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Thursday, 23 November 2017

Sub-Saharan Capital Markets Roundtable 2007: Part 3

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IFR: The US pension funds have been going outside of the US over the last two years or so, and that is going to keep going.

Francis Beddington: I think in Europe there has been a legacy of trading in multiple currencies anyway. So there are a lot of spare Italian swaps traders around.

Alex von Sponeck: I think one very interesting thing we have seen – slightly off the subject but very relevant – is a large number of US investors, regardless of the fact that it is maybe a Reg S only deal (which is relevant from an African perspective because of the disclosure and timing is not always going to allow you to get to a 144a disclosure standard), have no issue looking at a Reg S only deal and booking it in one of their offshore booking centres.

The fear of "if we cannot do 144a we are limited to a US$200m deal size", it is not there at the moment. The search for yield and the search by US investors and pension funds for diversification and getting into these deals has meant that the traditional Reg S/144a barrier is much less important. They will buy their Reg S only deal and just book it offshore.

Francis Beddington: Because they are doing their own due diligence.

Alex von Sponeck: Exactly.

Francis Beddington: This product is not going to people where that distinction is so crucial.

Alex von Sponeck: I agree.

Francis Beddington: They have done their own credit work. If you’ve been buying Reg S deals in Russia, Kazakhstan, second-tier Brazilian banks, you do quite a lot of due diligence. You buy on your own due diligence, not the fact that it is 144a or Reg S. Some are restricted to 144a and they just get annoyed.

Stuart Culverhouse: Just on the point of who are the investors, certainly from our side, just to reiterate what Francis said, a lot of the investors are dedicated emerging market specialists. We have seen new African funds set up in the last year, which previously we would never have heard of, but some African funds have been going for 10 years, five years, seven years.

So it is not a new area. It is just that it has been very small and niche. Hedge funds, the label, hides a multitude of sins (but that is probably the wrong word), and there are very different strategies. They are providing liquidity, which is obviously helping issuers raise the finance in the first place, which is what you need. The other aspect of hedge funds is that it is not just portfolio that we are seeing. There are the private equity houses. A lot of that investment is akin to FDI. Textbooks are not saying that that is bad. It can be volatile, but a lot of companies are taking reasonable strategic stakes in these companies and bringing the technological know-how that that gives to IPOs. So that is going to be a positive. The label is not always helpful.

Francis Beddington: I think the private equity thing is interesting. We have seen a number of transactions in South Africa. So we are starting to see an offshore high yield market developing on the back of private equity involvement in South Africa. It is not that different to look beyond that.

Alex von Sponeck: And many of those same private equity houses are now buying convertibles, they are buying all sorts of non-traditional equity instruments or equity-linked instruments in Nigeria. There have been a number of them.

François Ekam-Dick: Most of the deals we’ve from the private sector involving debt and convertibles have been sold to private equity. You know, private equity money has been in sub-Saharan Africa well before capital markets. The number of private equity institutions is just growing all the time.

Ade Adebajo: Another issue is that a lot of countries, particularly in West Africa, have traditionally been real equities markets. There are 300-odd companies quoted on the Nigerian stock exchange. The other phenomenon that we are seeing on the global investor front, in addition to diversification out of Europe and starting to get interest from offshore accounts in paper coming out of Africa, is we are also interestingly increasingly seeing some interest coming out from the Middle East and the Asian markets, where not so long ago you would not even have very much interest within the region. You would not really have Hong Kong investors looking much further away than Singapore, but now we are starting to get interest and starting to get queries from Asia on the back of a lot of work that has been done on corporates in Nigeria or looking at opportunities in Zambia, whether that be local currency or hard currency.

That is quite an interesting development. I don’t think it is going to be a huge – for now it is not going to be a huge proportion of any book. Traditionally it will still be Europe. But it’s interesting to the extent that they are looking at diversifying and tapping into some new pockets of liquidity and maybe developing some new investors outside of the traditional space.

Francis Beddington: I bet there will be an African Sukuk before year-end.

Alex von Sponeck: An interesting thing to throw out would be if someone would be willing to seriously look at municipal financings or state government financings in Nigeria, or if some of the northern Nigerian states would do some Islamic financings. There is, I think, a whole second wave of potential opportunities as we as a firm get more and more comfortable. If the first deal we took to the credit committee was a Kano state Sukuk, that would probably not have been the right idea. But, you know, a year from now, six months from now . . .

In this business although we do not often have time to do it, I often try and stop and look at where we were a year ago. We have had this bull run, that is true, but despite the bull run, the pace of innovation or the pace at which people no longer look at something and say: "Subordinated debt from Nigeria? No way!" It is incredible. I think that the only real limit at the moment is the supply-demand limit, US interest rates and what’s happening there because it will play a factor of course, and also just time.

Francis Beddington: There is not enough paper, full stop.

IFR: We have not seen much structured finance paper, such as securitisation, secured debt or cashflow financing. Is that something that is on the way?

Ade Adebajo: You have not seen so much in the international markets, but you have actually seen that a lot in some of the domestic markets. Even subordinated debt capital, which is not particularly that innovative, we have been involved in five, I think, countries where we have raised anything ranging from lower tier 2 capital to non-cumulative pref share capital for Standard Chartered Bank subsidiaries in Africa, and that has been primarily driven by better management of foreign exchange risk or replacing group capital with local currency capital.

We did a transaction a couple of years back for the government of Botswana where they effectively securitised a pool of parastatal loans in pula. So there have been some things done and there will be some structured deals.

François Ekam-Dick: Eighty per cent of our transactions, starting with Cote d'Ivoire, are structured. In Cameroon we did the first securitisation of a municipality (for the City of Douala). We also did a multi-currency structured loan deal via an SPV for a client involving debt, securitisation of contracts, civil engineering work, combined with equity.

Francis Beddington: I think that is definitely going to grow. As housing markets and mortgage markets start to take off, bank balance sheets will run out of space very quickly. We have seen that in the Russian market. So I think securitising it will happen. I think it will happen in Nigeria quite quickly.

I went to the Nigerian capital markets day at the London Stock Exchange, and the banks were all saying: "We are getting out of government paper, we are doing credit card loans, we are doing home loans". That eats into capital so quickly. They will need to securitise it. So those things will come and will come quickly.

Alex von Sponeck: In Nigeria, there is this race going on at the moment with the banks. All the banks are scared and mention it pretty openly that the government is going to put a new threshold on the minimum capital they need. So there is this crazy rush to become the biggest, in asset size or shareholder’s equity, whatever, so long as you can say, "I am number 1".

Francis Beddington: "And you cannot close me down".

Alex von Sponeck: When I go out and visit, I say: "Look, you might be number 10 in size, but size really is not everything". Because they will say to you, "Thank God you are here. We would like to discuss raising US$500m of new equity". And you will say: "But you only have US$250m at the moment. You want to raise US$500m more? What you going to do with it?" "Well, to survive we are going to need . . . “ Some real reality testing needs to happen.

But at the same time, one very interesting feature of the Nigerian market has been that until now it’s all been about equity. I have never worked in a market where the first set of goggles on the issuer is an equity pair of glasses. They have these equity eyes on and whenever you speak to them, they say: "We want to raise equity". I say: "What is it for?" They reply: "To increase our capital". I say: "Okay, why don't you raise US$100m of equity and US$200m of hybrid capital?" "No, we just want equity," they say. They understand equity in Nigeria because for so long they have been able to go to the equity capital markets.

François Ekam-Dick: But you can’t look at Nigeria and then draw a parallel with the rest of Africa.

Francis Beddington: Two years ago Nigeria did not have a debt curve that went beyond 91 days. It is hard to raise capital. Now they are starting to think about it.

Ade Adebajo: Coming back to structured finance, we worked with a number of clients across different countries, including Nigeria, Ghana, Kenya. One of the constraints, I think, as well, why you have not seen quite as much on the international side, has been the role that the ratings process plays in that. Given that a number of the countries themselves have not got rated until one and a half, two years ago at most, that has been one of the biggest challenges, to get all the issuer default ratings, and then to start looking at where the transactions are to be rated.

Take the example of Sonangol, in Angola. I think the biggest challenge from the issuer's perspective was where that company will be rated, given that the sovereign is not rated, and what are the implications and what you have to go through, and is worth the headache, or do you simply turn to your traditional bank that has been providing capital for the last 15 years?

Francis Beddington: Or the Chinese.

François Ekam-Dick: There is no question that on a structured credit deal, certainly on commodities, the international loan market is just competitive. To make a structured credit deal international, you need to get size. We look at a lot of asset monetisation. But the opportunities are more in the local currencies. We are not seeing that much opportunity in the G7 currencies.

Kenya Commercial Bank just did a US$25m deal with the IFC; it’s like a trade monetisation programme where the IFC issues guarantees against KCB’s underlying trade transactions. When you look at the time and the cost of putting these deals together, it’s substantial, but for these guys, at the end of the day, if they can raise funds at Libor plus 150bp, they are going to on-lend it at 300bp to 400bp over..

We looked at non performing loan monetisation programmes, particularly in Kenya, with banks like KCB, National Bank of Kenya. The problem with non performing loans is the cost of equity, basically the loss that they are going to bear. For a lot of banks, that is just too much. We certainly did a lot of work on that front in Kenya and in Uganda as well, and I think it is just impossible to get the banks to take the lead.

IFR: One of the other areas a functioning capital market needs is lay-off mechanisms, derivatives, interest-rate swaps, currency swaps etc. What is happening on that front? Is that a liquid market?

Alex von Sponeck: It is not liquid, no.

Francis Beddington: You are starting to see a nascent Naira swaps market, both interest-rate and currency.

Alex von Sponeck: We did our first naira deal last week.

François Ekam-Dick: Interest-rate swap?

Alex von Sponeck: Yes. You want the name of the bank too?

Francis Beddington: Currency options are quoted in Kenya and in Tanzania, and in Zambia, which quite surprised me, given the currency moves 35% to 40%; I have not seen the pricing of that yet. But I know people have traded kwacha currency options in Zambia. So these are starting to develop. There are a number of central banks that are pushing it. It is an odd one. Mozambique; if you read speeches from the Governor of the Central Bank of Mozambique, he spends most of his time berating his banking system for being incompetent, lacking imagination or innovation, and not looking at things like swaps, options. He regularly berates them. People have not paid that much attention to Mozambique, but I think it is a great story.

Alex von Sponeck: On the back of what you said about the African Development Bank, I think those local currency issues are starting to kick-start cross currency swaps etc because the banks that are underwriting those deals are looking to lay off that risk.

François Ekam-Dick: Cross-currency swaps have been done for quite a long time, particularly in East Africa.

Francis Beddington: I think this is a fact of life not just in Africa. These markets are new in the CIS. They are relatively new in the EU members of Eastern Europe. When did the Slovak swap market kick off? In the late 1990s? We have seen this movie before. We know how these local markets will develop. We have seen it in Poland, Czech, Hungary, Slovakia, Mexico, Brazil. Because Africa is playing catch-up, these markets are developing much, much faster.

If you look how long it took Poland to get to a 10-year curve, Nigeria went from 91 days to seven years in about a year and a half. The pace of movement is much, much faster. There is a lot of learning from the top to the bottom.

François Ekam-Dick: I think there is also a question of the business models of local banks. Other than the foreign banks, which have been having them as part of their business models, treasury products are not entrenched yet.

Even if you take the big foreign banks in Africa, like Standard Chartered, Standard Bank, Citi etc you have the feeling that those products are provided to a limited number of clients, i,e big multinationals. There’s a bit of an interbank market, but then you have another constraint, which is counterparty risk, because a lot of indigenous banks cannot trade with some of the banks with expertise.

Of course you have to add up the fact that they still need to acquire skills, they need training, they need to get the board to understand the relevance of the product. So all those basic infrastructure issues still lack and you need to build them up. It is not that the demand is not there. The Central Bank of Kenya, for example, has been pushing exporters to speak to the banks, but I think there is going to be a long wait until the banks can integrate those products into their infrastructure.

Francis Beddington: For derivatives, countries need to go down the sensible route and adopt ISDA documentation rather than write their own. A number of countries say they need their own. That’s going to take 20 years. But the smarter countries just say: "Fine, we will do ISDA.". It is usually often the government that drives this. I know in Egypt a lot of it was driven by the debt management office saying, "This is the documentation you will use”.

Alex von Sponeck: Whereas in the Nigeria I think it is the private sector.

Francis Beddington: Yes. The private sector has said: "This is what we would like to use".

IFR: With regard to the progress and the speed in which Africa is developing relative to Poland or Slovakia, how much that is dependent on having a favourable backdrop? Even if, say, there is another emerging markets crisis, could Africa still progress quickly towards the goals we’ve been talking about? On the favourable backdrop, are people looking at Africa now because they can’t find yield anywhere else?

Francis Beddington: I think the point is by looking at it, people have realised it is not necessarily any riskier than anywhere else. So it just forms part of the portfolio.

IFR: That is going to stay like that whatever happens?

Francis Beddington: My instinct is it will. Everything will get eased back. If we have a big crisis, the big banks will lay people off – we have seen this before – but are they going to totally stop trading when they have built up desks and built up expertise? Is Alex's group going to axe Africa? Of course not. There’s money to be made. The world is underweight in Africa, I think, because they did not pay enough attention to it. They looked it and it now forms a part of your portfolio. You have reasonably rapid growth. You have a good commodity diversification base and you do not have a huge debt overhang. I think the pricing will change, which will be nice.

IFR: Stuart, what is your view about the durability of Africa?

Stuart Culverhouse: I think the durability is there, but I think you also need to discriminate across the countries. Nigeria is not the same country it was three years ago. It has improved enormously in terms of the credit perspective and what is going on domestically, as has Kenya. Ghana is doing all the right things and improving, although there are some issues there, but those countries that are going in the right direction will still be there.

There are other countries where you wonder about the quality of policies or which have inherent vulnerabilities. The Seychelles probably will not be able to launch another bond, for instance. I think you will see a tiering effect. But that is, I think, the same across all markets.

Francis Beddington: Right, that is global. There is very little differentiation in credit markets between countries. You know, if we see a good old-fashioned set-off, there will be increased focus on the individual countries. I agree. Nigeria is not going away.

IFR: Could you say when Latin America was at the stage Africa is now?

Francis Beddington: I think it depends on which market. If you are talking about the local currency bond market, when did Slovakia start: 1997, 1998? You were starting to see that swaps market develop and a lengthening of curves. When did Mexico do its first 10-year peso? Not that long ago.

Stuart Culverhouse: Local currency in the Americas is quite a recent phenomenon. You would have to look at Chile really as the only example of something that has been doing it for a very long period of time.

Francis Beddington: Kenya had a 10-year bond market before Poland probably. Kenya was always an exception. South Africa was always another exception. But even Zambia, Zambia has been doing five years.

François Ekam-Dick: African countries have been issuing bonds for a long time. I think it is a question of developing infrastructure. The CFA countries have been issuing bonds for quite some time. They just did not improve their liability management in the same way. So the question, I think, Francis is right. We are in a situation where things will stay.

In fact, when we had the Asian crisis in 1997, we carried on doing the same old things, doing bond issues for EADB and so on and so forth. I think what has changed today is the awareness by international investors. Yes, I will agree with Alex, there is no question that will create some momentum. What you did not have, which you now have today, is effectively large investment banks including Africa as part of their business models. There were some tentative initiatives in 1997, and it did not work out. Boom, you shut down.

Francis Beddington: In 1997, 1998, I put together a paper when I was at Chase to start trading Kenya. At the African Development Bank meeting that year, you met guys from Merrill Lynch, Morgan Stanley, Deutsche Bank, markets guys. You know, the Russian crisis happened, you did not see another markets person at an African Development Bank meeting until Shanghai, virtually. [The African Development Bank held its annual general meeting in Shanghai in 2007].

So it was looked at. But I think so much infrastructure has been put in place of specialist traders. All of the big shops now have an African desk, I do not see why you would close a whole desk. If you close the whole desk, someone else will get given that responsibility anyway. The Middle East trader will end up trading Middle East and Africa or Balkans and Africa. I just do not see the market will go away.

I think the big push into the local markets was the mini-correction we had in April/May last year, when everything went nuts at the same time except the two big African trades: Egypt local currency and Nigerian local currency did not move at all. That was quite powerful. When you look at EMTA volumes, Nigeria and Egypt have gone very large and very mainstream very quickly.

François Ekam-Dick: There is also the domestic bid. It is interesting that in Ghana, in Kenya, you see guys competing because local liquidity is tremendous. I know everybody is talking about Nigeria, but for me Kenya is always the top of the top. There is no question about it in terms of the quality of diversification. You have a population of large asset managers so you always have that domestic bid.

I think what Nigeria has managed to do is get the infrastructure right, get the primary dealers in place etc. But I still believe that in places like Kenya the quality of investor base is much more first-class. You have the diversification in terms of all the big asset managers with large portfolios, thanks to the pension reforms. So you have an investor base which is much, much stronger and less dependent on foreign investors. We will see how Nigeria will behave when investors want to bail out.

Francis Beddington: I think we have seen this in South Africa. There have been three emerging market crises and currency moves of 20% to 30% and interest-rate moves. They lived with it because the domestic financial institutions were sold to foreigners and bought back cheap. I would imagine in Kenya that if there is a crisis and rates spike up and foreigners chuck in all their paper, locals will be sitting there thinking "Thank you”. We have seen this before: sell it to foreigners expensive and buy it back off them cheap when they trade out.

Ade Adebajo: What you will probably find is that you will have some players who have traditionally been, say, East European specialist investment banking houses look at Africa as a new area. We have certainly seen some people come in and take people from the established banks. But if there is a shock, they may say: "You know what? Perhaps it was too early or perhaps we need to downsize". But I think a lot of institutional investors have started to appreciate the lack of correlation to a lot of the other emerging markets anyway.

Stuart Culverhouse: Until Africa becomes really successful, then it will be a problem.

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