Tougher times ahead for emerging market borrowers

LONDON Thu Sep 29, 2011 8:03am BST

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LONDON (Reuters) - Sovereign and corporate borrowers from emerging economies are unlikely to meet ambitious full-year targets for new debt sales after a torrid third-quarter for high-yield bonds as financial markets froze on double-dip recession fears.

The sector borrowed a record $300 billion (192 billion pounds) in 2010, according to some industry estimates, taking up the slack for the absence from the market of some high profile sovereign issuers in the euro zone.

But that trend looks set to be overcome by a broader retrenchment by creditors this year as ongoing worries about euro sovereign defaults and fresh fears of a protracted global economic slowdown hit the financial sector at large.

As a result, 2010 may well prove to be the high watermark for some years to come.

"Emerging market issuance has been very low as euro zone jitters and U.S. growth concerns have kept many issuers from the market and investors are reluctant to draw down cash," said David Spegel, global head of emerging markets strategy at ING.

"For now, it's all about high-grade issuance, which I expect will remain the case for the foreseeable future."

Junk-rated corporates like Turkey's Akbank, Nigerian Guaranty Trust Bank and Ukraine's Metinvest were among those taking advantage of stable spreads over U.S. Treasuries last year and earlier this year.

But spreads of dollar-denominated bonds over U.S. Treasuries have gapped out alarmingly in the last few weeks to as much as 432 basis points, their widest in two years.

That slashed emerging debt issuance to $28.4 billion for the third quarter, down 66 percent from the previous quarter and 70 percent from the same quarter last year, according to data from Dutch bank ING.

Total issuance for the year so far is $205 billion, according to bank estimates.

FORECASTS CUT

Banks last year estimated at least $240 billion in new issuance for 2011, but are starting to revise down those forecasts.

JPMorgan saw around $77 billion in new issuance from sovereigns for 2011, but is now expecting less than $70 billion, with only $16 billion of that still to be issued.

Serbia was a rare issuer in emerging sovereign debt markets this month, launching a $1 billion 10-year bond, but the bond has performed poorly, investors say.

With somewhat bad timing given the recent sell-off in global financial and commodity markets, Namibia embarked on a roadshow this week for a debut Eurobond.

Meanwhile, reflecting the trend for higher-quality names, Bahrain is planning a $1 billion sovereign Islamic bond, banking sources say.

Latvia also said this week it was planning to issue, but not until next year

CORPORATE WORRIES

While last year was also a record one for emerging corporate issuance, as investors reckoned companies had strong balance sheets compared with alternatives in the developed world, risk aversion has cut demand for the sector.

Speculative grade issuance amounted to only 28 percent of the total in the third quarter, compared with 40 percent in the second quarter, according to ING.

"The slowing in the pace of primary corporate issuance, as market volatility has increased, may act to keep gross emerging market corporate issuance below our 2011 target of $195 billion," said JPMorgan analysts in a client note.

Returns for the year-to-date for fixed income assets remain 4-8 percent, JPMorgan analysts wrote, but corporate returns have underperformed the EMBI-global sovereign index and are likely to do even worse.

"Our new spread forecasts imply (corporate emerging bond index) returns will likely be negative for the remainder of the year," JPMorgan said.

"Higher quality Middle East names as well as utility, infrastructure and oil and gas sectors, as well as select TM and investment grade miners offer the best value."

CAUTION IS BYWORD

Appetite for risk has not been helped by the performance of some riskier frontier market borrowers in 2011.

Belarus launched only its second Eurobond earlier this year, a $800 million seven-year deal with a yield of 8.95 percent. But worries about the sovereign's ability to repay its debt have sent the bond's yield to nearly 17 percent.

Ivory Coast defaulted on a $2.3 billion bond due to civil war, with no promise of resuming payments until next year. The bond is trading at 50 cents on the dollar.

Kazakh sovereign wealth fund-owned bank BTA's bonds have plummeted in the secondary market on concerns about the bank's financial health, following a debt restructuring, again completed only last year.

In addition, sliding currencies in Asia, Latin America and central Europe have cut demand for local currency debt, previously one of this year's trending markets.

"There seems very little confidence right now, there are pretty big risks for the market," Kevin Daly, emerging debt fund manager at Aberdeen Asset Management, told a Thomson Reuters conference this week.

"I think this is short-term, I don't think it's going to go on for months...with the caveat of a blow-up of a European bank."

Longer term, the need for emerging market borrowers to issue debt, often in local currency, will reassert itself, analysts say.

Thierry Apoteker, CEO of emerging markets research firm TAC Financial, says tighter fiscal approaches are likely to leave emerging sovereigns with relatively little need for new debt, but borrowers will come from outside the sovereign sector.

"Corporates are still needing funds, and local banks are also very likely to issue medium to long-term bonds," he said.

"The dollar will be subject to downward pressure, the key is to identify the local currencies that will perform well."

(Graphic by Scott Barber; editing by Patrick Graham)

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