Sunday, 16 December 2018

Pipeline must open

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Global economic malaise means that EM corporate debt is looking at its weakest year since 2011. But refinancing pressure means that the pipeline needs to open soon

Emerging market corporate debt has not made for a pretty picture so far this year. Bond sales totalled US$217.79bn in the first six months of 2015, a wince-making 34% drop from the US$327.62bn printed over the same period last year and the weakest first-half performance since 2011, according to Thomson Reuters data. But the outlook does not get any better looking forward; and it is telling that no bankers are prepared to make any kind of a guess as to what kind of annual volumes we could be looking at.

“Over the past two or three weeks, we have seen a lot of emerging market sovereigns come to market – Pakistan and Colombia for example – but almost all of the corporate transactions that have been roadshowing have been put on hold waiting for a more conducive market window,” said Cecile Camilli, head of CEEMEA debt capital markets at Societie Generale, in late September.

Since the debt crisis, bankers have become used to massive growth in emerging market corporate debt. Almost 20% of global corporate debt came from emerging markets last year. What has happened?

The simple answer for the shrinking market is the lack of Russian and Brazilian issuers.

“The reason for the decline of emerging market debt is driven by Russia, which used to make up about 15% of new issuance. It has been sanctioned. And on top of that, this year, Brazil has been harmed by the Petrobras scandal,” said Apostolos Bantis, emerging markets sellside credit analyst at Commerzbank.

Western sanctions were imposed on Russia after its military escapades in the Ukraine last year, which has, to all intents and purposes, closed down the supply of Russian debt. And Brazilian oil behemoth Petrobras has been mired in controversy since the first quarter of this year following a kick-back scandal and a distinct reluctance to release its audited results.

Ratings agency Moody’s cut the company’s ratings to junk and, in September, the sovereign followed and was cut to BB+ with negative outlook by Standard & Poor’s. That cast a shadow over any debt from the Latin America country.

But, of course, underneath the hood there is a more complex story to the lack of emerging market corporate debt.

There is no doubt that the US dollar remains the preferred currency. “Some EM corporates prioritise their domestic bond markets, but for those looking at the external debt markets, while a handful have access to the euro market, the currency of choice overall remains the US dollar,” said Simon Ollerenshaw, head of CEEMEA debt capital markets at Barclays.

It might seem obvious, therefore, to suggest that issuance has been plagued by the strength of the US dollar. Certainly, its appreciation should not be underestimated. At the end of September, for example, the Malaysian ringgit was trading at 4.425 to the US dollar – its lowest level since January 1998.

Beyond FX

But some think that the strong dollar’s impact on EM debt issuance has been overstated.

It is true that, following the dollar surge over the past four years, there has been a strong and growing dollar mismatch with many emerging market currencies. At first sight, this means that numerous companies that borrow in dollars but have revenues in a local currency have seen their debt-service costs rise. But although there has been a rise in defaults, many argue that has nothing to do with an FX mismatch at all.

“First of all, corporates in emerging markets that could borrow in the US dollar market are well established and they have banking relationships,” said Jan Dehn, head of research at Ashmore Group in London. “They are experts at this. If they have a long-term liability stream in dollars, then they hedge it properly with a rolling short-dated hedge. I have never met a corporate chief executive who didn’t know how to fix the FX. They are certainly not going to throw it all away on the roulette table of the global currency market.”

It has also become a truism to say that emerging market debt issuance has been affected by downgrades. Again, the answer is not quite so black and white. Certainly, there have been a significant number of ratings downgrades recently. Russia lost its investment-grade status earlier this year and S&P’s downgrade of Brazil is likely to be followed by one from Moody’s in the New Year. In fact, so far this year, 31 emerging market countries have been downgraded by at least one of the three major ratings agencies and several more are in the firing line, notably Venezuela, Colombia and Kazakhstan.

But investor demand remains. “Our general sense is that the market has reasonable cash positions to invest when opportunities are right,” said Barclays’ Ollerenshaw.

Part of the reason is that EM investors are conscious of the significant difference between emerging market names – which have often been downgraded because of the downgrade of the sovereign – and US and even EU high-yield credits, which might have a low rating because they are highly leveraged.

Commerzbank’s Bantis calls the ratings changes “a transitional phase” but not necessarily a bad thing. “The downgrades do have a negative impact in terms of higher costs,” he said, “but there is an investor appeal. This has opened the door to high-yield, indices which means that many names are now in demand from high-yield institutional investors.”

But for all of the investor interest, there is no doubt that deals in the market are struggling.

Rising premiums

“Single B names just can’t borrow at the moment,” said one London-based banker bluntly. And even familiar and highly rated names would shudder at the premiums they would have to pay. Ashmore Group’s Dehn talks about the extent to which spreads have been hit by market pessimism and the way that corporates have become more expensive relative to sovereign dollar debt. “Rather than 250bp over sovereigns, we are now seeing 400bp over sovereigns,” he said.

The last couple of weeks of September saw a handful of emerging market names roadshow, but none of the deals managed to make it across the line. “Issuers that have potential are suffering from the overall market environment which is volatile,” says SG’s Camilli.

Russian nickel and palladium company Norilsk Nickel had been looking to complete the first benchmark Russian bond this year via Barclays, Citigroup, ING, Societe Generale and UniCredit; Turkcell was going to be the first Turkish corporate issuer of the year with a 144A/Reg S via BNP Paribas, Citigroup and HSBC; and Poland’s state-owned power company PGE Polska Grupa Energetyczna was planning a euro deal arranged by Citigroup, Credit Suisse and Deutsche Bank. As October dawned, none had appeared.

In these cases, issuers appear to be been spooked by more immediate and short-term issues – in other words, they have been delayed rather than pulled. However overblown reactions have been, it is impossible to discount the ructions created by the tinkerings of the Chinese central bank, the devaluation of the yuan and fears of a Chinese slowdown.

“The magnitude of nervousness is out of all proportion to the risk,” said Dehn. This, on top of the perpetual game of chicken that the US Federal Reserve has been playing with interest rates, has created a climate in the market into which only the most brave corporate would venture.

At the end of September, Abu Dhabi Commercial Bank put its head above the parapet – and all too quickly pulled it back down again. Although not strictly a corporate, ADCB had prepared the first bond deal from a Gulf financial for several months and was being watched closely as to how it would perform. The six-year Reg S benchmark deal got as far as initial price thoughts before it fell flat on its face.

The immediate outlook might be far from rosy, but there is no escaping the fact the market needs to open up soon. S&P estimates that US$692bn of emerging market corporate debt needs to be refinanced by end of 2020.

When the markets opened again after the debt crisis in 2010, the next few years saw some serious volume issued. A significant amount of Russian debt, for example, emerged in 2013, say bankers.

Few would go as far as to say that there are going to be significant bottlenecks or even difficulties in getting deals away, but with the majority of EM debt issued with a five-year tenor, the markets need to wake up soon.


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