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Monday, 11 December 2017

Dollar benefits

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  • Emerging Europe (excl CIS) Supply, 2010

The extent to which European emerging markets have outperformed peripheral eurozone sovereigns was underlined by Croatia’s latest 10-year dollar Eurobond, which trades well inside the Irish and Portuguese curves. Such strength partly reflects US funds’ appetite for EM dollar paper and their distrust of the eurozone straitjacket. John Weavers reports.

In the aftermath of the Greek/EU debt crisis explosion, US pension funds have recoiled from peripheral eurozone countries. Most stigmatised have been Portugal, Ireland, Greece and Spain – known as the PIGS.

In stark contrast, a deepening American bid for non-eurozone EU nations has continued to develop. Cash rich US funds are anxious to increase their exposure to this space which benefits from favourable fundamentals and relative value versus LatAm sovereigns, as well as US high yield and high grade.

The appetite for EEA sovereign paper was underlined on September 6 2010 when Lithuania (Baa1/BBB/BBB) priced a US$750m seven-year Reg S/144a issue 320bp wide of Treasuries, which was in line with Ireland’s seven-year spread and just a few basis points above Portugal.

Such are the benefits from dollar issuance that after 12 years without any dollar supply, Lithuania has now made three successive visits to that market, raising US$4.25bn within 11 months.  

The week before the September 2010 print a roadshow arranged by bookrunners Barclays Capital, HSBC and RBS had actually focused on updating European accounts, having previously concentrated on dollar buyers for its two previous deals. The feedback confirmed that although a euro deal was a possibility, European accounts would prefer a dollar transaction.

Ulrik Ross, head of European public sector and CEE/CIS region debt capital markets at HSBC explained that “while a euro deal was possible it made far more sense to go with the dollar market which has a deeper investor base, dominated by real money accounts.”

Alan Roch, director of EM syndicate at RBS, concurred. “Investors had expressed a preference for a Lithuanian dollar deal for liquidity reasons. The decision to proceed with a dollar transaction was warranted by the very swift execution and aggressive pricing with no new-issue premium.”

Despite the European bias of the roadshow, US investors still took 39% of the allocation. It was an impressive allotment, but was nevertheless well down on the previous two issues.

Lithuania had raised US$2bn from a record-breaking 10-year year Reg S/144a transaction in February 2010, less than five months after a US$1.5bn five-year print in October 2009. US funds accounted for 67% of the 10-year allocation and 57% for the five-year. 

Importantly for investors, dollar spreads held in better than euro spreads during the 2010 spring sell-off, and outperformed again through the subsequent recovery.

Dollar sweet dollar

On the sell side, the reduced attractiveness of EU and eurozone membership, and the collapse of convergence plays, make non-eurozone countries more willing to tap the dollar market. This is especially true when factoring in the currency risks that have become associated with the euro. 

“For those non-EU countries (especially from the CIS) and non-eurozone EU nations such as Lithuania the dollar market still makes more sense than euros,” said one origination manager.

Alongside Lithuania, fellow EU nations Poland and Hungary, as well as EU hopefulCroatia, successfully turned to the US dollar market to diversify their investor bases with hefty deals.

The Republic of Croatia (Baa3/BBB/BBB–) had originally sent out RFPs in April for a euro transaction, before the EU sovereign debt crisis raised the cost of euro issuance to such an extent that the deal was never mandated. Three months later the Finance Ministry took advantage of an improved market backdrop by deftly announcing and printing a US$1.25bn 10-year Reg S/144a deal within 12 hours.

The bond pays a 6.625% coupon and was priced at 99.102 to yield 6.75%, equivalent to Treasuries plus 381.3bp. It had rallied to 109 1/8 mid-market by mid September with the spread to Treasuries retreating below 300bp (to 296bp), well inside the Irish and Portuguese differentials.

This, the Republic’s second dollar issuance in less than nine months after October 2009’s US$1.5bn 10-year, also reflected the shift in pricing and demand realities for the euro and greenback markets.

Stefan Weiler, executive director at JP Morgan debt capital markets (which co-led both Croatia deals), stressed the buyside benefits of the dollar market where US funds are sitting on vast cash piles that they are anxious to put to work in the EM space.

At the same time, European banks, which typically represent a large chunk of euro demand, have been reluctant to increase their exposure to European sovereign risk.

The strength of US fund demand is also reflected in the deal statistics, which show American accounts taking over half of each Croatia transaction.

One logical assumption from these deals was that cash-strapped eurozone governments, notably Greece, Spain and Portugal, would visit the dollar market to help relieve their fiscal pressures as they struggled to raise sufficient funds in the euro market. Portugal raised US$1.25bn from a five-year print in March, but Spain’s expected spring dollar transaction failed to materialise.

As the debt crisis deepened, US pension funds began to shy away from peripheral eurozone countries, whose debt problems are being compounded – at least in their view – by the “straitjacket” of the single currency. Cash-strapped Greece had targeted a huge dollar benchmark in April that Morgan Stanley was due to arrange. Bankers away from the deal said the proposed offering was reduced from US$5bn−$10bn to US$1bn−$4bn as American interest waned, before being abandoned completely. Athens eventually resolved its near-term funding problems with massive soft loans from the IMF and the EU. It will therefore not have to access international financial markets again until 2012.

Meanwhile, other struggling eurozone countries were able to access to a €440bn Triple A rated SPV provided by the European Financial Stability Facility. Thus, a combination of waning US demand and cheaper alternative funding means the dollar market for peripheral eurozone countries has remained limited.

De-euroisation

However, US pension funds retain an appetite for non-eurozone sovereigns from Central and Eastern Europe, whether they are EU members or not, as long as their country-specific fundamentals stand up to scrutiny.

Underlining the reduced interest in euro paper, Serbian Finance Minister Diana Dragutinovic has outlined her country’s “de-euroisation” funding strategy, which means it is unlikely to issue any Eurobonds in 2010 or 2011. Serbia will continue to rely on bilateral and multilateral loans as well as the local market to fund its deficit.

The deeper and more liquid its domestic market is – the Russian rouble market being a good example – the better chance a government has of sustaining its funding needs without relying on external demand. Local currency issuance, either via the domestic or Eurobond markets, is becoming a growing force in the European EM space. The Russian Federation is planning an inaugural Eurorouble issuance of up to US$3bn equivalent (around Rbs90bn).

Belarus, Ukraine and Kazakhstan are potential sovereign Eurorouble issuers going forward. Turkey is believed to be considering a first ever lira-denominated Eurobond.

This does not mean the euro market has been completely sidelined by emerging European sovereigns. On the same day Lithuania printed its September dollar deal, another European sovereign stuck to its euro issuance plans, as Montenegro (Ba3/BB/NR) raised €200m from a five-year Reg S only offering. 

Four years after achieving independence, Montenegro became the latest EM sovereign debutant by pricing an inaugural international bond at 8.0%, in a transaction arranged by Credit Suisse and Deutsche Bank.

A three-day roadshow the previous week confirmed that Montenegro “would be able to take advantage of the appetite for sovereign and debut deals in the Central and Eastern European landscape”, according to Neil Slee, director in EM and corporate syndication at Credit Suisse.

A syndication manager away from the deal suggested a dollar issue would have achieved a better result because of the larger demand for greenback paper, especially in view of the euro high-yield market’s corporate focus.

Slee explained that although a dollar deal was certainly an option for Montenegro, the government – which applied to join the EU in 2008 – expressed a clear preference for its inaugural issuance to be in euros. 

Only three other EM sovereigns out of the EEMEA region printed in euros in 2010. This trio is made up of Israel, Romania and the Republic of Turkey (Ba2/BB–/BB+) which, after 11 successive dollar deals, made its first appearance in the euro market since January 2007 in April with a €1.5bn 10-year that priced at mid-swaps plus 190bp.

The smoothness of the transaction contrasted markedly with Greece’s regular debt-raising crises as Ankara reaped the rewards of a strong domestic banking sector and well-respected funding strategy.

Greece’s €5bn 10-year which printed a month earlier was trading 400bp wide of swaps as Turkey launched. With this in mind, it is hardly surprising that Turkey’s EU accession prospects are no longer mentioned as a means of securing spread convergence. “The convergence play is dead and buried,” said one EM trader.

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