Credit where credits due is a dubious proposition at the best of times. But thats at the heart of whats going on as cautious investors look at buying MTNs from CEEMEA issuers.
Gaining emerging market exposure through buying bonds in a local currency is an established practice across the fixed income markets and particularly so in the MTN sector.
Issuers such as the European Bank of Reconstruction and Development and the World Bank have obtained large amounts of funding denominated in currencies such as the Brazilian real, South African rand or the Turkish lira.
However, the same picture has not been true of the CEEMEA region where interest in local credits is variable at best.
The reason for this is mostly to do with ratings and credit quality. MTNs are much less liquid than benchmark issues and while most investors in private placements are happy to sacrifice liquidity for the best investment grade names, only the most intrepid can consider buying MTNs from sub-investment grade borrowers.
"The private placement market for central and eastern European borrowers is much smaller than the high grade market, and opportunities are fairly scarce," says Ulrik Ross, head of CEE and CIS origination at HSBC.
"Investors in the region generally need liquidity and size, and wont be comfortable doing private placements, unless theyre buying big, well known blue chip, or government owned, corporate names in the strongest countries."
Because MTNs are rarely a main source of funding, it makes sense that most investors want to see a presence in benchmarks before they will consider private placements. However, in some countries, growth market borrowers which started out funding in their domestic markets have turned to the private markets to satisfy their growing funding needs.
Hungary and the Czech Republic are two such examples. Having outgrown their domestic funding base, some borrowers from these countries have looked to the private markets next, first tapping Schuldschein and then MTNs.
"The MTN market opened with Czech and Hungarian issuers around 2002," says Ben Lamberg, global head of MTNs and private placements at Crédit Agricole. "Local authorities such as the Czech cities of Brno and Prague were followed by commercial and mortgage banks such as FHB and OTP."
One Czech borrower that recently tapped the MTN market is utility company Cez. In February it sold a ¥11.5bn ($139m) 12 year note to a Japanese institutional investor, proving that there is demand for emerging market paper if the credit is right.
Cez set up its MTN programme in 2007 (before that it issued off standalone documentation). It uses its programme for large benchmark deals and smaller, reverse-enquiry driven private placements. The market suits Cezs needs perfectly, says Ondrej Dvorák, manager of structured and corporate finance at Cez in Prague.
"Our programme was originally Eu2bn in size, but weve increased it to Eu8bn," he says. "Weve gone from being an occasional borrower to a much more frequent issuer, and the MTN programme is one of our primary funding sources, as the market functions very well in terms of providing liquidity in a short time in the volumes we require.
"We normally do one or two benchmarks a year only in euros but we are able to look at private placements in other currencies as well."
Speed of execution is one of the strongest selling points for a private placement. While benchmark bonds often require months of planning, MTNs can be done in days, allowing issuers to be opportunistic and take advantage of investors offers as they see fit.
"We generally do our private placements on a reverse enquiry basis," says Dvorák. "If the price and other terms are right, we take the opportunity to issue. Its much faster and less expensive than a public deal."
Advantages over loans
MTNs also offer certain advantages over the bilateral loan market, in particular the availability of longer maturities although decreased reliance on the state of the bank market is also a bonus.
"With MTNs, you can get more duration than with a loan up to 15 years rather than being limited to below seven and you can still get funding when the loan market dips," says Dvorák.
"The price is more competitive and more transparent. Its not quite as flexible as a bilateral loan, but the documentation is easier, and we dont have to spend weeks negotiating."
The Czech Export Bank has used this flexibility in maturities to its advantage, raising private placement funding that exactly matches its asset liability management needs.
"As loans to our clients have an amortising structure, issuing private placements in smaller amounts helps us to match our asset profile and manage a refinancing risk as well," says Milan Cizinsky, head of capital markets at CEB in Prague.
These tailor-made private placements suit CEB so well that they make up 50% of its bond funding profile. "Roughly half of our bond funding is in pure private placements," says Cizinsky. "The rest are essentially public deals with a higher number of investors. The MTN programme is a useful platform for our funding, and it is well worth the connected costs and time."
It is not just Czech companies that have had success in using MTNs. The National Bank of Abu Dhabi recently tapped the market, and Russian bank VTB has been active for some time. But the market for MTNs from CEEMEA credits is still small.
"The key to break the ice would be more flexibility from issuers," says Armin Bogner, head of EMTNs at Raiffeisen Bank International. "We see demand for simple structured issuance from CEE borrowers, but its a difficult proposition to sell to the issuer. They need to accommodate investors demands."
Another factor that has hindered access for CEEMEA names is the exit of key investors, says Crédit Agricoles Lamberg. "The German Landesbanks provided a strong investor base for this paper," he says. "But in recent years, they have sharply reduced their new investments in CEEMEA credits to focus more on the management of their existing portfolios."
Other European banks such as Dexia and Depfa were large buyers of CEE private placements before the credit crisis but have been forced to cut back in recent years due to internal problems.
Its all about the credit
But the main problem is still credit quality.
For the moment, most MTN investors are happy to get their exposure to emerging markets through buying local currency notes from established triple-A rated issuers. And while certain names stand out as being more acceptable, most other emerging borrowers will have to make do with the high yield, leveraged and bilateral loan markets until they have a big enough presence to take advantage of the arbitrage offered by MTNs.
"If you want to place an emerging market credit, you have to do the investor work and it takes time," says a London-based MTN dealer. "Investors need liquidity and generally wont buy 100% of the issue. Exceptions will be by credit, but in general, the riskier the name, the less likely the investor is to sacrifice liquidity by buying MTNs rather than benchmark paper.
"That said there is a small market for domestic private placements, generally because domestic investors know the names and are comfortable with them."
The bigger, the better
Cezs Dvorák agrees that private placements are difficult to access for anyone but the most established emerging market names. Getting a rating is the first hurdle.
"You have to be able to get a reasonable rating or a rating at all, and that requires some history, some future for agencies to assess," he says. "You also have to be able to carry the additional costs related to setting up and keeping the programme, and you need to have some presence in benchmarks, about Eu300m-Eu400m anything lower than that wont achieve the necessary liquidity.
"People often arent interested in the smaller private placements if there isnt a benchmark to use as a reference."
One way to get round this is to set up an MTN programme with the aim to use it for benchmark issuance. Once an issuer has established a benchmark curve, the arbitrage offered by MTNs is within reach and the programme is already there.
"The fact that most issuers from the CEEMEA region are fairly small makes it difficult for them to build up a presence in MTNs," says Konrad Merkofer at UBS. "One way in to the market is to establish an MTN programme as a platform for public deals, before branching out into MTNs."
Once the public deals have broken the ice, investors will begin to see the value in the region, says RBIs Bogner."The most popular countries are Hungary, the Czech Republic, Poland, Slovakia and Slovenia. These countries have pretty good fundamentals theyre beautiful. And the market is starting to realise that."