By Jo O’Connor
Emerging markets may have captured the imagination of the big investment firms, but for capital markets
In January, Merrill Lynch chairman and CEO John Thain unveiled ambitious plans for the bank to expand in the emerging markets of Brazil, Russia, India and China, as markets reeled from the announcement of its $22 billion loses from subprime related writedowns.
Thain said the bank’s shift towards emerging markets would mean that overall headcount at the bank would not fall, even as it slashed about 1,000 staff from its mortgage and fixed-income divisions.
Citigroup also surfaced – just after its own $21 billion writedowns – to broadcast the centrality of emerging markets to its growth plan. Other investment banks too have joined the party. “What we are experiencing is not just ‘flavour of the month’ kind of change; it is really a fundamental change,” says Atiq Ur Rehman, Citigroup’s co-head of global loans, leveraged and emerging markets finance.
“We are at a crossroads, which is laying the foundations of a permanent change in the world – just look at the vast wealth creation that is increasing consumption in these countries,” he says.
But this rush by investment banks to expand their emerging markets businesses has coincided with a slump in new issuance in both the bond and equity markets. Some investors may talk of adding emerging market exposure, but for many, better value can be found in investment grade European and US banks.
Issuance by emerging market borrowers from Latin America, non-Japan Asia and EEMEA (eastern Europe, the Middle East and Africa) in dollars, sterling or euros until May 7 reached the equivalent of just $36.6 billion – a fall of more than 55% on the same period in 2007, when more than $82 billion of bonds were sold in those three currencies.The first quarter of 2008 was a mixed one for emerging market bond origination and syndicate desks. From a depressing start when only sovereigns dared to venture out with new issues, life improved in April when a host of Russian blue chip corporates brought chunky deals priced to sell.
Gazprom, Evraz and Vimplecom successfully priced new deals, and Halyk Bank, Kazakhstan’s most conservative lender, demonstrated that even banks – albeit unique ones – could price deals.
But while the success of the blue chips is encouraging, the market remains bifurcated, and banks that majored in straight Eurobond issues for second tier CIS banks have suffered the most.
As part of the split, there are the top notch issuers that can access the public markets for chunky deals. And then there are small, lowly rated or unrated issuers which, unable to borrow in the loan market, are selling private bonds with coupons of 10–20% and equity kickers.
Within this paradigm, second-tier banks remain the market’s untouchables. Unwilling to pay the sorts of premiums demanded in the private market and unable to tap the public market for sizeable transactions, they are caught in no man’s land.
And although investors are showing signs of a renewed risk appetite, there remains an aversion to sub-investment grade rated banks. Halyk Bank aside, which priced its $500 million, 2013 bond in April, not a single financial institution from the EEMEA region has priced a bond for the last six months.
For banks that have majored in bookrunning straight Eurobond deals for lower rated corporates and banks, a market that was once a rich oasis of potential deals has become a desert.
Targeting investors
Banks with a wide distribution capability across a host of markets, and strong links with retail investors have continued to do deals.
The retail-centred Swiss franc and Malaysian ringgit markets have proved fertile ground for a handful of highly rated emerging market borrowers.
In early February, Bank of Moscow successfully executed a Sfr200 million, three-year issue through UBS. Priced at 370bp over mid-swaps, with a 6.253% coupon, the deal attracted orders from 157 mostly retail accounts. It was later tapped for an extra Sfr50 million. The deal showed that retail demand remains significant and that borrowers with the right credit profile can achieve decent size with retail targeted deals.
Turkey’s Bankpozitif priced $150 million of five-year fixed rate bonds through Citigroup and Commerzbank. Bankpozitif is majority owned by Israel’s Bank Hapoalim, and the bookrunners exploited its links to the country, adding Tel Aviv to a roadshow that also toured London, Vienna and Frankfurt.
The deal was priced with a 7.1% coupon, or 441bp over the 2.875% 2013 Treasury – a level bankers away from the transaction agreed was tight. Much of the deal went to a specific investor base – private bank demand with close ties to Bankpozitif’s parent, Hapoalim and to Israel more generally – and this alone accounted for its tight pricing.
For many other bankers, this is exactly the point: specific credits with unique investor bases are still able to print deals at competitive levels. But bankers agree that there is not a great deal of volume in these markets which tend to offer only shallow pools of liquidity. Borrowers seeking to raise large sums will still have to go to the dollar or euro markets.
Blue chips
In the bond market, banks have adopted a host of strategies to survive the drought in new issuance and even to increase market share. Those with strong relationships with blue chip companies are focusing on these top borrowers who are able to access the markets for large issues.
Put bluntly, bankers are focusing on deals that have a fighting chance of being executed.
These borrowers issue in size and pay decent fees and as such, mandates from the Russian blue chips are highly coveted among bond originators. There is also growing evidence that some banks are cutting fees to win business.
The handful of banks that are slashing fees hope that by accepting tighter margins, for the first wave of deals to emerge from the pipeline, they will be better positioned to win business from those borrowers further down the credit curve waiting on the sidelines.
But, not all agree. Bankers are notoriously unwilling to discuss fees, but according to one syndicate manager, “Some banks are slashing fees, but this is not the right strategy. The time for cutting fees to win business has well and truly passed.”
He may have a point. Bankers are searching harder for investors willing to participate in deals at the right price, and are working harder at selling issuers’ credit stories. Picking windows of opportunity is critical and once a deal is priced, secondary market support is more critical than ever.
Bankers have long argued that decent fees incentivize them to support a deal in the secondary market. Borrowers such as Ukraine, which has driven fees ever lower, will end up with a selection of sub-optimal leads running their deals, the theory goes.
Gazprom, for whom a $1 billion new issue is standard, pays fees of 50 cents, or $5 million per $1 billion issue. Compare this with fees of less than 10 cents ($1 million or less per $1 billion deal) paid by sovereigns like Ukraine, and it’s not hard to see why bankers are chasing Russian blue chip credits.