Saturday, April 14, 2012

Genting 5.125% bond [part 2]

There has been quite an number of discussions on the Genting 5.125% bond. Quite a number of people pointed out that the bond do not have a fixed end date and were uncomfortable investing in this counter as it will be quite volatile as interest rates changes. As interest rates are at all time low levels, there are fears of this bond dropping below par value if interest rates were to rise suddenly. With an increase in interest rates, investor will find it safer to leave their money in banks as compared to a bond.

So, what are the chances of increase in interest rates? if so, what levels could it possibly increase to?

My analysis:
Even if interest rates were to rise, my guess will be that a 12-month fixed deposit interest will not increase to a value of more than 2.5%. The rationale is simple: CPF

CPF OA interest rates are pegged to 12-month fixed deposits (subjected to a minimum of 2.5%) and
CPF-SA and MA are pegged to 10-year Singapore Government Securities + 1 % (subjected to a minimum of 4%)

Extracted from CPF website:
Interest Rate for Ordinary Account Monies
For Ordinary Account (OA), CPF members receive a market-related interest rate based on the 12-month fixed deposit and month-end savings rates of the major local banks.

The computed CPF interest rate, derived from the major local banks’ interest rates for the three-month period, 1st November 2011 to 31st January 2012, worked out to be 0.16% per annum. However, members will receive the higher rate of 2.50% as legislated by the CPF Act.

Interest Rate for Special and Medisave Account Monies
Savings in the Special and Medisave Account (SMA) currently earn either 4% or the 12-month average yield of 10-year Singapore Government Securities (10YSGS) plus 1%, whichever is the higher. The interest rate on SMA savings is adjusted quarterly, based on interest rates on 10YSGS over a preceding 12-month period.

The 12-month average yield of the 10YSGS plus 1%, from 1st March 2011 to 29th February 2012, works out to be 2.93%. Accordingly, the SMA interest rate payable to CPF members from 1st April 2012 to 30th June 2012 will be maintained at the current floor of 4%.

If interest rates of a 12 month fixed deposit hit say 3%, that will mean that CPF board has to pay out interest rates of 3%!  Do you think the government will allow interest rates to increase so significantly?

Not only that, as interest rates drop, consumer spending increase, simulating economic growth. Likewise, if interest rates increases, consumer spending decreases, companies cut their borrowings. Economy growth will slow down or even contract. As Singapore is likely to continue to concentrate on economic growth, I highly doubt that interest rates will increase significantly over the next 5-10 years. 

That being said, I will definitely apply for the Genting 5.125% bond. No doubt we can get a higher yield through other instruments like REITS, but they belong to different asset classes. A yield of 5.125% is attractive compared to other fixed income instruments.

Related Posts:
Genting 5.125% bond [part 1]


Anonymous said...

Well said.

Singapore interest rate depends very much on US Federal Fund rate. Given the situation in US now, we won't see high interest rate for a very long time. In fact, we have a higher chance of getting QE3 than a hike in interest rate in the near future.

Genting's free cashflow is SGD118m last year. Net Operating cashflow is about SGD1b. CAPEX is estimated to be SGD200m this year. The interest payment for 2.5b perp is SGD 128m. With SGD3b cash, they have more than enough to pay the interest payment for many years. Even with the greenfield development, I think they have no problem maintaining their payment and I suspect they may even redeem the perps before 2022 when the coupon rate steps up to 6.125%.

Good choice.

Mad Stranger said...

Thanks. Depending on the situation 10 years from now, Genting may even issue a new bond with lower coupon payout and redeem this 5.125% instead of stepping it up to 6.125%.

Will you be applying for this too?