Violent domestic conflict, global capital market turmoil and opposition threats to default on new debt issues. That was the background to Sri Lanka’s global Eurobond debut last October.
Its success is largely down to Ajith Nivard Cabraal, central bank governor of Sri Lanka, who withstood international and domestic pressures, pressed on with the bond and went to great lengths to explain the difficult credit to worldwide investors.
The $500 million, five-year bonds attracted $1.6 billion of orders, with 136 accounts participating in the sale.
What makes the bond’s relatively smooth execution and bullish foreign investor interest so remarkable is that the issue was hit by unprecedented domestic controversy.
Before the bond was launched, the opposition United National Party (UNP) argued that it would be unjustifiably costly and place an unsustainable burden on the public finances. They said the landmark deal did not have legal approval and dismissed central bank claims that the proceeds would target infrastructure investment. Instead, they argued revenues would be used for unnecessary state spending while bilateral and multilateral loans could provide cheaper funding for projects.
The party even wrote hostile letters to leads Barclays Capital, HSBC and JP Morgan outlining their position. They also threatened to default if the UNP regained power.
INVESTOR EDUCATION
Despite this, Sri Lanka’s central bank governor Cabraal educated investors about the history of the nation, and the evolving nature of the conflict with the separatist Tamil Tigers.
“The central bank governor was the key figure in successfully bringing a deal to the market that had every possible challenge from day one,” says Reuben Tucker, director of Asian debt capital markets at Barclays Capital in Hong Kong.
Cabraal also reassured investors of the legality of the issue, explaining that the attorney-general and parliament had approved the sale while the president holds the ultimate say over foreign debt.
“He had successful discussions with investors, assuring them that the approval process for the issue had been carried out properly. This helped to allay their fears,” says Tucker.
His work was helped by ratings agency Fitch, which a week before the bond issue advised that the opposition was unlikely to implement threats to default once in power. As a result, the bond did not incur a heavy political risk premium. The B+/BB- rated deal carried a 8.25% coupon and was reoffered at par to yield 397bp over US Treasuries.
Given the domestic and global market pressures, this pricing was impressive considering that similarly rated Fiji’s 2013 paper was yielding between 9% and 10% at the time. Moreover, politically stable B+/B+ rated Ghana’s debut bond the month before carried an 8.5% coupon.
The appetite for Sri Lankan risk was well spread out geographically, with US accounts taking 40% of the bonds, Asia 30%, and Europe, Middle East and Africa 30%. By investor type, asset managers took 53% of the paper, investment banks 25%, hedge funds 10%, insurance and pensions funds 7% and retail and private banks 5%.
“There was a high-quality order book, dominated by stable hold-to-maturity accounts,” says Tucker. He says investors were prepared to weather the domestic instability and global market storm because the bond offered a rare chance for investors to diversify their Asian sovereign exposure.
“During the window that opened between late September and mid-October, there was a genuine demand for new stories. There was a flow of funds towards vanilla exposures in the emerging market space. Asia is still very much under-represented with very few benchmark issuers,” he says.
But exuberance for the credit has cooled. In February, Emerging Markets’ sister publication, EuroWeek, surveyed leading investors in Asian international bond markets in a poll reviewing the best and worst deals of 2007. It was voted the ‘least impressive Asian bond’ last year, with investors accusing the leads of poor execution and arguing that, given the myriad economic and political risks in the conflict-ridden aid dependent nation, the bond was too cheap.
In the initial after-market the paper immediately hit a high of 101 before negative sentiment dragged it down to par. The bond has since been battered in the secondary market and is quoted at 91.00/93.00.
Tucker says: “It is difficult to make backward-looking assessments of relative value, especially given recent market conditions as well as Sri Lanka’s unique positioning within the Asian credit universe.”
LATER DOWNGRADE
Sentiment has been partly dragged down by Fitch’s downgrade of the sovereign’s long-term foreign and local-currency issuer default ratings to B+ from BB- in early April. “The downgrade reflects the increased vulnerability of sovereign creditworthiness to adverse shocks associated with rising inflation, and persistently large fiscal deficits and worsened terms of trade due to soaring oil prices. This is in the context of greater government recourse to commercial and market-based financing,” says Paul Rawkins, senior director in Fitch’s sovereign rating team in London.
But Tucker says the sovereign’s debt repayment record is impeccable: “The country has an absolutely unblemished record to both concessional lenders and banks.”
By diversifying the external sources of financing, Cabraal has sought to reduce the country’s traditional reliance on western aid and multilateral lending after assistance has been restricted following concerns over Sri Lanka’s human rights record.
His active involvement in the debt sale and enthusiastic courtship of foreign investors enabled him to secure extremely competitive funding for a debut issuer.