Emerging market debt up; Philippines taps 2014 bonds; Germany's debt repackage questioned

By Reshmi Basu and Paul A. Harris

New York, June 29 - Emerging market debt rose Tuesday as uneasy investors awaited the wrap-up of the much anticipated Federal Reserve meeting Wednesday.

The U.S. central bank is expected to raise interest rates by 25 basis points in its first hike in four years. The announcement is expected around 2:15 pm ET, ending months of nerve-wracking speculation by investors.

Overall emerging markets debt was up during Tuesday's session. The JP Morgan EMBI Global Index rose 0.24%. Its spread to Treasuries tightened by one basis point to 479 basis points.

"It was a positive Treasury market," said a trader.

"And the Latin American local markets were positive. So all of the buyers were out today."

U.S. Treasury prices closed higher Tuesday despite a surge in consumer confidence to a two-year high.

And Brazilian paper was firmer during Tuesday's session.

"Brazil was down 0.75 on Monday. On Tuesday it was up 1.375 on a similar Treasury move," said the trader.

"The markets continue to have underlying strength to them," the trader added.

"We continue to see people who like the fundamentals. There is not a lot of upside and not a lot of downside."

The Brazil bond due 2040 was up 1½ to 92.9 bid while the C bond was bid at 91.125, up 0.938, in late trading.

Brazil's component of the JP Morgan Index jumped 0.93%. Its spread to Treasuries tightened by 15 basis points to 647 basis points.

Philippines taps 2017 bond

In primary action, the government of the Philippines slipped in before the conclusion of the Fed meeting with a $250 million reopening of its bond due 2017 (Ba2/BB/BB) to help cash-starved National Power Corp.

This is the second issuance by the government this year to help the state-run company, which is in dire need of $1.5 billion of funding this year.

However, one source said the move is surprising, given the political concerns over newly elected Philippines president Gloria Arroyo as she begins her six-year term amidst election controversy. However, Napocor's crushing debt may mean more issuance this year.

"We're hearing that the government expects to issue $1 billion this year to bail out Napocor," said another trader.

The $250 million add-on to the Philippines' 9.375% bonds due Jan. 18, 2017 priced at 100.25 for a yield of 9.326% or a spread to U.S. Treasuries of 461 basis points.

The $250 million tap brings the total deal size to $1 billion.

The Philippines' component of the EMBI Index fell 0.72% in trading Tuesday. Its spread to Treasuries widened 13 basis points to 451 basis points.

Cyprus, India bank start marketing

In other action, the Republic of Cyprus and the Export Import Bank of India are heading on the road.

The Republic of Cyprus plans to roadshow a euro-denominated benchmark deal (A2/A) from July 2 to 5 via Credit Suisse First Boston and UBS Securities

And Export Import Bank of India is planning to market its minimum $200 million offering of five-year senior unsecured notes (Baa3/BB/BB+) from July 2 to 6.

Citigroup and Deutsche Bank Securities are running the Regulation S deal.

Germany debt repackaging may set trend

Germany's repackaging of Paris Club debt has incited a sell-off of Russian paper, as investors wonder if the dumping of bilateral debt will be the new trend in emerging markets.

"Although this is not a bond issued by Russia, it does in fact move Russian credit risk from Germany's hands to the market's hand," said a buy-side source.

That supply concern incited a Russian paper sell-off last week, coupled with uncertainties over the structure of the deal.

"It does look cheap versus the Russian curve and versus comparables like Colombia and Peru - the double B universe in general," added the buy-side source.

"It seems that from what we're hearing, there is pretty good demand in general."

Germany's repackaging is being issued through special-purpose vehicle Aries Vermogensverwaltungs GmbH. The deal will be $250 million and €250 million in three tranches (Ba2/BB+) with talk for euro-denominated floating-rate notes due 2007 at six-month Euribor plus 300 to 325 basis points, for euro-denominated fixed-rate notes due 2009 at 7¾%-8% and for dollar-denominated fixed-rate notes due 2014 at 9¾%-10%. Exact tranche sizes are still to be determined. Deutsche Bank Securities and Goldman Sachs & Co. are bookrunners for the Rule 144A/Regulation S financing.

However, whether this deal will set a trend will depend on how much interest the indebted country is paying on Paris Club debt and how much it will cost the creditor countries such as France or Germany to carry out such a deal.

"I think in order to get investor demand, the coupon or yield that you are going to get on this kind of deal has to be more than what you are getting on the sovereign," said the buy-side source.

Most of the time, Paris Club arrangements have very favorable interest rates.

In any case, the creditor -the country that securitizes the Paris Club debt - is going to have to pay for that transaction.

"It's not public information. We don't know how much the country is paying," added the buy-side source.

With some $300 billion Paris Club debt owed by emerging market countries, the quality of the indebted nation will figure into how such a transaction will play into the market. And Asian countries, such as China and Indonesia, carry much of the debt load.

"China trades very tight as it is," said the buy-side source. "I can't imagine any deal like that would be more 10 to 20 basis points off the back of China."

The deal for Germany will be a litmus test for other similar deals, although many factors need to be considered.

"This will depend on the creditor country not on the debtor country," said the buy-side source.

Nonetheless, the deal has unsettled a lot of investors as it raises the possibility that Paris Club securitizations could be a persistent supply threat, according to an emerging market analyst.

"The big problem is that nobody really knows whether this will be a one-time-only event or whether there will be more of this kind of deals to come," he said.

"Russia is especially threatened because of its more than $50 billion in bilateral obligations but there are plenty of other credits who could also potentially be at risk.

"Some investors are arguing that this won't happen very often because the sovereign creditors [like Germany] who repackage their bilateral loans have to pay more on the bonds than they receive on the bilateral loans.

"But the additional spread isn't necessarily that high and it unloads a lot of risk onto the market while at the same time giving the sovereign creditor a windfall cash infusion up front. We won't know what this will mean for the market as a whole for a while, but it's definitely going to be another risk factor in the months ahead," he added.

In response to the Aries deal, Banc of America analyst Callum Henderson cut his recommendation on Russia to market weight from overweight until the picture about possible new supply is clearer - although he noted that Russia's fundamental outlook remains favorable with high oil prices helping push economic growth to 6% to 7% this year as the country records a fiscal and current account surplus.

Up to €14 billion of new paper could be pushed into the market from securitization of Russian debt, Henderson wrote in Banc of America's Situation Room report, and other countries such as Indonesia, Russia, China, Nigeria, Egypt, Thailand, Poland, Algeria and the Philippines could also be affected.

The result could be a "significant underperformance" of emerging market debt.

But at the same time, Henderson noted the Aires offering is the first of its kind since a French securitization of Polish debt in 1997. Furthermore, he said Banc of America's economists believe the sale is not related to the Maastricht criteria but to German national law which requires a state of emergency to be called if the budget deficit exceeds investment spending.

After falling in recent sessions, Russia did recover in trading Tuesday. The Russia bond due 2007 was unchanged at 112¾ bid. The bond due 2010 was up 3.10 to 107.56 bid and the bond due 2018 was up a quarter of a point to 124¾ bid. But the bond due 2005 was down 1.012 to 104.3 bid.

Russia's component of the EMBI was up 0.51%. Its spread to Treasuries tightened by six basis points to 295 basis points.

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