First Capital Research

“NEW LOW IN THE MAKING”

First Capital Fixed Income Recommendation – 18th June 2020

Analyst: Atchuthan Srirangan

Dimantha Mathew
Nisansala Kuruppumudali
 8.0%
7.5%
7.0%
6.0%
6.0%
5.0%
SRR cut to 5.0%
4.0%

overwhelmingly 4.0%

boost liquidity… 3.0%

2.0% 2.0%

1.0%

…Liquidity
On 16th Jun 2020 CBSL has reduced SSR by 200bps from 4% to 2%. The reduction is expected
touches a 16- to release over LKR 115Bn of liquidity into the banking system, allowing banks to accelerate
credit flows into the economy, while reducing cost of funds. We expect LKR 100Bn top-up, in
Year high the existing refinance scheme which may enhance additional liquidity to the domestic
money market above LKR 250Bn. At the current level of LKR 221Bn (17th Jun) excess liquidity
is already at a 16-year high.

Further top-up in existing refinance scheme may push CBSL Holding (printed money) closer
to LKR 500Bn from current LKR 317Bn.
Jun 2020 FIRST CAPITAL RESEARCH 2
 Policy rates

12.00%
SDFR
SLFR
5.50%
6.50%
4.50%
5.50%
100bps rate cut on
10.00%
the cards
8.58% ❑ CBSL presumes the excess liquidity may factor in as a stimulus for
LCB’s to lend to businesses in support of government’s efforts to
8.00% revive the economy. On the contrary, LCB’s may expedite this as
7.50% 6.6% an opportunity to position in either short term treasury
instruments or under SDF facility interest rate deriving a
6.50% substantial interest on the deposit.
6.00% 6.50%
❑ Thereby, the possibility exists that bulk of the money may not
5.50% move into the revival of businesses via credit schemes, therefore,
5.00% the intention of CBSL may not materialize.
4.00%

❑ We believe that the Central Bank is yet again in a vulnerable

2.00% position and the possibility of a policy rate cut is on the cards in
2.00%
order push banks to consider the lending opportunities.
❑ First Capital Research allocates a policy rate cut expectation of
100bps bringing the SDFR and SLFR to 4.50% and 5.50%,
0.00% respectively. Despite prevailing the low interest rate environment
it will have a ripple effect on the overall economy.

SDFR SLFR SRR 1 Yr T'Bill

Jun 2020 FIRST CAPITAL RESEARCH 3

 All-time high liquidity position counts on
❑ With the liquidity position surging over LKR 200Bn and bulk of the excess
liquidity likely to be parked in short term Government Securities, we expect
a significant downward pressure on the Yield curve
❑ Considering the possibility of a major rate cut to discourage using of the
SDFR facility, we expect an accelerated downward pressure on the yield
curve.
❑ Further, the Government has decided to expand its quasi-fiscal re-financing
facility from LKR 50Bn to LKR 150Bn requiring additional LKR 100Bn funding
for planned disbursement. The remedial action to revive the economy may
further boost liquidity in the system which as mentioned prior may push
CBSL Holdings closer to LKR 500Bn.
May 2020 Short Term (Appendix 1) View Upgraded
Bond Yield bands adjusted downwards by 125-150bps for Jun – Sep 2020 period
In our previous recommendation we expected a further surge in liquidity in 2Q-
3Q which may bring yields by 25-50bps. However, the current SRR cut, possible
policy rate cut, and additional LKR 100Bn funding may bring the yields further
down, thereby we bring down our bond yield bands by 125-150 bps as
illustrated in Slide 5.

Jun 2020 FIRST CAPITAL RESEARCH 4

Bond Yield Expectations for Jun-Sep 2020 (Short-Term View);
Expectations adjusted downwards 1Yr by 125bps and 5Yr, 10Yr
by 150bps
1Yr, 5Yr & 10Yr Expectations adjusted downwards
1 Yr 5 Yr 10 Yr
11.0
Jan 2020 May 2020
10.5 Forecast Forecast
150bps
10.0
150bps
9.5
9.0
8.5%
8.5
125bps 8.0%
8.0
7.5
7.5%
7.0 6.75%
7.0%
6.5
6.0
5.5 5.75%

1 Year 5 Year 10 Year Source: First Capital Research

Jun 2020 FIRST CAPITAL RESEARCH 5

 Yield Curve Recommendation
9.0% Current
Tenure Recommendation
Yield

< 91 Days < 3M Short 6.10% Buy

8.0%
< 182 Days < 6M Short 6.25% Buy
< 364 Days < 1Y Short 6.45% Buy
7.0%
01-Oct-22 < 2Y Short 6.85% Buy
15-Jul-23 < 3Y Short 7.10% Buy
15-Sep-24 < 4Y Mid 7.43% Buy
6.0% 01-May-25 < 5Y Mid 7.63% Buy
01-Aug-26 < 6Y Mid 7.80% Buy
15-Oct-27 < 7Y Mid 8.00% Buy
5.0% 01-Sep-28 < 8Y Mid 8.10% Buy
01-May-29 < 10Y Long 8.15% Buy
15-Mar-32 < 12Y Long 8.35% Buy
4.0%
< 3M < 6M 1Y 2Y 3Y 4Y 5Y 6Y 7Y 8Y 10Y 12Y 15Y 20Y 15-Sep-34 < 15Y Long 8.45% Buy
Low Band Mid Band High Band Prevailing Rate
15-Aug-39 < 20Y Long 8.55% Buy
Source: First Capital Research

Jun 2020 FIRST CAPITAL RESEARCH 6

Profit Analysis considering bottom of the
bands * Considered Clean Price

Maturity Coupon Purchased Purchase Sale Sale

Face Value Profit
Date Rate Yield Value* Yield Value*
01-Oct-22 10.00% 100,000,000 6.85% 106,558,600 6.25% 107,343,000 784,400
15-Jul-23 10.20% 100,000,000 7.10% 108,430,100 6.60% 109,388,700 958,600
15-Sep-24 9.85% 100,000,000 7.43% 108,655,800 6.80% 110,702,000 2,046,200
01-May-25 9.00% 100,000,000 7.63% 105,475,600 7.00% 107,888,500 2,412,900
01-Aug-26 11.50% 100,000,000 7.80% 117,731,200 7.15% 120,803,300 3,072,100
15-Oct-27 10.30% 100,000,000 8.00% 112,550,000 7.30% 116,487,500 3,937,500
01-Sep-28 11.50% 100,000,000 8.10% 120,074,700 7.40% 124,514,000 4,439,300
15-May-30 11.00% 100,000,000 8.15% 119,112,900 7.50% 123,873,300 4,760,400
01-Jan-32 8.00% 100,000,000 8.35% 97,432,800 7.60% 102,996,200 5,563,400
15-Sep-34 10.25% 100,000,000 8.45% 114,724,200 7.70% 121,675,000 6,950,800
15-Aug-39 10.50% 100,000,000 8.55% 118,198,900 7.80% 126,524,500 8,325,600

Jun 2020 FIRST CAPITAL RESEARCH 7

 Economic
Health Score
 Jun 2020 FI Economic Health Score
Health score to improve before deteriorating…..

- 55 + 02 - 03 - 54

- 07 + 01 - 01 - 07

- 61
[As against 62 inMay 2020 &
Source: First Capital Research 63 in Jun 2019 (1 Year ago)]
Jun 2020 FIRST CAPITAL RESEARCH 09
New Score Changes to Health Score – Priority Criteria

11/15 14/15 10/15 01/10 09/10 09/10

Foreign Reserves Liquidity Inflation Foreign Activity Credit CBSL Holdings
Foreign reserves CBSL continuously CCPI dipped to 4.0% Net outflow of LKR Private credit CBSL holdings hovers
dipped by USD 0.7Bn conducting term in May 2020 as the 12.5Bn in govt. increased by LKR above LKR 300.0Bn
during the month of reverse repo price of food items securities over the 13.4Bn in Apr 2020 along with improved
May 2020 to USD auctions to maintain dipped notably last 2 months; recording the ninth liquidity
6.5Bn from USD liquidity Foreign holding consecutive credit
7.2Bn in Apr 2020 around 0.4% growth
Current Score

-1 +1 -1 -1 +1

12/15 13/15 10/15 02/10 10/10 08/10

Jun 2020 FIRST CAPITAL RESEARCH 10

New Score Changes to Health Score – Secondary Criteria

0/05 0/05 04/05 02/05 01/05

Rating Outlook External BOT & BOP Political Risk Investor Confidence
Environment
Fitch downgraded YTD USD/LKR has Trade deficit Delays in BCI drops to 89 in
sovereign rating depreciated by over decreased to USD parliamentary May marking the 5th
outlook to ‘B-’ 2% 549.0Mn in Mar elections due to consecutive monthly
predicting economic 2020, from USD COVID-19 outbreak fall since 51 month
shock from COVID-19 574.0Mn in Feb 2020 and fight to flatten high in Dec 2019
the curve
Current Score

-1 +1

0/05 0/05 05/05 02/05 0/05

Jun 2020 FIRST CAPITAL RESEARCH 11
Appendix
May 2020 Econ Outlook Re Cap:
Lacklustre 2Q & 3Q & CBSL intentions may push short
term rates down for a limited period
With the Government’s intention to open up the economy and
CBSL’s push to lower interest rates, there are caps being
imposed on the recent Bill & Bond auctions which illustrates the
intention of the CBSL to maintain lower rates in order boost
economic activity and growth.

◦“Considering the risks in the system and the worsening

macro indicators First Capital Research prefers to maintain
our bond yield bands at the mentioned levels in the
previous slide”

However, with the lacklustre 2Q & 3Q, possible further increase

in CBSL Holdings while also considering the intentions and the
new rules of the CBSL to push rates lower, we would like to
highlight that short-mid term yields may decline by 25-50bps for
a very limited period.

Jun 2020 FIRST CAPITAL RESEARCH 13

 This Review is prepared and issued by First Capital Holdings PLC based
on information in the public domain, internally developed and other sources,
believed to be correct. Although all reasonable care has been taken to ensure
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Jun 2020 FIRST CAPITAL RESEARCH 14

CONTACT US

Dimantha Mathew +94 11 2639 853 Hiruni Perera +94 11 2639 864

Atchuthan Srirangan +94 11 2639 863 Nisansala Kuruppumudali +94 11 2639 866

Jun 2020 FIRST CAPITAL RESEARCH 15