EMTA's Second Corporate Bond Forum Held in New York
eMTA continued its Corporate Bond Forum series in New York on Wednesday, May 9, 2007. ING Financial Markets sponsored the event, which was held at the Parker Meridien Hotel. This follows EMTA’s initial Corporate Bond Forum, held in London in January 2007 (see EMTA’s First Quarter 2007 bulletin).
In introductory remarks, EMTA Board Director and ING Global Head of EM Strategy H. David Spegel stressed the importance of corporate bond issues in the EM marketplace. Spegel noted that such debt issues now accounting for 40% of the tradable universe, up from a 10% share in 2000, and that there are currently 1,100 corporate issuers with outstanding bonds.
Vincent Truglia of Moody’s Investors Service delivered the Forum’s keynote presentation, discussing both his agency’s methodology for rating corporate bonds and the circumstances necessary for a corporate to pierce the sovereign ceiling. Truglia began his presentation with an overview of EM corporate bond ratings, noting that Moody’s currently rates 448 EM corporates.
Truglia noted that Moody’s has allowed an individual security—though not an issuer—to pierce the sovereign foreign-currency ceiling since 2001. In May 2006 Moody’s revised its sovereign rating methodology. Previously a country’s sovereign rating almost always equaled its foreign-currency government bond rating; this was based on an assumption of a 100% probability of a general foreign-currency debt payment moratorium following a sovereign foreign-currency default. However recent historical examples such as Belize, the Dominican Republic, Moldova, Pakistan, Russia, Ukraine and Uruguay did not include a general moratorium on foreign currency-debt payments, with only Argentina’s default resembling the “old-style” defaults of the 1970s and 1980s. Moody’s new methodology has thus evolved to address recent default history, new reality, and the agency now factors in both the country’s foreign-currency default probability and the probability of a subsequent general foreign currency payment moratorium in formulating its country ceiling.
Bonds are still allowed to pierce a country’s ceiling under the revised methodology, but an important (and admittedly controversial) pre-requisite is that the bonds be “marketable” and sold under foreign law, thereby decreasing the sovereign’s ability to influence local institutions. The agency determines whether an issue can be rated higher than its sovereign by an analysis of the government’s foreign-currency bond rating, the probability of a moratorium following a sovereign default, the special circumstances of the issuer and the issuer’s creditworthiness, i.e. its local currency bond rating.
Click Here for slides from Truglia’s speech.
Truglia’s presentation was followed by a panel discussion of EM corporate experts. ING’s Warut Promboon moderated the session, beginning by asking Anne Milne (Deutsche Bank) to discuss the effects of global liquidity on the asset class. Milne noted that EM corporates have benefited from increased allocations from the buy-side, and by the decline of sovereign issuance in recent years. Spread differentials on higher- and lower-rated issues are quite low due to the increased appetite for corporates in general. Milne commented that a decrease in liquidity could affect corporate pricing in different ways, depending on the trigger event; however, while “marginal players could leave, core players would still support the asset class.”
Alfredo Chang of GE Asset Management added that liquidity has allowed many issuers to come to market that would not have markets access in less benign conditions, or at least not at such tight spreads. More recent investors lack the “battle scars” of the Asian crisis, he noted. Chang called for increased research coverage of corporate issuers, suggesting that the growth in issuers will become an industry issue.
Katherine Renfrew (TIAA-CREF) acknowledged that with such compressed spreads, it is not easy to decide where to invest. “When you are not paid appropriately for the additional risk of a company, we are not buyers,” she stated. However she acknowledged that there are some cases where she might reconsider an issue on price dips that had originally been passed on. Renfrew specified that corporates comprise 45% of her portfolio.
Panelists discussed risks to the sector. Renfrew voiced concerns regarding crowded trades, and the potential for “not sticky” crossover investors to hold a greater share of EM corporates. Promboon reminded the audience of the Ocean Grand debacle, stressing the importance of “doing one’s homework.” Chang underscored that a portfolio manager must be patient in the quest for the “right package,” i.e. a bond that comes at the right price with acceptable covenants.
Aaron Holsberg of ABN Amro forecast that issuance trends in the second half of the year would largely mirror those in the first half. “We have borrowers coming out of the woodwork to take advantage of market conditions,” he noted, predicting that lower-rated credits and new issuers will comprise an increasing percentage of new debt as some previous issuers have been upgraded and are accessing capital via the syndicated loan market. Holsberg advised investors that in order to find value, one must “roll up your sleeves and do the credit work.”
Turning to audience questions, sell side speakers agreed that rhetoric by Venezuelan president concerning possible nationalizations and a withdrawal from the IMF would not serve as a trigger event for a sell-off and that a compromise would be reached. Other topics included a comparison of corporate governance on a regional level, with speakers praising improvements in Brazil and Mexico and suggesting that transparency in Latin America compares favorably to other areas. Finally, one speaker noted that corporate bond analysts are so flooded with work on new issue analysis that there is little time left to develop a corporate bond index that would have wide appeal.
The panel concluded with speaker recommendations. Holsberg stated that it was difficult for a researcher to recommend any “100 bp ideas, it’s more like 25 bp ideas.” He joked that the best thing a portfolio manager could do was to pick the “right new issue…and get allocated!” Milne, while advising that current returns are below the level where she likes to make recommendations, suggested Cemex perpetual bonds and Argentine corporates as worth a look.
Renfrew spoke positively on TAM and Gol, arguing that Brazilian airlines do not face the labor issues that have beleaguered their US counterparts. She specified that the Egyptian telecom firm Orascom was an issue that she had originally passed on, but which might be worth a second look. Chang expressed interest in the short end of Kazakh bank issues, Brazilian meatpackers, and concurred with Hoslberg on Isa Capital of Brazil and the Mexican entertainment company CIE.
“The EM corporate bond market is dynamic and its evolution is exciting,” summarized Promboon as he invited attendees to attend a cocktail reception with a magnificent 42nd floor view of Central Park.