Investors have paid the Central Bank of Kenya (CBK) a premium price to switch their holdings in a bond maturing in February 2028 to benefit from the higher interest rate and preferential tax charge on another paper with 3.2 years left to redemption.
In the offer, investors were asked to swap Sh10 billion from a 15-year bond that was first sold in 2013 into a 10-year paper first issued in 2019.
The 2013 bond, which is to mature in February 2028, carries an annual interest rate of 11.25 percent, while the 10-year bond pays interest at 12.28 percent and matures in November 2029.
In addition to the higher coupon on the destination bond, those transferring their capital were effectively buying into a three-year exposure at a more favourable withholding tax rate of 10 percent on interest earned.
This is lower than the 15 percent tax that would be applicable if they were to purchase a brand new three-year bond. All bonds of five years and below attract a 15 percent tax on interest.
A swap bond occurs when holders of a paper that is nearing maturity are offered the exclusive chance to move all or part of their principal directly into another longer bond.
In chasing the higher return, investors offered to swap Sh13.52 billion, with the CBK taking up Sh11 billion. The bondholders agreed to an average price of Sh106.79 per bond unit of Sh100 in order to secure the swap.
However, the premium was inclusive of a Sh3.84 charge per unit to cover for accrued interest, given that they will be paid their next coupon earlier in November 2026 on the new bond as opposed to February 2027 if they had kept their money in the 15-year bond.
Ideally, a unit of a bond is priced at Sh100, with investors getting a return from the paper’s fixed interest rate. However, when a reopened bond pays a lower return compared to what the market is demanding, investors are given a discount on the Sh100 in order to entice them to lend to the government.
Alternatively, when investors indicate they are willing to take a return that is lower than a bond’s coupon rate, they end up paying a premium to the CBK in order to secure the bond.
This was the second straight switch bond sale in which investors were asked to transfer their holdings into the 10-year, 2019 paper, following the August issuance in which they swapped Sh22.5 billion from maturing T-tills and a 15-year paper from 2021.
“The repeated use of the 10-year, 2019 bond could reflect the CBK’s efforts to proactively manage upcoming maturities while extending into a debt security that doesn’t pose much redemption risk considering the timeline and outstanding amount,” said analysts at Sterling Capital in a note on the switch bond.
