Still dancing

05/10/2009 | Toby Fildes

International capital markets are wide open again for emerging markets: competition for mandates is back, and investors are once again onside. But many banks that dumped EM staff after the Lehman collapse are finding themselves woefully unprepared for the rebound

Even by their own standards, the notoriously fickle international capital markets have fallen back in love with the emerging markets with almost indecent haste.

By the end of September, banks were busily restocking their teams as the velocity of emerging market dealflow from sovereigns as well as corporates and financial institutions from across Asia, emerging Europe, the Middle East, Africa and Latin America approached, and in some cases even exceeded, pre-crisis levels. Meanwhile, key EM (emerging markets) sovereign CDS (credit default swaps) spreads were back to around their July 2008 marks.

You could be forgiven for thinking the collapse of Lehman Brothers never happened.

But just six months ago, it was all very different: many banks couldn’t get out of the business fast enough. Deal volumes were depressingly low. Following the final quarter of 2008, during which no issuance saw the light of day, there were just $5 billion of bonds, all at the sovereign level, in January. February and March were even worse, with $2 billion each.

As a result, and as unpleasant as it was, it was unsurprising that senior emerging market staff, including experienced origination and syndicate officials from both the bond and loan markets, were being ignominiously jettisoned, as banks looked to cut costs to keep their capital markets businesses afloat.

The bond syndicate communities in Europe and Asia were especially badly hit, with Deutsche Bank, Citi, UBS, Merrill Lynch and Morgan Stanley all getting rid of EM syndicate specialists. Other houses such as Credit Suisse and JP Morgan shifted their EMEA (Europe, Middle East and Africa) syndicate bankers over to the corporate sector.

Some capital markets businesses managed to persuade other parts of the bank to take on the costs, for example, Citi moved Maryam Khosrowshahi, who was co-head of sovereign, agency and supranational debt capital markets, over to the banking side.

Others who saw their EM syndicate specialists leave on their own volition, such as Jonathan Brown of UBS, chose not to replace the position, instead sharing the workload around the bank.

To even the most experienced emerging market specialists, it looked like appetite for EM risk had been destroyed, and the progress its capital markets had made over the last 20 years all but wiped out. In particular, eastern Europe was in danger of becoming a capital markets graveyard.

BACK FROM THE DEAD

But almost as soon as the last rites had been read over the emerging markets as a mainstream business for banks, signs of life began to appear in the form of deals towards the end of March and early April.

The recovery was sudden and largely due to five key factors: China’s robust response to the crisis in the form of a powerful stimulus (and proof that it was beginning to bear fruit); the general tracking by emerging markets of the improved global market; the implementation of bailout packages from the IMF for countries such as Hungary, Ukraine and the Baltic states, and flexible credit for the likes of Mexico; worries over Russia easing; and the bounce in commodities – fears about banks and Russian corporate refinancing dissipated somewhat when oil prices increased and Russian reserves came back up.

In CEEMEA (central and eastern Europe, Middle East and Africa), some $12 billion of bonds came to market in April, $8 billion from sovereigns and $4 billion from corporates, and while June only posted $7 billion, volumes roared back in July with $14 billion issued. Even August, the holiday month, managed to contribute $2 billion of deals.

The volumes have been so impressive that some banks that had dumped parts of their emerging markets business could not capitalize on the reinvigorated sector.

“With the last new issue of 2008 printing in September and the outlook for emerging markets very uncertain, there was a dramatic cutback in the industry,” says Jonathan Brown, who after leaving UBS joined Barclays Capital in August as head of its emerging markets and European credit syndicate in London.

“Many banks simply cut their EM DCM [debt capital market] and syndicate staffing down to minimal levels and that then prevented them participating in the vibrant market we have enjoyed in 2009.”

The large volumes so far this year help make up the remarkable statistic that, despite the first three months of the year being almost a write-off, and despite three more months to go until the end of the year, 61 new issues have been priced in CEEMEA in 2009 with a total value of $63 billion, surpassing the $52 billion full-year level for 2008.

“We had a very volatile start to the year, and all markets were suffering,” says Eirik Winter, managing director and head of debt capital markets, EMEA, at Citi in London.

“But there was a big over-reaction when it came to the emerging markets. People perhaps forgot about the underlying factors that had made these countries attractive in the first place – commodities, genuine growth potential, big populations and good companies. And on top of this, many countries have powerful backers in the form of sovereign wealth funds.”

The return of deals has seen the partial – if not complete – recovery of the EM capital markets workforce, in particular in the bond market. Many bankers who lost their jobs have found new positions since the market recovery.

CRITICAL LINKS

For Brown at Barclays, having an emerging market capital markets function is not just about the fees that come from winning bond mandates – the sector itself is a fundamental and interlinked part of a bank’s offering to its clients.

“Emerging market new issuance touches many points within a bank’s sales and distribution and is a sector that cannot be ignored,” he says. “At the same time it needs experienced practitioners who are comfortable advising issuers on how to access liquidity. On a macro level, the EM component of global GDP growth is increasing all the time. Understanding these countries is critical to the success of a firm within global markets.”

Paul Tregidgo, vice-chairman of debt capital markets at Credit Suisse in New York, agrees with Brown about the strategic importance of the emerging markets business, but also argues that emerging markets themselves were not to blame for their harsh treatment at the hands of the investment banks.

“The fact that some investment bank firing and hiring practices have been volatile round the emerging market space is as much a function of investment banking industry constraints and practices, not the fundamentals of emerging market prospects and opportunity,” he says.

“The picture is clear if you look at recent rating agency actions, including in Brazil and Indonesia, the inflows into emerging market funds and the bond market’s reception of sovereign and now corporate deals.”

As Tredidgo’s positive reading of the emerging markets suggests, and as the recent restocking of emerging market talent implies, competition in the bond business is returning. And in some cases to cut-throat levels last seen in the boom years of 2006 and the early part of 2007.

The recent bidding process for Romania’s sovereign bond mandate is a case in point. The sovereign sent a request for proposals to 22 banks and shortlisted 10 before choosing three – Deutsche Bank, EFG Eurobank and HSBC – and agreeing to pay eye-wateringly tight fees of 4bp.

To the consternation of the vast majority of the original 22 banks, Deutsche had bid zero fees, EFG 2bp and HSBC 4bp–5bp.

Romania has a reputation for squeezing the fees for its Eurobonds – in June 2008, when Credit Suisse, UBS and EFG Eurobank were chosen for its $750 million deal, similar criticisms were made. But still, bankers not part of the winning group were amazed that fees on this latest deal had been squeezed so hard and so early on in the cycle.

“When they were whittling down the 10 to three, there was a lot of pressure to decrease fees, and we were hearing that this was what the choice would come down to,” said a banker involved in the process.

“It was pretty much exclusively a fee discussion. We had made the decision, along with several other top-tier names, that we would not go below the 12.5bp mark. We have learned our lessons from the credit crisis, and we will be very firm on that – we have to make money on these trades, irrespective of how strategically important certain EM sovereign mandates are and how prestigious they can be.

“We’re only a year on from the collapse of Lehman, and it’s far too early to be returning to these loss-making fee levels in our emerging markets business. But somehow we are back there.”

UGLY BUT UNDERSTANDABLE

Normal service among the banks, it appears, has resumed in the emerging markets. But is it all a bit too early and too much? The recovery in confidence and dealflow seemingly ignores the dangers still stalking the global economy. The risk of a double-dip recession for the global economy is still uncertain. And there is also the fear that once China exits its fiscal stimulus it will reveal the true extent of the damage left by nine months of rampant, state-sponsored growth, and that could spook sentiment across the asset class.

The emerging markets are also particularly vulnerable to rate rises in the US – almost inevitable when the US exits from its monetary and fiscal stimulus and attempts to drain liquidity from the system and curb inflation.

“The rules haven’t changed,” as one emerging markets DCM specialist in London points out. “The old weaknesses are still there despite all that has gone on over the last two years in the West. Decoupling was always a fanciful idea in an interconnected world, and the emerging markets, including their capital markets, will always be at the mercy of events that they cannot necessarily control.”

And if the old weaknesses are still there, what is to stop banks repeating what they did earlier this year, throwing the baby out with the bathwater?

Not much is the answer. DCM teams live and die by deal flow, and if there are no deals in front of them – irrespective of the promise of pipeline – then banks will act quickly and decisively by cutting costs, which means getting rid of specialist staff.

“A leopard doesn’t change its spots,” says a senior EM banker. “But that’s not just the behavioural pattern towards EM in particular: it’s much broader than that. The hiring back into EM is no more or less than the frenzy across other areas.

“However, as it relates to EM, the approach will need to evolve, because you could make the case for extinction of investment banks much easier than the case for extinction of EM today.”

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