CEE sovereigns ride wave of ECB euphoria
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Emerging Markets

CEE sovereigns ride wave of ECB euphoria

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Central and eastern Europe was a lifeboat in the storm for emerging market investors in 2014. But this year the region is breaking the hearts of DCM bankers as sovereign issuance volumes plummet

International bankers are taught that in a negotiation, Russians typically focus strategy not on being the ones who benefit the most but on being the ones who lose the least.

But for Russian bond issuers this year, it may be different. It may be hard for them not to envy the huge benefits that have fallen into the laps of their counterparts in central and eastern Europe, thanks to the European Central Bank and its quantitative easing programme.

So far this year, only $12.7bn of CEE international sovereign bonds have been placed, less than half the $28.7bn printed over the same time period in 2014 and far less than any other year this decade (see table).

But there are reasons to be cheerful — not least because of the big rally in the region following investors turning away from Russia and desperately searching for yield after the start of the ECB’s public sector purchase programme on March 9.

“The ECB move was widely expected and the direction of benchmark yields and credit spreads has not been surprising,” says Blazej Dankowski, a DCM official at Citi in London. “What may have surprised some though is the depth of QE impact. Poland’s euro 2024 bond is trading at mid-swaps plus low 20bp this week (early May) — that spread is a quarter of what it was a year ago. That’s an extraordinary rally.”

Although Poland is usually among the first to tap international markets, this year it waited until March to issue €1bn of Eurobonds. Bankers said this was a strategic move by the ministry of finance designed to capture the rally. The move worked — the sovereign sold the 12 year bond with a coupon of 0.875% and followed in April with a negative yielding deal in Swiss francs.

“I wouldn’t be surprised if, as the ECB continues with QE, euro CEE yields turn negative,” says Dankowski. “Not just the yields of countries like Slovakia, where part of its curve is already in negative territory as bonds are being directly bought, but others like Poland that would have their spreads pulled down on a relative value basis.”

As demand for European countries outside the eurozone is not driven by the ECB, the technical pressure is much less though. Because of that, investors are much more hesitant as yields approach zero.

Poland’s $2bn 2024s were trading around 2.7% in mid-April, having tightened over 50bp in the previous six months. Slovakia’s €2bn 2023s were trading at 0.2%, having tightened 90bp over the same timeframe.

The rally had started to wane by late April though, with yields on 10 year Bunds doubling, albeit from a very low base. The sell-off did not spread into the emerging markets at that point, but it did take some steam out of the tightening.

HOLDING FIRE

But though CEE sovereigns are trading very tightly, there is little appetite to issue. Many frequent borrowers, such as Poland, have prefunded much of their need in 2014 while others, such as Turkey, simply had a lower borrowing requirement this year. By the end of the first quarter of 2015, Turkey had completed 33% of its TL99.7bn borrowing target for the full year. Croatia and Slovakia have already completed about half of their full year issuance plans. Slovenia, with heavy pre-financing from last year, is already fully funded for 2015.

“We have a dilemma of so far quite limited activity on the euro market, despite the very encouraging environment,” says Bogdan Klimaszewski, Poland’s deputy director of its public debt department. “It comes from limited amount of borrowing requirements in foreign currencies, substantial hard currencies reserves and a strategic target to reduce the share of foreign currency denominated debt.”

Poland has now financed 66% of its annual state budget borrowing requirements.

“The two big questions now are whether borrowers have significant enough issuance needs for us to see a lot more paper this year, and whether the rally has gone so far that demand from investors is subdued,” says John Wright, a syndicate official at Barclays in London.

PILING INTO EUROS

Volumes of CEE sovereign bonds printed in euros are also down on an absolute basis, but the proportion of bonds being printed in the common currency has rocketed. In 2014, €9.2bn of CEE sovereign bonds were sold, accounting for 43% of the total. That year set a record for euro issuance, but this year, though only €8.4bn of euro denominated CEE sovereign bonds have been sold, those bonds account for 73% of CEE sovereign international bond funding, according to Dealogic data. And the deals have certainly not been struggling to find demand.

“It has been striking this year that every CEE sovereign deal printed has had something specific that has been impressive thanks to ECB QE,” says Peter Bakos, vice-president, debt capital markets CEE origination at Erste Bank in Vienna. “Slovenia issued a 20 year, which was its longest tenor, while Montenegro printed its largest Eurobond ever. Croatia did a €1.5bn 10 year with the lowest euro coupon it has ever achieved and Bulgaria sold a €3.1bn deal, which was the biggest euro deal by an EM sovereign. In addition, Poland printed at super-low yield in euros and at negative yield in Swiss francs.”

And the ground breaking looks set to continue as the longer end of the curve looks most attractive to issuers and investors. “The most visible impact [of QE] has been on our euro denominated bonds, with yields falling down and spreads tightening across the curve,” says Klimaszewski. “It creates of course the temptation to tap the market with long tenors.”

This year over 80% of CEE funding has been done in maturities of 10 years or longer. In 2014 it was around 67%.

“Bulgaria this year printed a 20 year bond in a good size with a significant oversubscription,” says Dankowski. “A year ago Bulgaria’s access to 20 year euros would have been arguable. A few CEE issuers could even do what Mexico did and print a 100 year, but I’m not sure they would want to.”

Sovereigns as unusual as Azerbaijan and Kazakhstan are considering printing euro notes. But bankers say the euro market still has some limitations, with the depth of the market for non-investment grade issuers still uncertain.

None of the CEE sovereign deals that had been printed by the start of May were in dollars, but ECB QE will impact that market too. “The big focus on euros this year will only serve to increase the rarity value of the dollar bonds outstanding, and so the demand for new dollar deals,” says Wright. “When one of those or a quasi-sovereign does do a dollar deal, it’s going to fly.”

RUSSIAN HOLE

Bankers agree that Russia’s absence from the bond market has affected CEE sovereign bond trading but views on the extent differ. Danskowski argues that money has been directly redeployed into the CEE. Other views are more nuanced.

“Some CEE sovereign names have benefited more than others from Russia not being in the market,” says a syndicate official in London. “Turkey has been one of the biggest beneficiaries, but Poland is more of a beneficiary when investors have a reason for not wanting to buy western European names.”

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