The international financial crisis has reshaped the investor
base, pricing levels and market functioning of the emerging
corporate bond market, experts said this week as they grappled
with the systemic changes to the asset class.
But, with emerging market equity
investors increasingly attracted to corporate bonds, market
participants at this weeks Emerging Markets Traders
Association (EMTA) forum in London hoped that liquidity in the
asset class could improve in the coming year.
Emerging corporate bond prices
fell steeply last year in keeping with losses across all credit
markets. High yield corporate bonds in JPMorgans bond
indices were down 35% at year-end with emerging Europe the most
affected, losing 43%.
The Institute of International
Finance predicted this week that net private capital flows into
emerging markets this year will drop by 65% to $165bn,
contrasting with $929bn of inflows in 2007.
As a less liquid asset class,
emerging market bonds are more prone to precipitous price drops
and one investor noted that as accounts were selling to
deleverage, bonds dropped off overnight on a daily basis
following the mid-September collapse of Lehman Brothers. Some
emerging European corporate bonds have dropped from 80 cents to
20 cents on the dollar in recent weeks, as the market rapidly
and unexpectedly repriced risk.
Given this negative market
backdrop, investors, traders and credit analysts at this EMTA
corporate bond forum in London, predicted a collapse in
corporate debt supply this year.
Victoria Miles, co-head of EM
corporate research at JPMorgan, predicted there will be between
$35bn to $40bn in new cross-border issuance this year following
last years $57bn. That compares with the 2007 bull-run of
Investment grade and
quasi-sovereign issuers will be the only deals this year, as
has been the case so far in January. Miles suggested that there
was potential for cash-strapped lower tier credits to issue if
there were big reverse enquiry offers and the deal was small,
between three to five years in maturity and provided extremely
tight debt covenants.
"But getting any significant
traction out of the non-investment grade corporate market is
highly unlikely," she said. Investors overwhelming agreed.
One fund manager argued that
government revenues in Latin America and eastern European
countries from 2009 to 2010 might significantly undershoot
national budgets. As a result, more sovereigns may come to the
market to address public borrowing needs and to provide local
and foreign-currency liquidity to help companies refinance.
For all the news of the death of
crossover accounts and reduced proprietary trading at
investment houses, there is evidence of increased liquidity
flow from a new profile of investors.
Eric Jayaweera, an emerging
market trader at UBS, observed that equity-focused investors
are increasingly snapping up Latin and Asian corporate paper.
The investment case is made more compelling considering the
expected earning yields for emerging equities is 10% for 2009
compared with the 11% returns that investment grade corporate
bonds are offering.
He said local Russian banks have
been buying dollar-denominated cash bonds for domestic credits
such as Gazprom and VTB. This is because the economy has become
increasingly dollarised over the last few months as retailers
and corporates shun roubles and park US currency in bank
deposits. A few Russian banks are, therefore, taking credit
market positions as an outlet to absorb excess dollar
A disproportionately large
number of new deals over the past few years have come from
Russian issuers taking advantage of cheap credit. However, the
overleveraged private sector is now dealing with low oil
prices, retreating foreign investors and a falling
As a result, new issue premiums
are above acceptable pricing levels for even the elite of
Russian issuers. But in recent weeks, there have been rumours
of a Russian government guarantee programme to help
strategically important corporates re-enter the Eurobond
Max Wolman, portfolio manager at
Aberdeen Asset Management, said any new deal under this scheme
could offer an attractive pick-up to sovereign prices and
attract investor interest.
In addition, new deals may
fulfil the credit requirements to be included in bond market
indices such as JP Morgans EMBI, which would allow a
broad range of investors to buy the paper.
However, Polina Kurdyavko,
portfolio manager at BlueBay Asset Management disagreed. She
said there was an oversupply of Russian risk in the market with
outstanding Gazprom, VTB and Sberbank deals offering
double-digit returns. "Why would you want to go into a new
issue with a government guarantee that will price tighter than
the quasi-sovereign straight? This potential exercise
wont be successful."
Investors generally agreed that
there was a risk that US high-grade credit offered more
attractive pricing levels compared with emerging corporate
bonds, which further suffer from weak regulatory regimes in the
event that debt covenants are broken.
However, Kurdyavko argued that
emerging corporate debt comprises of simple capital structures
from lower-leveraged credits that are at a different stage in
the economic cycle than the West while offering an extra yield
to compensate for EM risk.
In any case, investors are
increasingly differentiating between countries as well as
credit fundamentals. "You cant take a bottom-up approach
anymore. You have to be a lot more macro-based. You would want
to avoid countries where there is a lack of political will to
help corporates refinance," said Wolman at Aberdeen.