IFR Comment: Emerging markets... First cracks after buoyant start to year

In a sign of how the new issuance frenzy got ahead itself, a number of high-yield and borderline investment-grade transactions across the emerging markets ran into difficulties in the past week, with deals canned or underperforming in the secondary market.

Latin America, in particular, has struggled after two deals were pulled and another was postponed. For the first time this year, a week passed with no LatAm deal printed in the dollar market as the City of Buenos Aires, fellow Argentine borrower, electrical utility EDESA, and Brazilian budget airline Gol cancelled transactions.

EDESA failed to entice investors even with an initial price guidance of 13.50% and a six-point discount on the issue price.

Signs of deal fatigue were already evident the previous week after Brazil’s Grupo Farias pulled a deal, having already announced price guidance, and the Dominican Republic’s Caucedo Investments delayed its offering. “The market is experiencing a major case of indigestion,” said an origination banker.

Latin America is not the only emerging region running into some difficulties. In emerging Europe, Global Yatirim recently considered reopening an exchange it did in December but then thought better of it.

In Asia, Cheung Kong Infrastructure was forced to delay its perpetual subordinated notes by a week due to documentation delays in Luxembourg, where the paper was due to list. After the deal was pulled, it was unclear if investors would remain on board when Luxembourg finally gave the green light.

“The market is experiencing a major case of indigestion”

CKI eventually priced a US$300m deal last Friday with a 7% coupon – a level that one syndicate official away from the transaction described as “incredibly punchy”.

Too punchy for many investors as the deal was hard underwritten by the lead managers, Goldman Sachs and JP Morgan. “In effect [the leads] bought the deal, took on 100% of the risk and resold to the market. The issuer is guaranteed the price that is quoted to [it],” said a source close to the transaction.

The two banks were unloading the bonds from their books at 99.00, at an effective yield to call – in five years – of 7.2%. The bonds were last seen at 98.75–99.25.

Liquidity still abundant

None of these borrowers’ problems mean new issuance is about to be choked off – witness the strong reception given to Indonesian utility Cikarang Listrindo – or that secondary prices are about to collapse, a disorderly Greek default notwithstanding. Liquidity is still abundant and not just because of central bank policies.

Portfolio flows to the asset class have been strong this year, at more than US$5bn. Two weeks ago emerging market bond funds saw a record US$2.1bn of net inflows, according to EPFR data, and while the amount moderated last week to US$673m the positive momentum remains intact.

What is questionable, however, are deals that are more appropriate for a bull market underpinned by strong fundamentals rather than one that’s being fuelled by the financial equivalent of speed.

Still, while the growing list of delays may not be good for the reputation of the borrowers involved, it’s better to delay than be sorry. Investors too are getting more selective.

The City of Buenos Aires, for example, was forced to walk away from the market after investors indicated that they would only buy if the deal was priced at more than 10%, a level the issuer was unwilling to meet. “They’re very price-sensitive,” said a source.

One investor said it was inevitable that some deals were failing to gain traction. “Correlations are running high across all asset classes,” said Robert Abad, portfolio manager and emerging market specialist for WAMCO, which has US$38bn under management in EM-related investments.

Underlying volatility

“It is never a good sign. It just signals a lot of underlying volatility ready to pop. If you want to chase that cheap debt deal, go ahead, but will the fundamentals be there when you want your coupon and principal [paid out]?”

In that vein, Brazilian sugar and ethanol producer Grupo Farias pulled a 7NC4 144a/Reg S deal the day before expected pricing. The deal had an initial guidance of 12.25%–12.50%.

“Sovereign, investment grade, high-yield – it didn’t matter. So the mindset going into 2012 was very much risk-off. Then the Fed says they’ll hold rates low until 2014, and a long-term refinancing option comes out of Europe to help their banks, and the issuance window reopens”

“Investors didn’t have a chance to do their homework on the company,” added Abad. “If it’s a first-time issuer in the market, how do people know if they can pay their 12.5% coupon? They’re just not going to take that punt.”

Abad said the year’s flurry of new issuance was largely down to a market making up for lost time. “Leading up to January 2012, Greece was hitting huge potholes, and the US had only promised to hold rates low through 2013. The big emerging market sell-off as a result of greater euro volatility dealt a big body blow to local markets,” he said.

He added: “Sovereign, investment grade, high-yield – it didn’t matter. So the mindset going into 2012 was very much risk-off. Then the Fed says they’ll hold rates low until 2014, and a long-term refinancing option comes out of Europe to help their banks, and the issuance window reopens.”

Since the turn of the year, however, supply has outstripped even the most optimistic forecasts. In LatAm, for example, dollar debt issuance has jumped 15.6% between January 1 and February 13 compared with the same period last year.

“Everyone felt like they needed to play catch-up and capture alpha while they could,” said Abad. “If these kind of macroeconomic signals had taken place in the fall, people would have probably thought ’wow, things must be really bad if they’re doing this now’.”