Sub-Saharan Eurobonds hold up under pressure

By Virginia Furness

Tuna bonds, patrol vessels and top-secret loans may sound like the makings of a racy financial thriller or James Bond film, but for some unlucky buyers of Mozambique’s debt, this is the stuff of real life. 

Private investigators at Kroll uncovered plenty of alarming details following Mozambique’s default on its Eurobond back in January – the first such event in Africa since Cote d’Ivoire missed payment on its Eurobonds in early 2011.

Barely six months after Mozambique’s default angered investors and the IMF, Republic of the Congo entered into a technical default for over a month after it missed a payment on its 2029 Eurobond. Restraining notices were issued at trustee level so that funds could not be released to bondholders. These were lifted in August, but not without an anxious period for investors. A few weeks earlier, the Republic of the Congo’s prime minister and cabinet resigned over the deteriorating economic situation, caused largely by low oil prices. 

The defaults by both Mozambique and Republic of the Congo have been a wake-up call for holders of African debt.

“Mozambique is a good example of what can happen if it all goes wrong,” says Stuart Culverhouse, chief economist at the specialist frontier markets firm Exotix Capital. “Sovereigns need to be serious and credible about fiscal plans, but also more open and transparent about debt management, and talk to investors and make more information available.”

Given the sobering mix of high debt burdens in some African economies and the backdrop of rising global interest rates, investors now wonder who could be next.

In recent years, low global yields and strong investor appetite for riskier debt has meant that African sovereign borrowers were able to raise capital easily and in some cases were tempted to lock in funding to plug the gaps left by falling commodity revenues, according to bankers. 

In all, 16 countries in sub-Saharan Africa have issued Eurobonds if you only count sovereign borrowing – or 15 if you include commercial debt. 

Sub-Saharan African Eurobond issuance surged as the price of Brent more than halved, falling from over $110 a barrel in April 2014 to around $50 in October of the same year. Eurobond volumes swelled to $9.2 billion, covering a total of 12 deals in 2014, and $6.7 billion the following year, according to Dealogic. 

If issued and managed prudently, Eurobonds can be an important funding tool, but access to funds without setting appropriate conditions has led, in countries such as Ghana and Zambia, to heavy reliance on external debt. This, combined with loose fiscal policies, heightens the risk of default. 

As funding and fiscal pressures increase and investors become more discerning, countries with prudent funding strategies will have an advantage over those that struggle to manage their debts.

One of the issues at the heart of the African bond market is the correlation with falling commodity prices, says Jan Dehn, chief economist at asset manager Ashmore.

Foreign borrowing may have offered a way to cope with the loss of revenues after the oil price shocks of 2008 and 2009, and then again in 2013 and 2014, but it was often accompanied by poor fiscal discipline and slowing growth. 

Dehn points out that Africa’s issuers have not had to go through the sometimes painful debt management process, until now, in large part because of the 1996 heavily indebted poor countries initiative and 2005 multilateral debt relief initiative, which helped 35 sub-Saharan African countries to cancel about $100 billion of external debt.

“The ability to issue debt made it tempting not to make the necessary fiscal adjustments,” Dehn says, adding that while most African countries have sustainable debt burdens, that will change and debt levels will become unsustainable if the lack of fiscal discipline continues. “Then it will be a problem.” 

The important ratio for investors to watch is of debt to GDP. The IMF forecast a debt-to-GDP ratio for Mozambique of 106.9% for this year. The other African countries with debt levels that verge on the unsustainable, based on the IMF’s calculations, are Ghana at 71.1%, Gabon 62%, Angola 61.3% and Zambia 57.7%.

In the case of Zambia, the ratio of debt to GDP rose from 18.9% in 2010 to 33.3% in 2014: in its sub-Saharan Africa regional economic outlook for 2017, the IMF puts the ratio at 57.7%. Zambia has $4 billion of Eurobonds outstanding, maturing between 2022 and 2024, according to Dealogic data.

In Angola, which has $2.5 billion of outstanding debt in Eurobond form, the debt-to-GDP ratio has ballooned from 22.7% in 2009 to a forecast 61.3% in 2017. This could worsen if the government goes ahead with plans to raise a further $2 billion with a Eurobond issue in the second half of 2017.

But it is Ghana that looks most alarming. With the exception of South Africa, Ghana has leaned on the international markets the most heavily, and has raised $4.5 billion of debt since it reopened the African bond market in 2007, following Paris Club debt relief. Access to the capital markets came at a high coupon cost for the sovereign, which pays an interest rate of over 9% on all of its outstanding obligations. 

Bankers agree that Ghana is the obvious example of over-reliance on the international markets for funding. The sovereign, says one debt capital markets banker, has not timed its access to market prudently. 

“They were just raising debt at any cost when it was available,” says this London-based banker. “In September last year, they paid 800 basis points for funding just ahead of their IMF agreement. Something like that is not good for the capital markets; they were just borrowing to pay other debt and interest rate costs.”

The banker says that if Ghana had waited a couple of months, it would have been able to achieve a better price and therefore a much lower yield. The bonds, issued at par, or 100, rallied to a price of 108 to 109, bringing yields down. The eight or nine cash point rise in the bonds went straight into investors’ pockets, at Ghana’s expense. “Is this really sensible?” the banker asks.

Ghana issued $1 billion of bonds in 2015 with a 15-year maturity. Even though the International Development Association guaranteed 40% of the notional amount, Ghana ended up paying a yield of 10.75%. 

Not only is Ghana’s debt large and expensive to service, but other factors have spooked investors. In the run-up to the general election last December, government overspending pushed up the deficit. More recently, Ghana said it would not extend its current Extended Fund Facility (EFF) under the IMF: that prompted a sell-off of Ghana’s Eurobonds. 

“Their announcement did not help confidence,” says Richard Segal, a senior credit analyst at Manulife Asset Management. “They need to stabilize their deficit, and bring it lower, which will be slow.”

While a high debt-to-GDP ratio serves as a red flag, prudent investors need to look beyond the nominal debt stock and consider other factors in assessing the risk of default, says Yvette Babb, sub-Saharan economist and strategist at JPMorgan in London. 

“Debt defaults do not just arise from high debt-to-GDP ratios alone,” she says, “but because of political and economic shocks and because of the profile of debt servicing. Vulnerabilities are divergent, but most are concerned with lumpy refinancing requirements in combination with a weak external sector.”

Nigeria is a good example of how the debt-to-GDP ratio can be unhelpful when assessing vulnerabilities, she says. 

Africa’s biggest economy has already borrowed $1.8 billion in Eurobonds this year, and recently announced its intention to raise up to $3 billion of international bonds to buy back naira-denominated treasury bills. 

Nigeria’s external debt-to-GDP ratio is forecast at 5.1% in 2017, though overall government indebtedness is 23.3% of GDP, according to the IMF, making it the lowest in the region.

But some economists point out that there is another way to look at the numbers. Of all the countries in Africa, Nigeria has by far the largest informal economy, estimated at around 65% of its GDP, according to a recent IMF working paper. Calculating the debt-to-GDP ratio based only on the formal sector, equivalent to 35% of GDP, puts the number much higher. 

Although the risk of a Nigerian default does not appear imminent, the country already spends 40% of its revenues on debt servicing payments, a worryingly high proportion and not a sustainable model, Babb says. Plus it would be difficult to raise more revenue to cover the cost of servicing that debt. 

“Their ability to raise domestic resources through taxation is poor, no more than 6% of budget compared to GDP,” she says. “Despite having one of the lowest debt-to-GDP ratios, there are valid concerns about how Nigeria will service that debt. Its debt servicing cost to revenue is far weaker.”

Concerns about Nigeria’s ability to manage its debt are exacerbated by its policy response to falling oil prices, says Ashmore’s Dehn. He warns that a lack of fiscal discipline is the single largest source of macro shock, adding that Nigeria is “a perfect example of how not to manage an oil shock”. 

Culverhouse at Exotix Capital is also worried about Nigeria’s medium-term fiscal stability.

“If you are consuming so much of your budget on interest payments, you have very little room for discretionary spending,” he says. “It may be an issue further down the line if they can’t adjust for another oil sell-off. This could have social and economic consequences further down.”

With interest rates set to rise, the spotlight is on refinancing requirements. For sub-Saharan Africa, these are heaviest between 2023 and 2025, but several sovereigns have bonds maturing in the next few years. As well as increasing the pressure on those countries with high ratios of debt to GDP, some issuers have lumpy maturity profiles, which bankers say will be difficult to refinance. Kenya is a prime example, with $750 million of loan financing due in October this year, $540 million in March 2019 and a $750 million Eurobond due later that year.

“Kenya’s refinancing profile over the next five years presents interesting risks,” says JPMorgan’s Babb. “They will rely heavily on the appetite of foreign investors and banks. In an adverse scenario of domestic shock such as political unrest or drought, they could face higher borrowing costs or worse challenges to refinance this debt.”

Higher global rates are also expected to reduce the relative attractiveness of African bonds. While analysts are not predicting capital flight in the vein of the taper tantrum of 2013 – which saw spreads widen and African borrowers all but shut out of the capital markets for several months – they will be watching for signs of outflows, particularly in light of the growing exchange-traded fund (ETF) market.

Higher yields on African debt have attracted the non-traditional emerging market, or shorter-term investors, who could dump their bonds at the first sign of political or economic shock, making it harder for African borrowers to service their debt. 

Giulia Pellegrini, portfolio manager and frontier markets economist at BlackRock, says that sub-Saharan Africa has attracted large inflows from non-dedicated investors. 

“A good chunk went into the Africa story, it is higher yielding and has cleaner balance sheets,” she says. “We saw some of this leaving…at the end of Q2. The commitment of that money was tested. The positioning is still significant, so we will continue to monitor this.” 

Manulife’s Segal agrees that technical selling of African debt is a concern. He points to previous examples of technical selling after the likes of BTG Pactual unwound large positions in African debt. 

“Sometimes the nature of who holds the debt causes a lot of technical selling,” he says. “We’ve seen a lot of inflows from exchange-traded funds, and we won’t know for some time how that will affect the market.”

Analysts warn that disorderly outflows or a rapid rise in rates could mean that some sovereigns will be unable to access funding from the markets. 

“Investors are going to start to apply more attention to those countries that are reforming, that have healthier external balances as a result of macro adjustment,” says BlackRock’s Pellegrini. “Investors are becoming more discerning.”

Some of the most challenged governments are showing encouraging signs of commitment to fiscal consolidation, says Babb.

Under its medium-term expenditure framework (MTEF), the Ghanaian government announced plans to reverse the combination of large primary deficits, greater reliance on external borrowing and currency depreciation. It aims to achieve a primary surplus of 2.2% of GDP by 2019, from a deficit of 1.4% in 2016.

Ghana’s expenditure fell to 6.6% of GDP against a targeted 8.3%; interest payments, which accounted for 31% of total expenditure, were 9% below budget, Babb wrote in her mid-year fiscal review in July. 

The government has also made it explicit that it won’t return to the Eurobond market and is using longer-dated notes to refinance short-term debt in an effort to spread out its maturity profile.

“These signs are favourable,” says Babb, “as over the past three years there has been a perception that the Ghanaian government will borrow at any cost.”

Exotix’s Culverhouse is less optimistic. “I don’t believe the government when they say they won’t borrow again,” he says. “They are addicted to debt. They’re lukewarm about the IMF and recently said they were going to do a bond issue next year. Although they have an ambition to get the deficit down, do we trust the figures?”

The case of Mozambique’s default also highlights the issue of trust over debt levels and shows just how quickly an emerging market with strong economic growth and the promise of riches from offshore gas can fall out of favour.

In 2013, a Mozambican state-owned tuna-fishing company repackaged a $500 million loan from Credit Suisse into a bond and then raised an additional $350 million from Russia’s VTB, saying it wanted to buy new fishing vessels. The debt was subsequently exchanged for government Eurobonds in 2016, but Mozambique was unable to meet interest payments and defaulted.

Investigators at Kroll later found that about $500 million of the funds could not be accounted for. Kroll’s audit – published in June in the wake of Mozambique’s default and the government’s admission that it had guaranteed undisclosed loans of more than $1 billion to two other state companies – also found evidence of massive overpayment for fishing and naval vessels as well as security hardware, and of huge fees paid to Credit Suisse and Russia’s VTB.

At the time of writing, Africa’s most indebted issuer remains locked in dispute with its creditors and the IMF, which halted budget support to Mozambique after the discovery of the secret loans last year.

Simon Howie, co-head of SA and Africa fixed income at Investec Asset Management, says the incident was a reminder to investors to be cautious about the use of proceeds and the legitimacy of the bond issue itself. He adds that it is the responsibility of the banks to be transparent about use of proceeds. 

“In this case, the banks have a lot to answer for,” he says.

While Mozambique’s example shows that an IMF programme does not provide complete protection against default, for many investors in African debt, an IMF funding programme is seen as an external stamp of approval. Of the 46 countries in sub-Saharan Africa, 20 are under IMF programmes, which can make a big difference to their funding costs.

Gabon, for example, was able to raise $200 million in August at no extra premium after higher oil prices, combined with its inking of an IMF programme in June, prompted its bonds to rally by five cash points, reducing the yield it had to pay. 

Zambia is also in talks with the IMF; bankers say that its borrowing costs are likely to fall, which will ease its high debt burden. Zambia’s bonds are among some of the highest yields in sub-Saharan Africa and domestic politics led to its debt underperforming the rest of the region in June. 

Careful management of deal proceeds can also help sovereigns to manage their debt burdens more effectively, say bankers. 

One school of thought is that proceeds should not be used for fiscal purposes but to fund profitable projects instead, using the proceeds from these to repay interest owed. 

Uganda’s president Yoweri Museveni is a strong advocate of this approach. Indeed Uganda has actively avoided Eurobond issuance. With international investors already buying in Uganda’s local currency bonds, there would be plenty of appetite for an international Ugandan bond, according to JPMorgan’s Babb. 

She points to Rwanda as another country that could easily raise more in the capital markets on account of its strong economic fundamentals, but which has resisted doing so. Rwanda raised $400 million of 10-year debt at a coupon of 6.625% in April 2013, but could easily have taken more. 

Despite some of the tightest borrowing conditions ever seen, Eurobond issuance has remained fairly muted this year. To date, sub-Saharan countries have issued $5 billion worth of debt. Of this, $1.8 billion comes from Nigeria. Senegal, Cote d’Ivoire and a recent $200 million tap from the Gabonese Republic make up the rest.

In addition, arranging banks are helping to advise issuers to access the market in a more considered and strategic way, according to Javier Penino Vinas, head of debt capital markets at Standard Bank in London. 

“From a spread perspective, a lot of these countries are benefiting from some of the tightest borrowing conditions that have ever been seen, but Africa is not over-indebted on the whole,” says Penino Vinas. “We have seen encouraging signs of sovereigns borrowing prudently and creatively, and taking advantage of current market conditions to tap longer tenors and new markets.”

For example, Nigeria, Senegal and Cote d'Ivoire have all issued 15-year debt this year, while other borrowers are choosing to diversify their funding sources or streamline their maturity profiles by exchanging short-dated debt for longer-dated notes. 

Côte d’Ivoire, for example, raised a portion of its financing this year in euros, which may have cost more than issuing in dollars but gave it access to a different pool of investors. 

Sub-Saharan Africa bond volumes are also not expected to rise much this year. Bankers say that policymakers are growing wary of Eurobonds and the risks associated with managing foreign currency debt, particularly in light of local currency depreciation. 

“Ghana and Zambia are beginning to question whether they have been wise to rely on external markets and are understanding the need to reduce reliance on forex and develop their local currency markets,” says Babb.

But with international funding dependent on global market conditions, the choice not to issue may, in the end, be made by the markets, not the sovereigns themselves. 

“Central bank normalization could be disruptive to global risk appetite and detrimental to sub-Saharan Africa countries,” she says. “We could see a serious erosion of appetite for higher-yielding assets, which would leave some countries struggling to find demand for their bonds.”

This year has been the biggest for African corporate bonds as borrowers took advantage of attractive funding conditions to issue new debt and streamline their existing debt profiles.

In the first seven months of 2017, international bond issuance from non-sovereign issuers in sub-Saharan African reached the highest level on record. African corporate, financial and supranational borrowers, excluding the African Development Bank, issued $7.85 billion of bonds, beating the $7.7 billion raised in 2013. 

Several high-yield issuers made their debut, while investment-grade regional development institutions, such as the West African Development Bank, returned to the capital market.

“Clearly this is a developing market,” says one London-based origination banker with an Africa focus.

 “Previously, South Africa has been a very large participant in terms of the corporate sector,” he adds. “This year we have seen a revival of bank issuance with the likes of Zenith and UBA, but more importantly we’ve had some new participants from the telecoms sector.”

Debut issuers Liquid Telecom, a producer of fibre optic cables, and Helios Towers Africa have raised $550 million and $600 million respectively in the last 12 months. Before that, fellow telecom tower operator IHS Nigeria raised $800 million, marking the largest-ever deal from a sub-investment grade issuer. 

While the market has largely been made up of borrowers from the financial, telecoms and mining sectors, bankers expect it to evolve as more companies see bond issuance as an alternative to bank financing. 

“Issuers are seeing they can get longer-term money with less restrictive covenants,” says the origination banker. “There are many companies that have reached, or are beginning to reach, the ebitda [earnings before interest, tax, depreciation and amortization] threshold that are considering the bond market more seriously. We’re also moving away from the commodity-specific credits, to those with generative cashflows, which is a good sign.”

After banks, the telco sector has made up the largest volume, with $7.1 billion of issuance in the last 10 years, according to Dealogic. Organic growth as well as M&A activity and refinancings have driven issuance, but some issuers are using current funding conditions to streamline cumbersome capital structures. That was the case with Helios Towers Africa, according to its CFO Tom Greenwood. 

The company raised $600 million of debt maturing in 2022 at a yield of 9.125% in March this year. Greenwood explains that while multiple term loans are appropriate forms of financing for a company in its infancy, as it matures a firm needs a more streamlined capital structure. 

Helios Towers used the proceeds of the deal to refinance all of its operating company loans and issue a simple bond in their place. 

“We removed any debt amortisation we had, meaning we can now use the cash we have for future investment and use the additional funds we raised for capex,” Greenwood says.

What is also evident from investors’ interaction with the likes of Helios Towers Africa, which operates in Tanzania, Democratic Republic of Congo, Republic of the Congo and Ghana, is that they are willing to engage with countries with which they are much less familiar, says Javier Penino Vinas, Standard Bank’s head of debt capital markets. 

“Jurisdictions like the DRC are relatively unfamiliar,” Penino Vinas says. “However, we saw a real focus on the underlying credit and how the company manages the risks inherent there.” 

He adds: “This real focus on credit analysis is a sign of a market for African risk that is continuing to mature.”

Bankers agree that despite vast inflows into emerging market debt, which raise concerns about frothy money in the sector, most investors in African corporate bonds are dedicated emerging markets investors. 

“Towards the end of the last credit cycle, you saw large leverage buy-outs in South Africa and new investor types coming into those deals,” says Penino Vinas. “On the deals we have worked on, the bonds are being held by proper EM players who understand the market ups and downs and are familiar with the region.”