Outlook 2017: Rates, oil prices, politics to continue to pose risks for EM bond issuers

By Christine Van Dusen

Atlanta, Dec. 30 – Emerging markets issuers – who in November and December put the brakes on a banner year for issuance amid uncertainty about global politics, interest rates and oil prices – face similar headwinds going into 2017 and could approach the primary market with caution.

Market sources estimate that emerging markets sovereigns sold more than $106 billion in debt in 2016, beating 2014’s record, while corporates printed more than $240 billion. But the march to the primary market came to a screeching halt in November, after Donald Trump unexpectedly won the presidential election in the United States. Once the markets began to adjust to that new reality, some emerging markets issuers tiptoed back to the market, with most attempting to push deals through before the Federal Reserve raised rates on Dec. 14.

“Higher United States interest rates will be something to watch in 2017, as it will increase the cost of funding,” said Cedric Rimaud, head of emerging markets for research firm Gimme Credit. “We are in an environment where credit differentiation is key.”

Supply risks for oil are rising, which could drive further fiscal consolidation for emerging markets and “drive another terms-of-trade shock,” according to a report from Morgan Stanley.

“This would pressure oil exporters, with Colombia, Venezuela, Russia and Malaysia most at risk,” the report said. “Spillover to other commodities could drag South Africa, Brazil, Chile and Indonesia lower as well.”

Turkey, however, could see some benefit, given its status as an oil importer. “But risk aversion is likely to prevail,” the report said.

Lat-Am sovereigns improving

Taking a closer look at Latin America, the credit picture there has been improving as a result of lower domestic costs, Rimaud said.

“Commodities have found a bottom during 2016 and will provide some support to several oil and mining issuers in EM,” he said.

Brazil, however, finds itself still in the midst of a recession while Argentina “has to cope with a still-difficult situation,” he said. “One country to watch, however, is Mexico, where the depreciation of the domestic currency will benefit companies with an international exposure, but penalize bond issuers with bonds denominated in dollars and revenues in Mexican pesos.”

Corporates manage capital

Numerous corporates in Latin America have been actively managing their capital structure by prepaying or launching tender offers for their shorter-dated bonds and taking advantage of the rally in spreads seen during the third quarter of 2016 to refinance in the global markets, Rimaud said.

“The debt maturity profile of many of the issuers we follow has thus been extended and the outlook for 2017 is one of reduced refinancing risk,” he said. “However, this has also been accompanied by a number of corporate defaults and distressed restructurings, due to some unsustainable capital structures for the weaker credits.”

Atlantida, Entre Rios eyed

With this as the backdrop, smaller names from Latin America could make their way to the primary market in 2017, Rimaud said.

Several of these potential issuers marketed potential deals during the second half of 2016 but didn’t get them done. On that list is Honduras-based Inversiones Atlantida, which is seeking to print its debut dollar-denominated bond via Oppenheimer.

Argentina’s Entre Rios province is another issuer that could revive a deal in the new year, after marketing a dollar bond in 2016 with Citigroup, HSBC and Santander. And Colombia’s Tecnoglass Inc. could bring its awaited $225 million debut issue with a tenor of five to seven years, a trader said. BofA Merrill Lynch and Morgan Stanley are the bookrunners for that deal.

Asia in focus

Looking to Asia, issuance in 2016 was fairly healthy, particularly in local bond markets, given that the government increased quotas for corporates to issue onshore in China.

The Chinese government “also liberalized the onshore market for foreign investors to invest in its domestic markets,” Rimaud said. “This drove onshore yields down further but raises financial vulnerability of the indebted corporates in the event of a sell-off.”

Now, concerns are increasing about the amount of debt that corporates had been issuing as they rode on the liquidity cycle and added debt to their balance sheets, Rimaud said, noting that issuance rose about 66% in the third quarter, year over year.

“Some borrowers will find it a difficult task to service their debts,” he said. “Deteriorating credit profiles were also caused by some of the most challenging times for commodity and energy producers, as well as property developers that had over-expanded. But demand for properties in lower-tier cities had failed to keep up with supply.”

Europe EM gets lifeline

From central and emerging Europe, corporate bond issuers got a lifeline in 2016 in the form of flexible exchange rates, Rimaud said.

“By lowering domestic costs relative to dollar income, several commodity exporters have been able to raise EBITDA levels, weathering the storm and working on rolling out their maturities to come out of the crisis,” he said. “This was the case for Russian corporate issuers that have most of their operating costs denominated in Russian ruble and export goods to Europe or elsewhere while they bill in U.S. dollars or euros.”

The ruble weakened in response to sanctions as a result of the crisis with Ukraine, he said.

“While sanctions against Russia, and oil prices, have remained at fairly low levels, the Russian government spread has now returned to pre-crisis levels,” Rimaud said. “A new U.S. policy toward Russia could bring a normalization of issuance, but it is way too early to know when and how.”

Rise in green bonds

The new year could bring an uptick in the issuance of green bonds, a trader said, following the example set by Poland, which in December became the first sovereign to issue these notes. The sovereign printed €750 million ½% green bonds due Dec. 20, 2021 at 99.343 to yield mid-swaps plus 148 bps via HSBC, JPMorgan and PKO BP, and the books were said to be €1.4 billion.

Issuance of green bonds in 2016 far outpaced 2015’s level of $42.4 billion, which was a record itself, according to the Institute for Energy Economics and Financial Analysis.

“Renewable energy and energy efficiency remain the most popular projects linked to green bond issuance, which is being driven by sustained and increasing interest from institutional investors,” the institute’s report said.

India could lead green supply

Corporates from India could emerge as bigger issuers of green bonds in the new year.

“The renewable energy debt market, once dominated by development banks, can be an important source of capital on attractive terms for the continued expansion of the Indian renewables sector,” the institute’s report said.

“With international bond rates of 2% to 4%, significantly lower than the usual 8% to 12% corporate borrowing costs in India, growing utilization of the green bond market will see the capital cost of these projects drop,” according to the report.

Qatar in focus

Looking to the Middle East, Qatar could issue new paper in the new year, after issuing $9 billion in sovereign bonds during 2016, a trader said.

“We are sitting here looking at a very impressive spread performance from this supply in the face of some decent challenges regionally and on macro dynamics,” he said. “I would suspect the sovereign may look again to issue paper. A sukuk has been rumored and would be welcome given the Jan. 18 sukuk maturity.”

“Commodities have found a bottom during 2016 and will provide some support to several oil and mining issuers in EM.” – Cedric Rimaud, head of emerging markets for research firm Gimme Credit

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