Emerging market debt trades flat to lower; Gazprom sells €1 billion 10-year bonds at 5 7/8%

By Reshmi Basu and Paul A. Harris

New York, May 20 - Emerging market debt ended the session mixed Friday, with double-B credits outperforming the broader market.

In the primary market, OJSC Gazprom, via its financing vehicle Gaz Capital SA, priced €1 billion of 10-year notes (Baa3/BB-/BB) at par to yield 5 7/8%.

Gazprom was originally going to issue a dual tranche offering of dollar- and euro-denominated notes, but eventually canceled the dollar portion.

One reason why they dropped the dollar tranche was because "they do a lot of business in Europe," said an investor.

"If you do it at 6% in euros, and your liabilities are more in line with your assets and it's a lower yield, why not do it."

ABN Amro and Credit Suisse First Boston ran the deal.

Meanwhile, Russia's announcement that it would raise its Gazprom holdings to a controlling stake had little impact on the new issue, according to a debt strategist.

The state will get a controlling stake via a cash buyback of Gazprom treasury stock, forsaking the merger between Gazprom and state oil firm Rosneft.

"I think people see both Gazprom and Rosneft as state-owned, said the strategist.

"The question is who in the state gets to do the owning.

"They aren't going to be dominated by government policy. This is more who gets to do what with whom and it's kind of inside baseball," he added.

Subdued session in EM

Overall, trading in emerging markets was subdued and quiet Friday, according to sources.

A trader described the session as mixed. Brazil traded flat. Double-B credits, such as Colombia, Peru and Panama, were up on the day.

The "updrift" in double-B credits was because of "little excess enthusiasm of what has been happening in the past days on the Brazilian front," said Enrique Alvarez, Latin America debt strategist for think tank IDEAglobal.

For the session, The Brazil bond due 2040 was unchanged at 155.30 bid, 115½ offered. The Columbia bond due 2033 was up half a point at 112¼ bid, 113 offered. The Panama bonds due 2034 were up half a point at 108½ bid, 109½ offered. And Peru's bonds due 2033 ended up a quarter of a point at 108¼ bid, 109 offered.

"All the external influences were either flat or sort of drifted," said Alvarez.

"You had the dollar a little stronger but the currencies in Latin America were also stronger, so there was nothing there."

The equities market ended mixed as well. The Dow Jones Industrial Average slipped 21.28 points to 10,471.91 while the Nasdaq composite moved up 3.84 points to 2.046.42.

U.S. Treasuries also traded very tight, noted Alvarez. The yield on the 10-year note stood at 4.12%, up slightly from 4.10% on Thursday.

"Oil continues to be an interesting story for Latin America. The lower oil goes, the better the sentiment all around," he added.

Looking ahead, Alvarez said that the coming week's drivers would depend on if there were any new developments on the General Motors Corp. front.

"Ford is now essentially a done deal and we have turned the page on that one," remarked Alvarez.

In late afternoon Thursday, Fitch downgraded Ford to BBB. The market eventually rallied on the news that the automaker's ratings were not cut to junk, said a market source

Regarding GM, "there could be some noise into emerging markets potentially, but I'm not convinced of that right now," said Alvarez.

The market's dependency on U.S. economic data still exists but its influence may wane slightly, given that it is the last week of the month, therefore Alvarez expects to see the market drift.

"They may be some attempts at the high above 116 on the Brazil '40, but I don't see that much else materializing unless the Fed says something in the minutes that we haven't foreseen," he added.

Trading will most likely be range-bound to flat until there is new evidence on the direction of the U.S. economy and inflation. That evidence starts coming out in the first week of June, he added.

Divergence of EM and junk

Emerging market debt and high-yield have been traveling on different paths for the past six or eight weeks, according to the trader.

"People look at high-yield versus emerging markets, and high-yield was so overdone in terms of credit fundamentals versus emerging markets," said the trader.

"High yield had been driven by technicals, whereas in emerging markets you had improving credit stories," he said.

"So it's easier to justify emerging markets tightening, especially on the Latin American side, while high-yield languishes.

"Plus you have all of these hedge funds that made these index plays, forcing spreads in certain directions. So in high-yield it's more of a technical sell-off than anything else.

"We're not feeling that pinch in emerging markets," added the trader.

The debt strategist agreed emerging markets has proven highly resilient to such stories as Ford, GM, CDO tranches, hedge funds - just about everything.

"There's really been very little impact on emerging market debt," he said.

The strategist argues that one reason why the market has proven resilient is because the automakers' woes are "not a big deal." The shock to the system is just not that big.

"We're talking about some relative value trades - sort of three dimensions removed from physical bonds," he said.

"A few people lost some money, but it wasn't very big money. And it wasn't that many people. The sheer size of it just wasn't big enough," he remarked.

Furthermore, there is no physical default, he said. Ford and GM were downgraded. They did not default, he emphasized.

"This is very far away from what happened in 1998. In 1998, you had an Asian debt crisis with massive illiquidity, followed by the insolvency of the Russian Federation.

"These were tens of billion of dollars that were moving around - huge numbers. We have nothing like that now," he remarked.

Even in a doomsday scenario, investors would not see the kind of losses seen with Russia's default, he added.

A second reason is that there still are positive inflows into emerging markets. The strategist has heard that there is over a billion dollars in debt mandates over the last few months for the asset class.

"That's a lot of money. Issuance has been modest," he noted.

"And lastly, the last time people really tried to short this thing, it didn't really work really well," he commented.

Looking at the Brazil 2040, the strategist said that the bond has gone down a point before bouncing back.

"In May of last year, we moved 10 points. So we've seen a tenth of the volatility we saw one year ago on this whole CDS, hedge fund kafuffle."

"It's just not a big deal. We are benefiting from the fact that the reality is that the commodity story, while it has come off its top, it's still strong enough that you see dramatic positive cash flows into the emerging markets on average and that really is a very positive liquidity driver that's holding up nicely."

Meanwhile, for the week ending May 18, emerging market bond funds took in $103.2 million, which adds up to $3.02 billion for the year to date, according to EmergingPortfolio.com Fund Research.

Still place for supply, says trader

There is still room for new supply, said the trader.

"The market gets unsettled the day the new supply comes, and ultimately the supply gets absorbed in two or three days.

"If you have multi-billion deals you do it here and there.

"Overall, on a credit-by-credit basis, the sovereigns do not have a lot more issuance to do. Brazil will come with more. But there is not a lot," added the trader.

"You have to assume the corporates will come because that window is going to open up more and more," added the trader.

But corporates and sovereigns attract different investment pools, remarked the trader.

"Some of the insurance funds will still buy corporates, and won't get into the sovereigns, whereas some of the dedicated real-money guys strictly play sovereigns.

"Since 1998 the markets are still pretty separate."

And lastly, local currency deals may be the one place where investors can still find value, said the strategist.

"It's not as rich as it has been, but it's not cheap yet. But there's still pockets of value here and there," he remarked.

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