dependent on movements in yields across eurozone bonds markets, the MGS Index is particularly volatile from one day to the next as was very evident again in recent weeks given the renewed turmoil across global markets, the ‘flight to safety’ and the concerns over certain periphery countries.
The Rizzo Farrugia Malta Corporate Bond Index is weighted by the market capitalisation of each bond and therefore the larger bonds in issue (namely the €70 million 4.8 per cent Bank of Valletta 2020 subordinated bonds and the €58.2 million 4.6 per cent HSBC Bank Malta 2017 subordinated bonds) have a larger weighting in the index than the smaller bonds such as the recent two bonds in issue of €3 million each of Central Business Centres and the £1.4 million six per cent Mediterranean Bank 2019-2024 bonds.
The Rizzo Farrugia Malta Corporate Bond Index is backdated to December 31, 2008, in order to measure the performance across the corporate bond market over the past seven years. Despite the shortcomings across the local corporate bond market, the historic performance on a yearly basis is very indicative of certain individual events and general market movements.
The most vivid example is the sharp decline in the Corporate Bond Index in 2011. In fact, between February 4, 2011, and March 23, 2011, the Rizzo Farrugia Malta Corporate Bond Index declined by 4.6 per cent. This was solely due to the sharp decline in the value of the Corinthia Group bonds (those issued by Corinthia Finance, International Hotel Investments and Mediterranean Investments Holding) as a result of the Libyan revolution.
IHI, MIH and Corinthia bonds accounted for circa 26 per cent of the overall index in 2011 and the sharp decline in prices due to the increased credit risk arising from the Libyan revolution negatively impacted the entire Corporate Bond Index. During that six-week period, the prices of the various bonds issued by these three companies dropped from above par to below the 75 per cent level in the case of 7.15 per cent MIH 2015/17 bonds. The prices then recovered back up to parity by October 2011.
It is worth noting that since then, given the growth in the overall local corporate bond market, the weighting of Corinthia Group bonds declined to circa 22 per cent at the beginning of February 2016 even after taking into consideration the acquisition of Island Hotels Group Holdings last year which has bonds in issue with a market cap of just over €52 million.
Another very interesting observation is the strong performance of the Corporate Bond Index since summer 2014 at the time when the European Central Bank president, Mario Draghi, announced a decline in interest rates on two occasions from 0.25 per cent to 0.05 per cent and indicated that the ECB could commence a quantitative easing (QE) programme.
During the 12-month period between August 2014 and the all-time high of the Corporate Bond Index on August 4, 2015, of 1,097.73 points, the index had rallied by 5.5 per cent.
The larger bonds in issue have a larger weighting in the index than the smaller bonds
As a result of the decline in official interest rates in summer 2014 and indications that further monetary stimulus may be adopted in early 2015, sovereign bond markets rallied and likewise the Maltese corporate bond market very much moved in tandem as showed by the sharp upward move in various corporate bond prices between mid-2014 and the first half of 2015. In fact, many of the longer-dated corporate bonds that had been issued earlier in the year, such as the six per cent AX Investments 2024 bond and the 5.3 per cent Mariner Finance 2024, rallied to new highs of over 109 per cent. The increased responsiveness of the corporate bond market was a healthy development and the ‘search for yield’ phenomenon also filtered through the equity market as investors turned to shares for a better yield.
The QE programme, also referred to as the Public Sector Purchase Programme (PSPP), was initially announced to the market by the ECB on January 22, 2015. The programme commenced on March 9 and until early May 2015, MGS prices rallied in line with the sharp upward movement in eurozone sovereign bond prices. Many local corporate bonds also performed positively reflecting the decline in yields across the local sovereign market as well as European sovereign and corporate bond markets. Due to the inverse relationship between prices and yields, an increase in the index represents a decline in yields and vice versa. In fact, several corporate bond prices continued to reach new highs as trading activity in some of the longer-dated corporate bonds was relatively encouraging.
2015 has been the best year for the Rizzo Farrugia Corporate Bond Index with an increase of 2.5 per cent. During the previous six years, the positive performances were milder. The only exception was in 2011 when the Corporate Bond Index declined by 1.5 per cent due to the reasons described earlier on. It is interesting to note that the 2.5 per cent increase in the Corporate Bond Index in 2015 is very much in line with the performance of the MGS Index (+2.7 per cent) showing that bond prices moved in tandem over the past 12 months. However, the Corporate Bond Index was much less volatile between May and December 2015 when compared to the wide movements in MGS prices.
On the other hand, however, the Corporate Bond Index very much underperformed the MGS Index in 2014. The MGS Index rallied by an extraordinary 8.4 per cent while the Corporate Bond Index only edged 1.3 per cent higher. This in part shows the lack of responsiveness and infrequent trading activity that characterised the corporate bond market until early 2015.
In terms of group weightings, while mention has been made of the Corinthia Group companies with an overall weighting of 22 per cent, the single largest issuer is Bank of Valletta at 23.3 per cent. This may increase further should the second tranche of subordinated bonds be issued shortly as part of their overall debt issuance programme. The third largest individual group exposure is of the three companies forming part of Hili Ventures (namely Premier Capital, PTL Holdings and Hili Properties) at eight per cent.
The banking sector has the largest weighting in the Corporate Bond Index at over 35 per cent. This declined from a high of just over 42 per cent in 2012 as a result of the various bonds issued by non-banking entities over recent years.
Since the start of 2016, the local bond markets moved in opposite directions with the Corporate Bond Index declining by 0.3 per cent and the MGS Index adding 0.3 per cent. This could be due to the fact that the prices of a number of callable corporate bonds are declining as they are approaching their possible early redemption dates.
Although the size of the corporate bond market has increased steadily over the past seven years (the market cap has risen from €536m to €1.3bn), the local financial system remains flushed with liquidity and hopefully many new issuers will tap the market to provide new investment opportunities to retail as well as institutional investors. Various investors tend to prefer exposure to local companies especially given the renewed turmoil across international markets.
Rizzo, Farrugia & Co. (Stockbrokers) Ltd (RFC) is a member of the Malta Stock Exchange and licensed by the Malta Financial Services Authority. This report has been prepared in accordance with legal requirements. It has not been disclosed to the company/s herein mentioned before its publication. It is based on public information only and is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. The author and other relevant persons may not trade in the securities to which this report relates (other than executing unsolicited client orders) until such time as the recipients of this report have had a reasonable opportunity to act thereon. RFC, its directors, the author of this report, other employees or RFC on behalf of its clients, have holdings in the securities herein mentioned and may at any time make purchases and/or sales in them as principal or agent, and may also have other business relationships with the company/s. Stock markets are volatile and subject to fluctuations which cannot be reasonably foreseen. Past performance is not necessarily indicative of future results. Neither RFC, nor any of its directors or employees accept any liability for any loss or damage arising out of the use of all or any part thereof and no representation or warranty is provided in respect of the reliability of the information contained in this report.
© 2016 Rizzo, Farrugia & Co. (Stockbrokers)Ltd. All rights reserved.
Edward Rizzo is a director at Rizzo, Farrugia & Co. (Stockbrokers) Ltd.