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Corporate Bond Forum NY - May 22, 2012

Upbeat Assessment of EM Corporate Bond Market for the Long-Term, While Short-Term Concerns Remain

Speakers reaffirmed their interest in the EM corporate asset-class during the EMTA Corporate Bond Forum on May 22, 2012.  ING sponsored the event, held at the Marriott Marquis Hotel in midtown Manhattan.  Over 125 market participants attended.

ING’s David Spegel started the discussion with a review of inflows into the asset-class.  He then discussed external risks to EM corporates, noting that the Greek crisis continues to overhang the market.  Investors also appeared to be monitoring the US election cycle, a deceleration of the Chinese economy and sluggish demand in Brazil, he added.  Spegel asked Corporate Forum panelists to identify the main drivers of asset-class performance.

Federated Investor’s Paolo Valle viewed performance as a function of generally strong EM domestic demand, low funding costs in G-3 countries and liquidity that was prompting a search for yield.  Prudential’s David Masse cited the Eurozone crisis as being the dominant factor, which he acknowledged was “very frustrating for a fundamentals-based analyst.”  In addition, other factors included corporate treatment in Argentina, the Venezuelan and Egyptian elections, and the political transition in China.

Bank of America’s Anne Milne differentiated between the short-term factors of Europe and China and longer term trends that favored the asset-class, such as inflows and increasing investor interest.  Eric Ollom of Citi cited US growth as a major factor weighing on EM corporate performance.

Spegel reviewed statistics on shrinking bank loans to EM companies and polled speakers on possible ramifications for bond issuance and liquidity.  Milne pointed out that a decline in bank lending to EM corporates from European banks was being offset to some extent by an increase in funding from Japanese banks and domestic LatAm markets.  Ollom concurred.  “This is what should happen,” he argued, “EM corporates should rely more on domestic sources of capital and less on external funding.”

Valle saw limited effects on Asian corporate issuers whereas there would be more ramifications on CEMEA credits.  Masse noted that firms able to access the dollar-bond markets would be the least affected by any decrease in bank loans.  Spegel noted the upbeat assessments from the panel, while expressing a concern that upcoming bank loan rollovers could prove complicated if, for any reason, demand from external investors were to dry up.

Credit fundamentals and recent EM corporate ratings downgrades were also debated.  “There is a slight deterioration in EM credit quality, though EM is still out-performing DM; it is something to monitor but important to realize that EM companies are still doing better than their developed-market peers,” commented Milne.  She also suggested that ratings tend to be based on historical information, rather than forward-looking.

Valle reasoned that “The cycle for EM credits has peaked on a short-term basis, but things still look good for the long-term.  Companies exposed to commodity price decreases would fare worse than those which focused on domestic consumers and leverage will likely increase.”  Ollom agreed, observing that “earnings are not that terrible, they have just come off peak levels especially in commodities.”

Masse offered a vision of “a credit plateau” rather than a peak.  “Growth just isn’t as strong as it was; pricing power is declining as margins are narrowing.”  He added that a large portion of ratings downgrades were related to Argentina, which masked a “true ratings drift which is sideways.”

On liquidity, Spegel observed that dealer inventories had decreased to one-third of 2008 levels, and referred to EMTA Trading Volume numbers which revealed a decrease in EM corporate bond trading velocity (60% of the outstanding supply of bonds changed hands on a quarterly basis in 2008, while that ratio dropped to 20% by year-end 2011, he noted).  The panel discussed the implications on liquidity of upcoming Basel and Dodd-Frank regulatory changes. 

Valle referred to a recent JPMorgan study which concluded that the turnover rate in EM corporates was outperforming relative to US corporates, with turnover rate measured as daily trading divided by asset-class size.  Recent “risk-on, risk-off” market fluctuations have deterred dealers from holding inventories, Masse argued, although he highlighted the increase in investors entering the asset-class.

Uncertainty about the Volcker Rule and its timing has indeed depressed volumes, agreed Ollom.  “While much is uncertain, what we do know is that increased compliance costs will drive dealers out of the market...and fewer market-makers means less liquidity,” he affirmed.  With the buyside now holding increasing amounts of EM corporate debt, sell-side firms have decreasing ability to provide liquidity.  The BlackRock initiative could be of interest to buyside firms, “but will you be able to move $50 million in Cemex paper that way?” he pondered.

“The market will have to be creative in this atmosphere of a growing buyside and a shrinking sellside,” Milne offered, “and the buyside may have to consider alternatives to provide liquidity amongst themselves.”  She added that EM corporate ETFs and products such as Total Return Swaps were just at their nascent stages and could prove a new tool for investment and hedging purposes.

On the topic of restructurings, bankruptcy code reform had thus far disappointed market participants, according to Ollom, with “Brazil probably still needing to do more work than Mexico.”  He underscored the benefits for local economies, “for example, these would allow for the removal of ineffective management teams.” 

Caveat emptor applied, according to Valle.  “You need to read the documentation, and understand the bankruptcy law and judicial systems in each country.”  Masse cautioned that China offered even less protection to foreign investors, with onshore assets largely immune from seizure by foreigners.

The panel concluded with investment recommendations.  Milne and Ollom concurred with positive comments on Mexican homebuilders, Cemex, and Country Garden.  Milne also spoke positively on Chilean paper companies, CSN and top tier, state-owned Russian banks; while Ollom favored Minerva and Fibria and would avoid Kaz Gas and Ukrainian corporates.  On a short-term basis, Valle liked high-grade over high-yield.  He also voiced enthusiasm for PDVSA, quasi-sovereigns from Brazil, Mexico and Indonesia and Russian telecoms.  Masse advised attendees to compare the asset-class to US corporate and EM sovereigns to determine where better value could be found.