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 $150bn.
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 liquidity.
Russian risk retreats
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 currency.
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 market.
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.