They predict that outrageously wide spreads will ensure only a trickle of small and expensive high-quality transactions with conservative structures. This will force potential bookrunners to work with selective fee-generating issuers against the threat of further banking job losses in an era where leverage is stigmatised, enforcing small deal volumes.
Lower interbank lending rates, monetary easing and recent international policy support for developing economies has triggered a bear market rally for sovereign and high-quality corporate bonds against their perilous lows over the past week. But despite European central banks cutting interest rates, fears of a global recession took the shine off some of the gains in EM spreads and CDS levels yesterday. Nevertheless, with some real money trading in hard currency cash bonds this week, the modestly-improved market tone for risk has sparked a debate about when and how the primary market window will be cautiously opened.
Investor demand for defensive assets, the need for hard currency cash, and the freedom to issue before financial statements are released suggest sovereign issuers with a liquid borrowing profile are most likely to issue but not before January 2009, bankers said.
Demand for sovereign issuers in central and eastern Europe is weak due to external deficits in the region compared with Latin American sovereigns, with regional bankers tipping Peru and Mexico. "We are waiting for Latin sovereign names to come and this will test the appetite for emerging market risk," said an EMEA debt capital markets banker in London.
Peru and Colombia likely
Peru has expressed an interest in issuing a new 30 year benchmark, however, its cash bonds have been trading as low as 80 cents on the dollar. Executing a new transaction would therefore be costly for the investment-grade issuer. In January, Mexico launched a $1.5bn due 2040 at a 9bp-10bp concession so any new deal could represent a 50bp to 100bp premium. This could make an expected dollar bond for next year politically unpalatable despite the borrowers bold reputation.
Meanwhile, Colombia has already secured its financing requirements for 2009 courtesy of a $1bn loan from the Inter-American Development Bank, $1bn from the World Bank and $400m from the Andean policy lender CAF. Pricing-sensitive Brazil is unlikely to come to the markets any time soon after ensuring just a 4bp concession for its deft 2017 $525m reopening in May 2008. Any new issue would be subject to an illiquidity premium and undermine its strategy of ensuring ever-tighter pricing for its hard currency bonds. "Brazil is way too price sensitive, Mexico probably does not need the money so I think Peru and Colombian issuance early next week is most likely," said a Latin American bond market banker.
In EMEA, Ukraine is unlikely to come to the markets after securing a $16.4bn loan from the IMF this week. Turkey usually has around $4.5bn funding needs every year but its borrowing programme will remain on hold until a decision on a new IMF loan is made. If a programme with the global policy lender is not established, investors are likely to demand extremely high premiums for the sovereign with its yawning current account deficit. Meanwhile, Albania has put on hold its plan to launch a Eu200m to Eu300m Eurobond next year due to global market distress.
Russians to come
Bankers say well-known quasi-sovereign Russian issuers such as Gazprom, VTB, Transeft and Russian Railways are more likely to open the primary markets in emerging Europe due to the historic dearth of sovereign supply in the region. In Latin America, rumours abound that Brazils Banco do Brasil and development bank BNDES are poised to issue dollar bonds in the first quarter in 2009. This will be complemented by familiar high-grade names such as Brazilian oil giant Petrobras, telecoms company Telemar and steel giant Gerdau, who are likely to open the corporate market, following sovereign issuance. For all borrowers, conservative structures such as three to five year tenors, benchmark size up to $1bn and RegS/ 144a format are expected.
As global deleveraging takes place, investors have dramatically fled corporate paper, retreating to sovereign bonds or safe assets such as cash, gold or US Treasuries. For any issuer to brave the global market meltdown, secondary levels need to come down from dizzyingly high levels to allow investors to add risk.
"We need stability in secondary market spreads and liquidity in trading for any new issues," said one banker. As yet, there are few signs of stability. For example, Brazilian mid-tier banks that issued short term paper over the last six months for retail banks in Zurich and Geneva are now effectively trading at distressed levels: Banco Daycoval issued a 3 year bond in July, yielding 7.375% but it is now trading at 18%. Whats more, Commerzabnk expects default rates among US high yield corporates to rise dramatically in the second and third quarter of 2009 from the current 3% level. This will spark spread widening for low quality US names as well as EM bond prices.
While EMEA names are more likely to pay up for expensive deals to due greater financing requirements compared with lower-leveraged Latin American names, the investor base is friendlier to the Americas. Real money US investors have snapped up Latin paper over the years while crossover investors have powered EMEA corporate transactions explaining the relative outperformance of the Latin American paper. Nevertheless, with Asian private banks seeing substantial cash outflows, hedge funds collapsing, smaller EM bank franchises and institutional funds beefing up redemptions, the emerging market investor base has shrunk dramatically.
Higher fees possible
As a result, the rapidly changing global financial landscape is prompting bankers to consider revenue-making strategies over the next year now their jobs are on the line amid restructuring of investment houses.
In the bull run for emerging market assets over the past years, sovereign and increasingly corporate issuers have demanded aggressive terms to bookrunners, which have been falling over themselves to execute prize-winning deals. But now, higher execution risk will entail higher compensation, say bankers. "We will be able to charge higher fees since a few basis points here or there is a statistical discrepancy for the issuer given their higher borrowing costs," said one debt capital markets syndicate head in New York.
Latin America sovereign issuers may be forced to pay around 5bp more but higher charges will be demanded for EMEA names, potentially in line with US high yield names. "For around 23bp-30bp, you get what you pay for when you recruit the top bookrunners that will have access to as many investors as possible and have experience of good execution."
In addition, the relationship between the issuer and bookrunner is set to change and price-sensitive issuers will be snubbed. "There will be fewer bankers covering issuers, fewer costly meetings, fewer non-deal roadshows and those borrowers that dont understand that the credit cycle has changed tremendously will be ignored since bankers need fees," the same syndicate banker added.
However, another origination banker added that if deal volumes remain low and job losses are slow to kick in, strong competition for arranging new bonds would keep fees low.
In the short term, a rebound in prices will only take place when global liquidity returns, allowing new deals to take place. In the medium term, fewer public transactions and declining number of investors may have significant negative and long term impact on the asset class despite the structural strength of emerging market borrowers.