On Friday 25th September the government of Malta published on the Government Gazette the issuance of new Malta Government Stock (MGS). MGSs as they are frequently referred to in technical jargon, are bonds issued by the government in order to finance its budget deficit. In essence, the government will have income from taxes and other sources, expenses from the supply of public goods (such as street lighting, road works, general government services…) and when the expenses are bigger than the income the government will issue bonds to make up the difference. Thus through MGSs the government would be borrowing money from investors to finance its operations.

The Offer

The latest offer made by the government is for the following 2 options:

• 2.00% MGS 2020
• 2.30% MGS 2029

The Amount

The amount to be issued is €120mln, with the option of issuing a further €60mln (which most likely be the case).

The Interest

The fixed interest is payable every 6 months on fixed dates – for the 2% MGS 2020 this would be 26th March and 26th September each year, while for the 2.30% MGS 2029 it would be 24th January and 24th July each year. Thus the first interest payment would be a pro-rata payment starting from October 12th until the first respective interest payment date of each bond.

The Offer Period

Applications are already available from authorised financial intermediaries, even though the actual offering period starts on Monday 5th October. The offer is scheduled to close on Wednesday 7th October, however the Accountant General always reserves the right to close the offer before if there is a high demand (and this could well be the case).

The Price

As is customary with every MGS issue, the issue price of the new MGSs will be announced just a few days before the offer period starts, in this case the announcement will be made on Thursday 1st October in the afternoon. What is this issue price? The issue price is the price at which the bonds will made available for sale to the public. Thus, although the bonds will mature at a price of €100 per 100 bonds at the end of their respective term, they will not necessarily be issued at a price of €100 per 100 shares. The government most likely will add on a premium over and above the €100 maturity price, which will effectively lower the yield to maturity of the bonds (click here for more about yield).

What are the estimated prices then? Both these MGSs are already trading on the market since they had already been previously issued in the past. Thus if we simply check out the price at which they have been trading lately we can get a better idea of where the new prices might be establish. It is interesting to note that the Central Bank of Malta (CBM) issues on a daily basis what are known as secondary market bid-prices. In effect this means that the CBM is always ready to buy any MGS trading on the market, at the established daily price which it publishes every day (normally between 10-11am). You can access the link to these prices here.

If we focus on the two MGSs at hand, we can see that as at Friday 25th September the latest price for the two MGSs were as follows:

• 2.00% MGS 2020 – €106.16
• 2.30% MGS 2029 – €102.56

What does this all mean? This means that as at Friday 25th September (roughly a week before the actual price will be issued) the CBM is willing to buy back these two MGSs at the quoted prices of €106.16 and €102.56 per 100 bonds, respectively. One might ask, why is the bond with the lower interest commanding a higher price than the one with the high interest rate? This is directly related to the maturity risk of the second MGS. Since the second MGS matures in 2029 (c. in 14 years time) as opposed to the first one that matures in 2020 (c. in 5 years). The longer term presents a greater risk of a fall in the price if interest rates had to go up. In addition, it is easier to assess the viability and financial strength of the government over a 5 year period than it is over a 14 year period. This adds to the higher yield being offered on the longer dated MGS.

The above is explained much better in a recent post of mine which discusses Are Bond still Worth Investing Into? In this post I give a practical example of what would happen to the price of the 3.00% MGS 2040 if in 5 years time we had to experience a rise in the base rate to 2.50% (as it was just a few years ago). The result was that the price would go down to around €75 per 100 nominal!

This example serves to show that even the issuers that are regarded as the most safe present a risk to investors. Although the likelihood of a default from the government of Malta is very small, there is still an interest rate and maturity risk present that could have an effect on the investor’s return.

Are there any new Bond Issues?

Luckily Yes, We have Hili Properties which is the property division of the Hili Group which have just announced a €37mln bond with an interest rate of 4.50% maturing in 2025. Furthermore, Bank of Valletta have just announced that they will also be coming to the market with a maximum amount of €150mln in new bonds to be issued over the coming year (most likely the first in this series of issues will be this year).

How do the Corporate Bonds compare to the Government Bonds?

There are many factors one needs to consider when deciding between investing in corporate bonds such as the Hili Properties and the BOV bond issues, versus the MGSs discussed above.

Relative Risk

From an issuer point of view the MGS are regarded as relatively safer than the corporate issuers, but this is just when it comes to default risk. If we had to compare the 2.3% MGS 2029 to the 4.5% Hili Properties 2025 the MGS is longer dated and hence presents more interest rate risk and more maturity risk. Nonetheless even the Hili Properties bond is regarded as a long dated investment since it has a maturity of 10 years. Thus should interest rates go up in the next ten years, both the Hili Properties bond and the MGSs would be negatively affected.

Resale Opportunity

The MGS have the advantage when it comes to selling them once bought since the CBM creates a market for MGSs by offering to buy them back at set prices on a daily basis. Having said, it is no secret there is currently high demand for almost any bond on the local market so it would not be envisaged to be difficult to sell the Hili Properties bond in the short term.

Capital Gain Opportunity

Both the MGSs and the corporate bonds would present an opportunity for capital gains, especially in the short term. Keep in mind that the government will be issuing €180mln of new bonds which is essentially new supply of MGSs. In basic economics we know that as supply grows the price of the object will go down. For this reason we would expect the price of the new MGS to be slightly lower than the current market prices. At the same time, virtually every time a new MGS has been issued the price has gone up on the market. Why? Simple – virtually every time the MGSs were issued they were over-subscribed meaning that there was a surge in demand. Back to basic economics, as demand goes up so does the price of the object.

With the corporate bonds the case is normally that the issuing price will be €100 per 100 bonds (i.e. no premium). Based on the same theory as the MGSs, there is normally an over subscription for the bonds and this in turn leads to an increase in the price, and thus a chance to sell at a  profit.

A simple introduction to bonds video can be displayed below:

The Bottom Line

One must be careful however here, what I have discussed in the above two paragraphs is an expectation over the first few days to weeks of the life of the bond/MGS. It may well be the case that new news comes to the market which could have a positive or a negative effect on the prices of the then issued bond/MGS. At the same time, there is no guarantee that the bond or the MGS would be oversubscribed. Even though past data suggests so, we all know the famous warning that past performance is not a guarantee of future performance and the value of your investment could go up as well as down.

As usual I must stress that this article is not intended to be used as investment advice and reference to the respective prospectuses should be made prior to investing in any of the instruments mentioned. Furthermore, Please refer to the Full Disclaimer.