The emerging market emperors' new clothes
New emerging market bond issues show the reality behind the groupthink delusion
The few recent new issues for EM borrowers that have made it to market have offered spreads beyond investors’ wildest bull market dreams. But some of them are still grumbling, which is ridiculous and they might be about to get found out.
Hungary's OTP Bank paid 426bp over swaps this month and Slovenia’s Nova Ljubljanska Banka has started at 480bp over. The next widest CEE senior preferred bank deal this year came at 215bp over, and was printed in January. Spain's Unicaja, with the same ratings and structure as OTP, paid only 305bp in June.
Syndicate bankers and issuers have expressed the somewhat desperate sounding view that in this market, any deal priced is a good deal. But strangely, some investors are not as delighted, in a rare instance of fund managers complaining about pricing being too wide.
As money has fled their funds this year — over $50bn of outflows in fact — they are growing increasingly worried about the future of their asset class. They make the point that a couple of super-wide prints is enough to undermine the rest of secondary trading. While a buyer might pick up few extra basis points on a new issue, funds then end up having to mark down a whole load of other assets where the screen prices don't match where bonds are changing hands for money.
This is one of the first times this asset class has faced this problem. In previous bouts of volatility such as the 2013 'taper tantrum', the whole market froze as issuers refused to print at all. The levels that they theoretically would have paid at peak fear never saw the light of day, with new issues only returning after the worst was over.
A lot of the EM benchmark indices have lost 15%-20% of their value this year. Funds are worried that some reckless new issue printing could push the whole EM bond market wider still and create a vicious circle. This will put EM issuers under even more pressure than they are right now.
With this investor grumbling we seem to have moved past the point where funds are baying to be paid for the risks they are taking. Now they just want their funds to survive. One fund manager made the point that funds get paid as a percentage of assets under management. As EM falls apart and their costs rise, the smaller funds in particular are feeling the pinch.
But while they complain about the new issues wrecking secondary market prices, many of them are also vocal in their views that there is worse to come for EM bonds heading into the second half of the year.
As the developed world heads into recession and default rates rise, even more money is expected to flee the developing world. Very few people see a sunlit upland on the horizon.
But with that in mind, it is fair to conclude that issuers are not printing bonds recklessly. They are printing either because they need the money or because they see the future primary market as even worse.
EM borrowers paying up in recent times are calling out their current secondary bond spreads for what they are — a fairytale that helps everyone sleep at night. They are not wrecking their curves. They are delivering a dose of reality.
If, to hijack Warren Buffett's analogy, the tide is about to go out and we find out who has been swimming naked, that is not the borrowers' fault but the investors' for pretending they were covered.