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Tuesday, 17 October 2017

Two tier system

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The global recession has created severe budgetary distress across Central and Eastern Europe. The fiscal crisis has been met with differing responses as better regarded sovereigns access international markets to help meet their shortfalls while high beta names are forced to seek assistance from multilateral agencies like the IMF. Mike Winfield and John Weavers report.

Among all the central and eastern European economies, Triple A-rated Austria is by far the best regarded. However, it has been severely impacted via its exposure to its eastern neighbours, more so than other EU states due to the relatively small size of its domestic economy and the resultant exposure of its banking system.

The sovereign has seen its 10-year bond spread widen from plus 40bp to a peak at plus 128bp over Bunds between last autumn and February 2009. While this hasn't particularly hampered the ability of Austria to fund itself internationally, it has clearly had a negative impact on the cost of funding.

Typically, Austria makes relatively infrequent recourse to the capital markets and often appears early on the calendar with the first of its syndicated deals. 2009 was no different with a €3bn long five-year issue sold at 15bp over mid-swaps in January, with a further deal yet to be announced later in the year.

In addition to its syndicated issues, Austria relies on monthly auctions of its outstanding debt, adding almost €1.8bn to its 3.9% July 2020 bond in February.

The suggestion in February by German finance minister Peer Steinbrueck, that Europe as a whole would eventually bail out the weaker member states was enough to create a short-covering rally which led to a spread tightening of all Eurozone member states.

This benefitted Austria and the other euro-based economies such as Slovenia (Aa2/AA/AA) which has also been able to access the capital market this year with a €1bn three-year benchmark deal at mid-swaps plus 165bp.

Slovenia, which has been a star performer among the new EU members, anticipates a domestic demand-led recovery in 2010, which should bring average growth back up to 2%. Despite this serious slowdown, it expects to remain one of the EMU's top achievers in terms of GDP growth. A country of around 2m people, Slovenia has modest 2009 borrowing requirements of just €2.8bn, of which €800m will be financed in the short-term market with €2bn of longer-dated financing.

Like all sovereigns, Slovenia has seen its differential to German debt widen, although as a shorter dated issuer (typically three or five-years), the fall in absolute interest rate levels since last year has in part offset this additional cost.

The situation of the Czech Republic and Poland is somewhat different: these economies are not yet using the single currency and have had additional funding requirements imposed by the devaluation of their own units. Both were able to issue 10-year euro-denominated debt last year with the Czech Republic (A1/A/A+) issuing at mid-swaps plus 25bp and Poland (A2/A–/A–) at plus 60bp.

Poland has already made its return to the Eurobond market in 2009 with a €1bn five-year deal that was priced at mid-swaps plus 300bp while the Czech Republic has mandated Barclays, Deutsche Bank and Ceska Sporitelna for a benchmark issue to be sold this year.

The performances of other recent EU entrants have been notably worse. Hungary, Romania and the three Baltic Republics in particular have struggled badly in macroeconomic, currency and bond spread terms. EU membership is no longer treated as a one way ticket out of the EM space. But the anchor provided by membership of the world's largest trading bloc, especially if combined with a desire to join the euro, caught the attention of convergence players, prompting spreads to tumble among the new entrants.

These convergence plays helped JP Morgan's benchmark EMBIGD spread over Treasuries, which was as high as 1,631bp in September 1998, retreat to just 151bp on June 1 2007, before bouncing back above 650bp.

Although a few investment banks continued to deal with new EU members from their EM desks, most banks removed them once they joined the world's largest trading bloc, reasoning that syndication teams execute the deals that best reflect the investor base they are aiming for.

JP Morgan kept responsibilities for 2006 newcomers Romania and Bulgaria within its EM team, but the 10 nations that signed up in 2004 were moved on to the sovereign's desk.

One syndication manager at a rival bank said that although nothing has been decided yet, Central Europe and the Baltic states will potentially shift back into the EM arena once they start issuing again. "These countries were passed from the EM desk a few years ago to the sovereign desk but there is now every likelihood of greater co-operation between the two desks given the surge in yields," he said.

"Crossover accounts in search of yield had moved away from their core markets but some can now be expected to return to credits they have more experience with which are offering attractive returns once again. Similarly, those investors that had shifted into structured products are likely to move back to vanilla bonds where yields have returned to the levels seen four or five years ago," the manager added.

Romania (Baa3/BB+/BBB) managed to print a 10-year in 2008 at mid-swaps plus 170bp but would have to pay substantially more in 2009. The government in Bucharest has said that 2009 issuance will target 10 to15-year maturities, "depending on the evolution of the financial conditions on such markets and on the financing needs of the budget deficit," with a maximum ceiling of 45% for euro-denominated debt in terms of its overall needs.

Meanwhile, on the outside….

There is little prospect of supply from many other higher beta EU or non EU Central and Eastern European countries in the near to medium term. Investor appetite for Latvia, Lithuania, Estonia and Hungary, for example, has dried up. Their governments are hardly likely to sanction overseas borrowing at draconian rates of interest, especially when more favourable terms can be found elsewhere.

In particular the IMF has re-emerged as a significant EM player having seen its influence dwindle dramatically during the bull market years up until 2007. The Fund's executive board approved a US$15.7bn loan for Hungary (A3/BBB/BBB) in November 2008 as part of a programme designed to ease financial market stress. This 17-month standby agreement from the IMF is part of a US$25bn financing package to which the European Union has committed €6.5bn (US$8.4bn) and the World Bank US$1.3bn.

A month later the IMF agreed to lend €1.7bn to Latvia (Baa1/BB+/BBB-) - one of the biggest ever loans extended by the Fund in terms of country size. That loan was also part of a package, totalling €7.5bn, which includes cash from the European Union, World Bank and other countries, including Poland and Nordic nations.

In March 2009 Romania reached an agreement in with the IMF for a €12.95bn two-year stand-by arrangement, as part of a €19.85bn package that includes loans from the EU and other international institutions.

Outside the EU, the IMF has agreed a €3bn 27-month loan programme to Serbia (NR/BB-/BB-) that replaced a US$520m loan approved in January 2009 to help insulate the country them from financial meltdown. Serbia committed to €1bn worth of spending cuts, equivalent to 3% of GDP, which the IMF has identified as the key to the country's economic stability as growth turns negative.

Elsewhere, the Republic of Croatia (Baa3/BBB/BBB-) has mandated BNP Paribas, Deutsche Bank and Unicredit for a new euro denominated Eurobond. RFPs were sent out earlier in the year and on March 6 Central Bank governor Zreljko Rohatinski said the republic planned to raise at least €750m from a five to six-year Eurobond in May to help refinance €1.4bn of debt due this year.

His comments followed a sharp downgrade in the governmen'"s 2009 GDP forecast, to –2.0% from +2.0%. In February Croatia secured a €750m syndicated loan to redeem a Eurobond maturing on February 11.

Croatia has a tradition of keeping its funding options open, while previous Eurobond plans have not reached fruition. In December 2007, the Ministry of Finance held discussions with several banks for a planned return to the Eurobond market with a €500m–700m issue to repay maturing debt. That failed to materialise, however.

Croatia has focused on domestic issuance in recent years and famously pulled a planned €500m seven-year Eurobond in February 2005 following objections from the Central Bank, which was concerned about excess domestic liquidity and kuna strength.

The republic last visited the international market on April 2 2004 with a €500m 6.75% 10-year through JP Morgan and UBS. The issue priced at 99.15, giving a spread of 114.4bp over the January 2014 Bund, equivalent to 100bp over mid-swaps.

The 2014s were yielding 7.70% on the bid side in early April, which indicates a new bond would have to pay 8% or more to ensure decent international demand.

However, one origination manager believes that any new euro offering would essentially be a private placement targeting domestic banks.

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