SPOTTING TRENDS IN times of crisis can be a tricky business. Structural shifts in supply and demand are easily obscured as investors take fright and markets slam shut – and the recurrent shocks emanating from the eurozone and the US over the past 18 months have been sufficiently cataclysmic to make a rational assessment of underlying conditions more than usually challenging.
Yet market turmoil can also be instructive – those deals that do succeed in the midst of global upheavals speak to both deep-seated demand on the part of investors and, given the inevitable premium to be paid for issuing into a volatile environment, an equally fundamental desire for funding on the part of borrowers.
In this light, claims by bankers on the emerging Europe beat that the region’s corporate debt markets are entering a new era seem less extravagant than an initial glance at the statistics would suggest. Although the number of companies that have placed Eurobonds over the past year has not been ground-breaking and many have had to downsize or postpone deals, the fact that any have managed to issue when markets have been closed for, according to some estimates, as much as 50% of the time, and nervous the rest, is impressive.
Even more striking is the fact that market access has not been restricted to well-established names or national champions. As well as high-grade names such as Novatek, Russia’s largest privately held gas company, recent Eurobond debutants have included Russian mid-market iron and coal producer Koks and Ukrainian agribusiness firms Mriya and Agroton.
Nor, despite an inevitable skew in that direction, has it been all about commodities. The first CEE corporate credit back into the market after the first Greek crisis in spring 2010 was Russian telecoms provider MTS, and the same sector has produced the region’s biggest borrower of the year in the shape of Vimpelcom, which has raised more than $4 billion in the global markets since the start of January.
The timing of deals has also become increasingly bold. Vimpelcom’s second market outing – a $2.2 billion issue that included a rare floating-rate component and a $1.5 billion 11-year tranche – came as anxiety about the future of the eurozone was reaching a peak in mid-June. And a month later, with fears of a US default shutting markets across the world, a pair of double-B rated Russian steel producers – Metalloinvest and Severstal – raised a total of $1.25 billion of seven-year funding in a pair of deals that were priced less than a week apart.
| "We are some way off from the breadth and depth of western European corporate bond markets, which have been issuing Eurobonds for 40 years, but we are seeing very rapid growth" |
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"It is proving itself to be a mainstream sector of the fixed-income market now," says Martin Hibbert, head of debt capital market origination for CEEMEA at Deutsche Bank. "Deals are printing in the face of uncertainty which is preventing more established, higher-rated names coming to market."
Of course, the popularity of emerging market debt is by now hardly headline news. Since 2008, when the financial crisis ushered in an era of ultra-low interest rates in the developed world, investors have been forced to look ever farther afield for yield – and the growth markets of CEEMEA, Asia and Latin America have been the natural beneficiaries.
What is new, according to DCM bankers, is buyers’ increasing willingness – at least before the sell-off in mid-September – to venture beyond sovereign and quasi-sovereign names in emerging economies. "Investors are now looking at much more credit intensive stories, ones that they can really get their teeth into," says Nick Darrant, head of CEEMEA debt syndicate at BNP Paribas in London.
Partly, this is a simple matter of logistics. Emerging market funds are awash with cash – global inflows this year had already topped $8 billion by the end of June – and sovereign supply, particularly from CEE, has been even more limited than usual over the past two years as governments have built up reserves and reduced debt.
Two-fold effects
The immediate effects of this have been two-fold, and both have benefited corporate issuers. In the first place, record demand has compressed spreads on sovereign and quasi-sovereign names, so that fund managers have had to move further down the credit curve in search of both supply and yield. And the extra research this has entailed has in turn led to buyers becoming increasingly familiar with – and impressed by – the potential of the corporate sector.
"Investors are becoming aware that these are very strong credits," says Hibbert. "They stack up on a global basis and they don’t have the noise around them that is coming out of the US or western Europe at the moment."
But it is not just about excess demand flooding the markets and eventually washing through into the corporate sector. Indeed, DCM bankers say over the summer some buyers were starting to see corporates as a refuge from the turmoil roiling the sovereign debt markets. "Investors are shying away from sovereigns and financial institutions while the corporate sector is less impacted," says Richad Soundardjee, head of CEEMEA equity and debt capital markets at Société Générale.
Rising inflation in emerging markets is also enhancing the appeal of company debt, especially from lower-rated names. "In an inflationary environment investors will tend towards bonds where a higher portion of the total yield is made up of the credit spread, because if interest rates are going up you’ve got less downside caused by rising interest rates," says Paul Hawker, head of CEEMEA DCM at Credit Suisse.
What is more, the same factors that are drawing emerging market funds towards CEE corporate credits – strong names, enhanced returns and risk diversification – are also attracting attention from less traditional investors. Bankers report increasing participation in corporate deals from an entirely new buyer base in the form of leading US investment-grade, crossover and high-yield funds, as well as a renewal of interest from hedge funds, particularly at the more exotic end of the issuance spectrum.
Some European institutional buyers from beyond the UK, Germany and Switzerland – never previously on the radar of emerging market issuers – are said to be showing a tentative interest in the sector. "We have started to dip our toe in the water with the European real-money investor base," says Darrant. "Because the asset class is predominantly US dollar focused, there will always be a limitation in terms of penetrating investor bases in continental Europe but that is being addressed to some extent in the incremental growing euro issuance in the asset class."
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"When commodity prices are high, it is very enticing for Russian industrials to develop that coal seam or that unutilized steel production line. If it wasn’t for the sovereign crisis, the industrials would have issued much more" |
And Russian borrowers have access to yet another investor base in the form of the country’s richest individual buyers. Russia’s oligarchs are already becoming price makers on smaller corporate deals and account for as much of 15% of demand even on global 144A/Reg S issues. Indeed, so fast has the sector grown that some bankers are predicting that the Russian bond market could soon match China’s, where ultra-high-net-worth individuals regularly take the lion’s share of local deals. "The US market is still where the deepest pockets are but the Russian bid is an important and growing investor group," says Hawker.
Nevertheless, despite the unprecedented depth and breadth of the current investor base for CEE corporate credits, issuers are not having it all their own way – which partly explains why the supply of deals has remained a trickle rather than a flood. Investors may be yield-hungry but they are not undiscriminating, and they are demanding compensation for buying in a volatile market. "The investor base is nervous and what they’re asking for is a little bit more new-issue premium to protect them from the downside and give them an expectation of good performance on the break," says Hawker.
Lars Fischer, head of DCM origination for CEE and the Middle East at Barclays Capital, agrees. "With underlying base rates exhibiting considerable shifts every week investors are demanding higher new-issue premiums to protect them against the base rate swings and, ultimately, the heightened likelihood of the new issue underperforming," he says. "In other words, this risk premium primarily reflects the uncertain macroeconomic backdrop and not an actual deterioration in the underlying credit."
As a result new-issue premiums, which in more settled markets could be as low as 10 basis points or less for stronger names, averaged closer to 25bp in the first half of the year for CEE corporates and topped 40bp at times of extreme turbulence. That has hurt issuers less when underlying rates have also fallen, as they did during the upheavals of early summer, but has still meant that some have had to sacrifice size for price, particularly if – like Severstal – they have had an outstanding curve to protect.
Calmer conditions
Others, unsurprisingly, have preferred to remain on the sidelines in the hope of calmer conditions later in the year. "The problem is not supply, it’s a question of whether the market is open at the right price for issuers," says Soundardjee at Société Générale. "New-issue premiums or volatility premiums in general are significantly higher compared with what we’ve seen historically, so many issuers are choosing to wait for more stable markets where investors will be less conservative in their approach to pricing."
Yet the mismatch between demand and supply is not entirely a result of companies’ reluctance to raise expensive cash in volatile markets. Despite the ever-increasing buyer base, bankers are not expecting a rush of issuance from CEE corporates if and when the US and Europe resolve their difficulties, primarily because most companies in the region have ample access to cheap funding via their domestic markets.
Polish corporates in particular have been notable by their absence from the global capital markets over the past two years because of extremely high levels of liquidity in the country’s banking sector, and Russia and Poland have also seen increasing demand for domestic bond issues from both local and international investors. "In Russia you have a real alternative for corporates today to do part of their debt capital markets funding domestically because the rouble bond market is very liquid now," says Soundardjee.
Nevertheless, DCM bankers are cautiously optimistic about the prospects for supply from the region over the coming year, partly because the long-term maturities that an increasing number of CEE corporates are after are simply not available in domestic bond markets or from local banks. "For issuers it’s a recognition that the international market offers tenor, size and diversification," says Darrant at BNP Paribas. "It’s the same old arguments that are now resonating with these clients in the face of much greater liquidity on the investor side internationally."
Or, as Hibbert at Deutsche succinctly puts it: "The rouble market may be slightly more advantageous in terms of funding costs but if you need to take $4 billion out and you want to term it out to 10 years, you’re only going one place for that."
Indeed, bankers report that several Russian companies are weighing the possibility of following the recent example of Brazil’s Braskem and raising funds in the 30-year maturity. "There is demand at the long end and we have explored it for issuers," says Darrant. "Some of the corporates are very market savvy and the low-rate environment has certainly piqued their interest in terms of locking in long-dated money."
Fischer at Barclays, however, is more sceptical. "Especially within the oil and gas sector there have been extensive discussions on raising funds in the long-maturity segments, even as long as 30 years," he says. "Whereas this development is encouraging, ultra long-dated issuance has yet to materialize as blue-chip borrowers ponder, ‘Do I need to pay up to get 30-year funds, am I not better off just refinancing every five to 10 years?’"
Enticing
What most DCM bankers can agree on is that high levels of investor demand will likely continue to attract new commodity names into the Eurobond arena when markets stabilize, either to refinance expensive bank loans taken out in the wake of the financial crisis or to fund capex spending. "When commodity prices are high, it is very enticing for Russian industrials to develop that coal seam or that unutilized steel production line," says Hawker. "If it wasn’t for the sovereign crisis, the industrials would have issued much more."
And, in Russia at least, there are signs that companies from more consumer-oriented sectors, such as media and retail, are looking to expand their funding options, while some bankers are also tipping the country’s dozens of pending infrastructure projects and newly privatized utilities as potential sources of corporate supply. "I think we are going to see a broadening out of the sectors," says Darrant. "But it’s not going to be a flood, it’s going to be name by name and it’s a gradual process."
Elsewhere in the region, the picture is more fragmented. Lack of liquidity in the local market is expected to continue to ensure a steady supply of corporate paper from Ukraine, both from the agricultural and petrochemicals sectors, and bankers also expect a handful of deals from Kazkahstan’s commodity producers.
Few, though, anticipate much genuine private-sector corporate issuance out of central Europe in the near future – although Fischer suggests that the success of a rare recent inflation-linked deal from Czech utility CEZ might yet tempt the region’s more sophisticated borrowers to explore the structured bond market.
Looking further ahead, however, some bankers speculate that the implementation of Basle III might finally kick start some moribund markets by making bank funding less competitive. "Poland is seeing a lot of lending by local banks on terms that are extremely aggressive both compared with global capital markets and to where international banks are willing to extend balance sheet," says one banker. "The adoption of Basle III will hopefully create a more normalized loan market that will lead to more borrowers looking for capital in the Eurobond markets."
(This will not make any difference to the Russian market for a while yet as the country’s banks have yet to adopt Basle II.)
Whether investor demand will still be at current levels by the time that happens, however, must be open to question and might well depend on the strength of the recovery in western economies.
Darrant, however, says western Europe – and especially the periphery – is unlikely to regain its appeal for investors for as long as its economies continue to stagnate. "The defining characteristic of our markets is growth," he says. "I’d have very little interest in looking at Spain or Greece, and nor would my investors. There’s no growth there."
He is resolutely upbeat about the prospects for CEE corporate debt markets. "We are some way off from the breadth and depth of western European corporate bond markets, which have been issuing Eurobonds for 40 years, but we are seeing very rapid growth," he adds. "There is clear identifiable progression being made – investors are wanting to get involved, they are putting in more resources on the credit research side, and more and more issuers are asking ‘is there a market for us?’. Recent volatility has made those questions quite difficult but I think when the dust settles our asset class will come up smelling of roses."
