Investors rush into debut EM bond issues.
Since 2010, maiden government issuers include Mongolia, Belarus, Zambia, Georgia, Bolivia, Tanzania, Paraguay, Angola, Nigeria, Albania, Montenegro, Jordan and most recently Honduras. Even Papua New Guinea and Rwanda are planning to sell inaugural international bonds soon.
“We’ve moved from risky but commodity-exporting countries to countries with the prospects of commodity exports and now to countries with no exports at all,” he says. “The yield may be better, but the credit quality is much worse.”
By Robin Wigglesworth
When Honduras, an impoverished Central American country, launched its inaugural sovereign bond sale, a senior fund manager with extensive experience of the country said: “You’ve got to be kidding.”
The government’s indebtedness is low, thanks to a huge debt relief initiative in 2005, but has been rising steadily again as the budget deficit has widened. The yawning current account deficit is eating into limited currency reserves, local service providers are going unpaid and the government is virtually unable to fund itself domestically.
Debut EM bond issues
Falling borrowing costs for riskier countries
Honduras is just the latest in a long line of countries to make their bond market debut. A swath of nations previously considered either too small or too risky have in recent years managed to sell bonds for the first time – thanks largely to ravenous investor appetite for higher-yielding debt.Yet fund managers were happy to welcome Honduras into their portfolios, accepting a 7.5 per cent yield for the 2024 bond. This despite Barclays, one of the two bookrunners, dropping out of the deal at the last minute after it emerged that Honduras had been named in a $200m lawsuit against a state-owned logging company.
“People are searching for yield and that is allowing countries from the lower end of the credit spectrum to issue for the first time,” says Bart Oosterveld, head of sovereign ratings at Moody’s.
Since 2010, maiden government issuers include Mongolia, Belarus, Zambia, Georgia, Bolivia, Tanzania, Paraguay, Angola, Nigeria, Albania, Montenegro, Jordan and most recently Honduras. Even Papua New Guinea and Rwanda are planning to sell inaugural international bonds soon.
“This is a crazy market where people will lend to anyone,” observes one senior analyst.
These countries’ ability to tap markets has been driven by huge capital inflows into global bond funds and asset managers dedicated to emerging market debt, as investors seek an alternative to the paltry returns of developed world bonds.
With yields on “mainstream” emerging market bondsnow exceptionally low as well, fund managers have ventured into increasingly risky assets. The yield of JPMorgan’s Nexgem index of more exotic government bonds has slumped from a financial crisis peak of almost 20 per cent to just 5.9 per cent.
We’ve moved from risky but commodity-exporting countries to countries with the prospects of commodity exports and now to countries with no exports at all- Francesc Balcells, Pimco
Indeed, lower-rated emerging market debt has this year proven more resilient to jitters over rising Treasury yields, the pricing benchmark for US dollar-denominated debt, than high-grade bonds from the likes of Mexico.
While the EMBI Global Diversified index has lost 1.9 per cent this year, largely due to rising Treasury yields, the Nexgem index has gained 1.5 per cent already, taking its 12-month return to 17.2 per cent. This is largely because the spreads on these lower rated bonds are higher, giving investors a cushion against a rise in the benchmark rate.
Yet many fund managers and analysts are becoming increasingly concerned that investors, in their hunger for higher returns, are lending too cheaply to politically and financially unsound countries that could struggle to repay them when the bonds come due. While the yields offered by these countries mitigate the risk from higher Treasury yields, investors are underestimating the chances of defaults, some warn.
Those warnings have become even louder this year, as Honduras’s bond sale underscored how many investors are willing to put aside spotty creditworthiness in return for at least some yield.
“This is a liquidity-fuelled market in which risk assessment is taking a back seat to yield and return,” says Carl Ross, managing director at Oppenheimer & Co. “The day of reckoning is far enough away that investors are heavily discounting the risks.”
Francesc Balcells, a portfolio manager at Pimco, points out that recent bond deals have not been met with the frenetic demand of some of last year’s issues, but says signs of froth are still clear. “The craze of last year has faded but it’s still there.”
“We’ve moved from risky but commodity-exporting countries to countries with the prospects of commodity exports and now to countries with no exports at all,” he says. “The yield may be better, but the credit quality is much worse.”
But even sceptical fund managers are being “forced to join the party”, says one senior emerging market bond trader, due to big investor inflows and concerns that they will underperform their benchmark if they are too cautious.
Hopes that they will be able to get out of riskier bonds before any trouble hits may be too optimistic, given how illiquid these securities are and how quickly their creditworthiness can deteriorate. The bond trader is unequivocal: “It’s going to end in tears at some point.”
Copyright The Financial Times Limited 2013. |
