Fixed Income

Emerging Debt Sales in for Another Bumper Year; Shy of 2012 Boom

Sujata Rao and Carolyn Cohn
Bloomberg | Getty Images

Asian firms and African governments will lead emerging borrowers hoping to tap into buoyant appetite for high-yield assets in 2013 although issuance levels and investor returns may fall short of last year.

The new year has already got off to a flying start - investors lent Turkey cash repayable in 10 years at a cost of 3.47 percent, the lowest it has ever achieved in the dollar debt market.

This comes hot on the heels of a year in which the emerging bond sector saw record sales and almost 20 percent returns.

Issuers as well as investors benefited in 2012, with the collapse in U.S. yields slashing borrowing costs for emerging entities and allowing them to sell a total $411 billion in bonds, according to estimates from JP Morgan.

That's a jump of more than 30 percent from 2011 levels.

Bond buyers, meanwhile, enjoyed robust premia over zero-yield German and U.S. debt, shovelling a record $94 billion in new cash into the sector and earning equity-like returns on dollar bonds as well as on emerging currency debt.

On some segments such as Venezuelan dollar bonds, returns were as high as 45 percent.

"Demand for emerging markets fixed income remains strong, fuelled by the on-going search for yield, as well as a supportive economic backdrop in many regions and the likelihood that currency volatility will remain subdued," HSBC says.

But HSBC analysts warn: "But there is little scope for a repeat of 2012 returns, given a starting point of tighter spreads and much lower yields."

The premium paid by emerging borrowers over U.S. Treasuries as measured by the leading EMBI Global index compressed 161 basis points over 2012. That of corporate bonds fell 142 basis points.

Analysts at HSBC expect 4 to 7 percent returns in external bonds, while local currency debt is expected to provide 8 percent. JP Morgan, which runs the most-used emerging debt indices, expects sovereign dollar bonds to return 5-6 percent this year, versus 18.5 percent in 2012.

Issuance is also set to fall back, in part due to a hangover from the borrower-friendly conditions seen in 2012.

The fall in U.S. yields allowed emerging issuers to raise capital cheaply, with many taking advantage by pre-financing 2013 needs. Sovereigns are also reckoned to have a lower net financing need than last year.

JP Morgan says companies will issue $281 billion in dollar debt, down from last year's record $329 billion. It predicts $78 billion in sovereign sales, a touch under 2012.

Inflows, too, should moderate to $70 billion, JPM reckons, after last year's 150 basis point yield spread compression.

The environment may be turning less bond-friendly. If global growth continues to pick up, more cash could rotate into equities, while higher U.S. yields may also pose a challenge. U.S. 10-year yields jumped to 8-month highs this week on signs of economic recovery and fears of an inflation bump.

On the other hand, developed world central banks are still pumping liquidity, with monetary easing from Japan now expected to push another wave of cash into emerging assets.

Nick Darrant, who heads the CEEMEA debt syndicate desk at BNP Paribas, says a structural shift in the global investor base is bringing in more and more non-traditional buyers of emerging market bonds.

"Some of the barriers are being broken down, some who only looked at OECD countries before have dropped that criteria," he said, referring to the group of 34 industrialised countries.

Corporate, Frontier Boom

A few themes stand out - corporate debt, Islamic bonds and debt from poor, so-called frontier markets. Their success in today's yield-scarce environment is unsurprising - companies for instance pay a 60 basis point yield premium over sovereign bonds.

The corporate bond boom can also be attributed to the lockdown in the syndicated loan market, due to banks' needs to comply with tighter regulations on capital buffers.

"Cross-border bank lending will be modest compared with historical levels. Syndicated loans are expensive and lending to lower-rated corporates requires even higher capital adequacy ratios. This suggests bond markets will take up the slack," said Jeremy Brewin, a fund manager at Aviva Investors.

Chinese property firms' debt sales in the first two weeks of the year alone are already running at nearly half of total 2012 dollar issuance, analysts note.

Analysts see CCC-rated Chinese developer Hopson's recent $300 million bond as a harbinger of more junk issuance in Asia.

"This year we will see a move down the credit spectrum, a move from quasi-sovereign to the private sector, people will look geographically where they did not look in the past, will go further down the capital structure, and to deals that are smaller than benchmark," BNP's Darrant said.

On frontier debt, Zambia's Eurobond last year was 17 times subscribed. That may encourage other potential debut borrowers such as Kenya, Bangladesh, Angola, Uganda and Tanzania.

JP Morgan predicts frontier issuance of $9.3 billion, double last year's levels.

Islamic debt, or sukuk, volumes last year doubled from 2011 levels to almost $20 billion, according to Thomson Reuters data, testifying to the appetite of cash-rich Gulf investors.

There are worries too. Hungary, keen to evade IMF aid and with the equivalent of $6.7 billion in external debt maturing this year, wants to tap capital markets soon but will likely be forced to pay a hefty premium. Egypt, grappling with a currency crisis, must also refinance around $2.5 billion in 2013.

Another possible flashpoint is Argentina, which escaped default in December via a court reprieve until March.

But defaults are expected to be lower than 2012, which kicked off with a $2.1 billion crash from Kazakhstan's BTA Bank.