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A story of contrasting fortunes

30 Apr 1998

Emerging from the nightmare of the former Yugoslavia, Slovenia and Croatia have tapped international markets in a bid to gain capital for modernising their economies. But there the similarity ends. While Slovenia has successfully turned its face to the north and positioned itself as a mid-European investment grade credit, Croatia remains firmly mired as a Balkan credit, which has been reflected in the dire performance of recent bond market ventures.

NEXT DOOR NEIGHBOURS THEY MAY BE, but in terms of their international images, Slovenia and Croatia are poles apart. While Slovenia is lauded as the Switzerland of central and eastern Europe, Croatia has been dogged by a reputation of being politically difficult.
The economic effect of this contrast in image is clearly demonstrated in the widely differing amounts of foreign direct investment the two countries have attracted since gaining their independence in 1991.
With a population of less than 2m, Slovenia has attracted cumulative foreign direct investment of $2.2bn, while the figure for Croatia with almost 5m inhabitants stands at a much more modest $750m.
And with image as much as economic fundamentals still a key driver behind bond performance, both countries have also enjoyed different experiences in the international bond markets.
As central and eastern Europe's top rated sovereign credit - Slovenia has an A3 rating from Moody's Investors Service, an A from Standard & Poor's and an A- from Fitch IBCA - and a leading candidate for EU membership early next century, Slovenia has come to be regarded as the premier borrower from the region. As a result it has been able to command pricing to match its glittering profile in the dollar and Deutschmark Eurobond sectors and both issues have traded well.
Having mandated JP Morgan and Paribas to lead an eagerly awaited Eu400m seven year in mid-May, Slovenia is now poised to set a pricing low in the single European currency, which its regional peers will be hard pressed to be beat.
By contrast, Croatia's struggle to establish its credentials in the international bond markets has proved every bit as bruising as its secession from the former Yugoslavia.
The pricing and performance of Croatia's three foreign currency issues to date - in US dollars, Deutschmarks and pesetas - lag far behind those of its neighbour.
Though no ratings slouch itself - the country has investment grade Baa3, BBB- and BBB- ratings from Moody's, S&P and Fitch IBCA respectively - Croatia has so far failed to punch its weight in the international bond market arena, with all three of its Eurobonds trading more in line with those of a double-B, rather than a triple-B, credit.
Having failed to make a splash in Europe, Croatia is now pinning its hopes on Daiwa Securities being able to rehabilitate its investor profile and lead a successful issue in Japan's Samurai bond market.
Slovenia's sole Eurobond of 1997 firmly cemented its position as the pricing pacesetter in the international bond markets for central and eastern Europe, its DM400m seven year issue via Credit Suisse First Boston and Dresdner Kleinwort Benson setting a new low for the region.
With a 5.75% coupon the transaction came at a yield of just 43bp over the 6.375% Treuhand on a fixed re-offer price of 99.043.
This comprehensively trumped the pricing on Slovenia's debut Eurobond - a $325m 7% five year Eurodollar transaction led by JP Morgan in July 1996 - which came at a then recordbreaking spread of 58bp, but which had since tightened in to a bid/offer level of 49bp/44bp over US Treasuries.
As a CSFB spokesman explains: "This deal was quite different to Slovenia's dollar issue. The dollar deal marked Slovenia's Euromarket debut and its success helped to provide a lot of positive momentum for this issue.
"Given the spread improvement on Slovenia's Eurodollar deal, the idea behind the Euro-DM transaction was to bring the country at an aggressive level."
Yet even at what the leads admitted was a highly competitive price, the Slovenia deal still managed to attract a strong institutional bid from across Europe and Asia. Many of those investors had missed out on the dollar issue and so were keen to fill unused credit lines and gain exposure to the country on its first visit to the core European currency bond market.
Given the rarity value of the issue - which was flagged as Slovenia's only Euromarket issue for 1997 - overwhelming demand enabled it to be increased to DM400m from DM300m shortly after launch. The deal quickly tightened to a bid-offer spread of 41bp/43bp over in aftermarket trading.
Although the two Slovenian Eurobonds caught a mild dose of Asian flu - the dollar issue widened out to 106bp and the Deutschmark offering to 966bp at one point - both issues have retraced much of those losses and by the end of April were trading at 73bp and 606bp respectively.
With May's euro issue predicted to come at benchmark low pricing for an emerging market credit, the outlook for Slovenia in the international bond markets remains rosy. With GDP growth set to average 4% over the next two years, CPI at a respectable 8% and the government deficit 0.5%, the economic backdrop for international bond issuance looks secure.
Furthermore, with membership of the EU likely in 2002-2004, Slovenia is set to be one of the leading EU economic convergence trades in the region, which will further enhance the attractiveness of its deals.
Following the euro issue, transactions in Japan's Samurai and the US Yankee bond markets are widely seen as the next steps. But, given the country's modest funding requirements, Slovenian bonds are set to remain rare and prized assets.
Croatia's integration into the international capital markets began smoothly enough with the launch of a Hrk300m 12.50% two year issue via Merrill Lynch, which successfully introduced the Croatian currency, the kuna, to a wider international audience.
The country's first foreign currency issue - a $300m five year Euro/144A offering via Merrill Lynch and UBS also enjoyed a positive reception in the primary stage.
Launched in February 1997, the issue was the first by a central and eastern European sovereign last year. It featured a 7% coupon to yield 80bp over the 6.25% January 2002 US Treasury on an issue/fixed re-offer price of 99.917.
During premarketing, the interest from investors seeking fixed income exposure to the country's investment grade rated economy had enabled the issue to be increased from an original target of a $250m three year offering priced to yield 100bp over US Treasuries
On an aggregate basis, the two leads placed 12.5% of their paper in Asia, 47.25% in Europe and 45.25% in the US. Demand was split between retail investors in Europe - in particular in Germany, where strong sponsorship emerged from the sizeable Croatian diaspora - as well as banks in Asia and funds in the US.
The institutional bid from the US was particularly noteworthy for the participation of non-emerging market funds alongside dedicated central and eastern European specialists - a trend which gathered pace throughout 1997, as mainstream investors increasingly diversified their holdings into emerging Europe to achieve high yield returns.
This enabled the issue to trade up in the aftermarket and it closed the first week at a bid/offer price of 100.10-100.30, equating to a mid-point spread of 75bp over Treasuries.
However, the country was soon to discover to its cost that traditional asset managers are often the first to offload their holdings when there is speculation about any market sell-off.
Such fears were raised in the run up to the March FOMC meeting, as analysts forecast that an interest rate hike by the Federal Reserve could spell the end of the benign rate environment, likely provoking a flight to quality away from the emerging market debt sector.
As the most aggressively priced of the recent crop of central and eastern European issues, Croatia's Eurodollar bond bore the full brunt of growing investor bearishness, widening to 137bp at one point in mid-March before recovering to 110bp over by the end of the first quarter after the Fed raised rates by 25bp, rather than 50bp as had been feared.
However, while other issues from the region continued to tighten until the emerging market sell-off in November, Croatia's dollar issue has never recovered from its poor launch.
Although the country's economic fundamentals remain among the best in the region, its political - and, by extension, its investor - image is among the poorest.
The assertion by a UBS syndicate official at the time of the Croatia's Eurodollar issue that "investors have learned to judge the country on its own merits, not as part of some amorphous Balkan bloc", has proved to be highly overoptimistic.
Croatia's international image as an autocratic country still on a war footing with Serbia has, if anything, sharpened since the two countries signed a peace agreement in 1995.
In an attempt to correct this image and to replace it with one of an economically progressive investment grade democracy, Croatia returned to the Euromarkets in July 1997 with a DM300m seven year issue via Credit Suisse First Boston and Deutsche Morgan Grenfell. Featuring a 6.125% coupon, the issue was priced to yield 95bp over Bunds on a fixed re-offer of 99.584.
Although this was inside the 103bp trading spread on the country's $300m 7% five year issue, the poor secondary market performance of the Eurodollar bond still meant that Croatia became the first central and eastern European sovereign not to be able to price a Euro-DM debut at a lower launch spread than its Eurodollar debut.
Thanks to the country's investment grade ratings and its scarcity as a Eurobond issuer, however, the transaction was nevertheless reported by the leads to be fully sold within hours of launch.
Other syndicate members reported muted investor response, though, with the poor performance of Croatia's dollar Eurobond bearing much of the blame.
In the immediate aftermarket, the Euro-DM deal tightened to 94bp over, but the issue soon fell victim to the same malaise as the dollar issue. Both bonds were further hit by the Asian crisis, each widening to as high as 350bp over their respective government bond benchmarks at one point.
This alarming spread deterioration - at times, Croatia's dollar and DM Eurobonds have traded 200bp wider than issues for similarly rated Poland and Hungary and at the same level as those for double-B rated Romania - has inevitably fed through into the pricing the country has been able to obtain in the Euromarkets this year.
In March, Croatia became only the second central and eastern European issuer to tap Spain's Matador bond market, with the launch of a Pta15bn three year offering via Santander Investments.
Featuring a 6.5% coupon, the issue was priced to yield 225bp over Bonos at the issue fixed re-offer price of 99.70 - at the bottom end of the indicative 225bp-240bp pricing range, but a far cry from the 80bp and 90bp launch spreads on its dollar and DM issues.
Although lead manager Santander claimed strong Spanish sponsorship for the name on the back of the 225bp launch spread at a time of record low absolute yields in Spain's fixed income market, syndicate members said they saw no interest from Spain.
They added that the only enquiries they had received had been from London based asset swap accounts looking to book an investment grade bond yielding 210bp over Libor on a US dollar basis.
By the end of April, the peseta issue had tightened to trade at 210bp, with the dollar at 190bp and the DM at 195bp.
While judged on Croatia's economic fundamentals and ratings, those spreads still seem ridiculously high - they are almost 21/2 times higher than spreads for Hungary and Poland - bankers say that they reflect the high price the country has to pay for its international image.
Despite the sovereign's Euromarket failures, a number of Croatian issuers are nevertheless looking to seek Eurobond funding this year.
Development bank HBOR is looking for a Euro-DM issue as a follow up to its well received Asch700m 5.625% five year offering via Bank Austria Creditanstalt in April 1997.
Meanwhile, electricity utility HEP (via Chase Manhattan) and the Croatian capital Zagreb (via Goldman Sachs) are mulling debut Eurobonds.
Whether they can overcome the hurdle of Croatia's international image remains open to question, but unless the country does succeed in rehabilitating its reputation abroad, Croatian bond issues are likely to remain challenging trades. EW

30 Apr 1998