The wave of deals this week has followed an extraordinary year that has seen $173.8bn of bonds printed in CEEMEA, already beating the previous high of 2010 by more than $44bn. And still more deals are expected before the end of the year.
But although excited at being within one of the few markets that has been on fire, bankers and analysts are starting to worry that some deals are signalling a market that has been pushed too far. All the notes printed this week were considered to be reasonable successes, with big books and mostly stable trading, but for some observers, the signs are starting to give cause for concern.
In spread terms, the Republic of Latvia’s $1.25bn long seven year bond was printed around 200bp inside where its last note was printed in February, for example. And Hungarian state-owned Magyar Eximbank sold its $500m with ease from a $2bn book, despite no IMF lending agreement being in place for Hungary and the sovereign having been shut out of the capital markets for much of this year.
That’s not all. Such is the demand for new paper — and in size — that Abu Dhabi’s Taqa priced flat to the higher-rated IPIC, while the Kingdom of Morocco saved 75bp simply by printing dollars rather than euros. Over the last week alone, three issuers have printed bonds that have been not been attempted since the bull market of 2007 — Federal Grid Company, Rosneft and Eurochem.
To cap it all, Turkey — an opportunistic issuer that has gained a reputation over the last three years for calling the top of the market — also put in an appearance.
But book sizes have sometimes been too good to be believed: for some, there is a sense that the party cannot continue.
"If someone was giving free money away, there wouldn’t be this much demand," said one fund manager in London. "It’s the perfect backdrop for an EM bubble — a low interest rate environment, inexperienced private investors making leveraged bets as an alternative to deposits and low defaults rates because of the cheap money available. But we won’t know it’s a bubble until it pops."
Others are more defensive of the EM story, saying that the increase in the variety of names accessing the debt capital markets is simply a rational function of investor desire to diversify away from the eurozone at any cost — and happily pick up a higher yield in the process. The amount of money being put to work is higher than ever before.
"The demand for EM assets at the moment is in part a reflection of the anxiety around European assets and the search for solid credits in alternative spaces," said Domenico Nardelli, managing director, fixed income at Jefferies. "Some of the accounts that participated in the Magyar Eximbank deal, for example, were not specialised EM accounts."
"It’s also a case of diversification though — with yields so low, it’s difficult to generate good returns and so investors are trying to branch out."
BB is the new BBB
Investors have been rapidly slipping down the credit curve since September, buying swathes of subordinated bank debt as well as lower rated names.
"Double-B is the new triple-B, not because default risk is being ignored but because if there’s free ECB or Fed money everywhere for two to three years then they’re going to find it just as easy to refinance," said Richard Segal, a credit analyst at Jefferies in London. "The caveat to that, though, is that I’m talking about double-Bs where people believe in the rating — not some of the European sovereigns, for example."
Origination bankers say that the slide down the credit curve has not simply been investor driven. Because of the continuing rally this year, investors now have to buy double-B paper to get the same yields that they could have captured a few months ago with triple-B.
But at the same time, higher rated issuers — many of which have rallied, but not to the same extent as the lower rated borrowers — are well funded and have not been so easily tempted into the market to raise money that they have no immediate need for, despite the low rates.
So with EM bond fund inflows still high — now more than $52.5bn for the year, with 26 unbroken weeks of inflows — and a thin secondary market, funds have had to choose between lower rated issuers, or not to invest the inflows at all.
Tommaso Ponsele, a credit analyst at Citi, argues that this is not necessarily the sign of an unhealthy market.
"Corporate issuance in CEEMEA is still relatively limited in its variety versus LatAm or Asia," he said. "In LatAm, a much broader range of corporate issuers — both large and small — have successfully accessed the bond market. For the smaller single-B or low BB rated issuers, the key to finding access has often been the quality of the offering structures. We are beginning to see some appreciation of this within the CEEMEA issuer community as well."
Not all the same
EM bonds are often thought of as a single asset class. But the economic trends and growth drivers differ significantly between Turkey, Russia, Middle East or central and eastern Europe, and similarly some areas have been identified as being more overbought versus their fundamentals than others.
Ukraine, which was downgraded by Moody’s on Wednesday by one notch to B3, has been one of the CEEMEA market’s best performers this year, despite the gas price rises that would unlock frozen funding from the IMF still not having taken place.
That country has managed to print $4.85bn since bankers and analysts said at the start of the year that an agreement with the IMF would need to be reached before there would be any demand for its debt. Its five year CDS now stands at 625bp, having come down from a high of 930bp in January.
Hungary, another country locked out of IMF lending until economic improvements are made, has seen its five year CDS move from the year’s high of 735bp in January to around 288bp this week. Its explicitly guaranteed Eximbank this week priced a $500m bond, although the sovereign itself has not yet returned to the market.
"There have been a few very toppy issues recently," said a second origination official in London. "Ukraine and Magyar Eximbank spring to mind, together with [Russian credit card lender] Tinkoff Credit System’s 14% sub debt issue."
But valuations differ. "I would put money to work in Hungary despite the IMF agreement not being in place — the press about the country is bad but the budget deficit is going to be only 3% of GDP at the end of this year, which most European countries would die for," said Segal.
"And I only slightly agree with the Ukraine downgrade. It’s not a major default risk but it would be if I agreed with their growth forecast, which is probably too pessimistic."
Away from those lower rated names, though, the situation looks less precarious.
"The higher beta issues have rallied strongly over the last few months and we’ve seen a significant degree of spread compression," said Ponsele. "The yield environment is now the lowest it’s ever been for a number of names in the region. Nonetheless, the higher rated names arguably still have some space to tighten. Ironically the rally in some of the strongest names has been dampened by the reallocation of capital towards higher yielding paper."
When’s the pop?
By some analysts’ reckoning, a messy bursting of the bubble is due. "A sell-off could be prompted by either a big event such as a very rapid rise in default rates, or if inflows do not catch up with the new supply," said the fund manager. "All it takes is one of those guys to start selling and the rest will do the same because trading is so thin that small movements in position are being reflected as big drops in price."
He pointed to the recent Mongolia new issue as a small scale example of that — it traded 10 points down in the secondary before rebounding five in its the first week of trading, despite been 10 times subscribed.
But others are saying that it might never come. "When you look at relative value, EM spreads still look fair or even attractive for some of the higher quality paper," said Ponsele. "On some of the lower rated paper, on the other hand, the market may have got a little ahead of itself.
He also argued that growth and high and fast returns are typical features of the EM bond market and in some instances and are not necessarily a warning sign.
"In a number of cases the rally is backed by rapidly improving fundamentals," said Ponsele "Zhaikmunai, for example, was able to achieve a much better yield on their latest deal this year but then their fundamentals have also improved dramatically. And that’s what you should want to see in EM — profitable growth and improving credit trends."
