Increased Interest in Corporate Bonds Highlights EMTA Corporate Bond Forum
EMTA held its first Corporate Bond event in London on Tuesday, January 30, 2007. The standing-room-only event was hosted by ING Wholesale Bank at its London Wall headquarters.
First on the agenda was a presentation by Fitch’s Trevor Pitman on the outlook for corporate bond ratings. Pitman reminded attendees of the general trends in the EM debt industry: record inflows of new funds coming into the market, sovereign credit spreads at historic lows and the increasing role of local markets instruments. Additionally, the amount of corporate issuance has outpaced sovereign issues, and investors are continuing to move down the credit curve to look at “exotic” and “frontier” markets in the quest for increased returns.
Fundamental improvements in EM macroeconomic polices have reduced external financing needs, and EM sovereign ratings have risen both as a result of these changes and in tandem with rising commodity prices. Issues rated at the B level and lower have declined to a much lower share of the EMBI Global index, while over 90% of the index is rated BB or above. Pitman pointed out that generally there is “very little difference” in average EM sovereign ratings between the three major ratings agencies, although Fitch’s country ceilings are generally more conservative.
Turning to the concept of the country ceiling, Pitman observed that the traditional definition of a sovereign ceiling rating had changed at Fitch in June 2004. Since that time, a sovereign’s rating has been differentiated from the country’s ceiling; the former is based on a financial profile of the sovereign, while the latter is the result of a broader analysis including legal and governance risks and “a judgement on the potential of foreign exchange controls that would impede the corporate sector’s ability to pay external debt.” It is now possible for certain corporations to be rated above the sovereign at the country ceiling if the corporate entity is judged to be able to absorb the economic shocks resulting from a sovereign default, based on agency stress tests. Factors helping a corporate issuer to pierce the sovereign rating usually include a strong credit profile, a high ratio of FX earnings to debt, overseas production facilities, a foreign owner or strategic partner, and past preferred treatment by the sovereign.
Addressing potential new opportunities for investors, Pitman observed that Fitch’s new Dubai office has received a record number of inquiries from local corporations regarding potential ratings, and that the market is just now seeing signs of increased Gulf issues. In contrast, there has not yet been a similar surge in inquiries at its two African offices.
Panel of Experts Concludes Interest and Opportunities Continue in Asset Class
Eric Ollom of ING Financial Markets chaired the event’s panel discussion. Ollom asked the panel’s trading representative, Eric Jayaweera of UBS, for his thoughts on leverage in the EM corporate bond sector. Jayaweera remarked he was not concerned that there was “excess leverage in the asset class; when we talk to hedge fund clients, they tell us they don’t have a lot of leverage here.”
Does the market still offer value? From a dealer perspective, “based on the number of headhunter calls we get on a daily basis, as well as increased capital being made available to the corporate desk, it is clear this is an attractive market,” Jayaweera replied. He acknowledged that, from an investor perspective, liquidity was not yet at an optimal level, although “there is movement to increase it.”
Ollom polled the panelists on whether they continue to see new allocations to EM corporate debt. Argo Capital’s Richard Segal replied this is “definitely the case.” He added that the range of issuers has also dramatically expanded, noting that new offerings are coming from Georgia and Mongolia, which would have raised eyebrows in the past. Polina Kurdyavko (BlueBay Asset Management) concurred that “this is a one-way street.” She rejected concerns that corporate spreads were now too tight, remarking “there is always money to be made in corporates.”
Anne Milne of Deutsche Bank discussed recent trends in Latin corporate issuance. In 2006, 56% of Latin American issuers were making their first foray into the market, she noted. In addition, 48% of Latin American corporate issues were non-investment grade, vs. a 35% share in 2005. Milne pointed out that in some major Latin countries, corporates were issuing more debt in the local markets than internationally, and suggested that these bonds might eventually be of interest to foreign investors, although thus far their small size and regulatory obstacles have prevented widespread appeal. Milne predicted that corporate issuance in local markets will continue to increase, and that “maybe some of these issuers will eventually make it to the international market.”
Turning to a discussion of risks for corporate investors, Kurdyavko cautioned that although liquidity is often cited as an asset class issue, investors should also look into the structure of each deal. “There were inappropriate covenants in a recent Argentine real estate company deal, and we as investors should not allow issues like that to happen,” she declared. Kurdyavko also criticized Vitro’s recent $1 billion bond, stating “that is too large an issue for a company with corporate governance issues.” Milne agreed with Kurdyavko that in a market sell-off, governance issues would be highlighted, but asserted that in graver situations such as Argentina’s default, “covenants didn’t even matter.” Ollom summarized that “those who do their homework [on bond covenants] will be much better off in a market re-pricing.”
Kurdyavko also offered a back-handed compliment to her Russian compatriots. “We are a very smart people. There are many ways that balance sheets can be pumped up,” she noted. She also predicted that “we might see some very interesting developments late this year or in 2008.” Segal concurred that there may well be cases of “creative accounting.”
The panel discussed the potential for asset-backed securities. Kurdyavko expressed a lack of confidence in the Russian legal system, and a consequent lack of enthusiasm for Russian asset-backed securities. Segal commented that EM asset-backed securities have been “locked away based on an incorrect assumption that EM investors wouldn’t be interested.”
Panelists See Many Opportunities
The discussion concluded with speaker recommendations. Segal spoke positively on Nigerian banks, Banco Macro and MHP, while noting he was concerned about the prospects for the Province of Buenos Aires and lower-rated Brazilian bank issues. Kurdyavko disagreed with Segal’s positive outlook for Nigerian banks, favoring the electricity sector in countries such as Argentina, Brazil and the Dominican Republic.
Milne reminded attendees she had been a “big proponent of Argentine restructured banks for a long time.” Milne also voiced enthusiasm for Multicanal, Metrogas, Edenor, the Province of Mendoza and Brazil’s meat producers, but recommended investors avoid CSN and Mastellone Hermanos. Jayaweera suggested an opportunistic strategy of “being patient and waiting for the occasional mis-priced deal.” Ollom agreed with Milne on the prospects for Brazilian meat producers, and, in contrast to Kurdyavko, spoke positively on Vitro (“they have delivered what they promised despite corporate governance issues”).