South Africa sells $1 billion 10-years; emerging market debt trades higher

By Reshmi Basu and Paul A. Harris

New York, May 25 - In primary action, South Africa and Korea Land Corp. came to market on Tuesday.

The Republic of South Africa priced its $1 billion 6½% 10-year global bonds (Baa2/BBB) at a spread of 195 basis points or a yield of 6.682%.

Ahead of the deal, some had said the sovereign issue would cue investors into what direction the primary market was taking.

But while the investment-grade deal was well received, a primary market source said it was too early to conclude that the bond issuance market is open for business.

"South Africa is an infrequent issuer and I think is viewed as a nice, defensive name to buy," said the primary market source.

"Also, it usually trades tight to Mexico and recently has been trading wide. Mex '14s have been bid in the 175-178 bps range today by comparison," added the source.

"The deal has gone well though and has traded well secondary. In this market, if you are going to do a deal you have to be doubly certain it will trade well."

Barclays Capital and JP Morgan ran the books for the off-the-shelf issue. The co-manager was Rand Merchant Bank.

In other primary news, Korea Land priced its $500 million10-year senior unsecured notes at 98.347 to yield U.S. Treasuries plus 125 basis points.

The issue came to market in line with price guidance which had put the spread in the area of 125 basis points over Treasuries.

Some investors were displeased with the tight spread.

"Too choppy of a market for me to participate in new deals. They don't meet my return target," said Steve M. Hope, managing partner of Outrider Management.

Citigroup and Deutsche Bank ran the books on the Rule 144A/Regulation S offering for the Korean land utilization company.

Based on the two deals pricing Tuesday, one emerging markets analyst disagreed with the primary market source quoted above and said the primary action may suggest a sense of stability for investment-grade issuers ready to enter the market.

"I think the successful deals in South Africa and Korea Land show that the market - at least temporarily - has settled down and has begun to return to normal," said the analyst.

"This should improve investor sentiment to some degree, although there still is not much evidence that sub-investment grade EM credits can come to market yet."

In other primary news, Russia's Promsvyazbank plans to issue a $200 million eurobond via ING and UBS Securities.

Market trades higher

Generally the market moved higher in trading Tuesday. The JP Morgan EMBI Index rose 0.66% while its spread to Treasuries tightened 12 basis points to 501 basis points.

The session was positive for Brazilian sovereigns, a buy-side source said.

But while the market appears to have recovered in the near-term, market jitter may sideline investors.

Looking ahead for emerging market debt, there will be more supply than demand, according to Outrider's Hope.

"I'm sitting on a lot of cash and am waiting for tremendous opportunities," said Hope.

"We're entering a period where paper is going to be offered not bought.

"I think we've gone in three months from a market where any offer was a good offer to a market where any bid is a good bid.

"Yesterday's flowers are today's weeds - to paraphrase Warren Buffet."

In a climate of rising risk aversion, finding buyers may be hard.

"I think the problem for distressed debt investors in the emerging market over the next year is that there will be very little take-out - i.e. the restructuring deals are going to get done and there will be no one to sell your new bonds to," said Hope.

"The presumption of an exit yield based on a liquid market for bonds on the far side of the transaction is a mistaken presumption.

"There is no dedicated market of sufficient size to take up those kinds of bonds," added Hope.

Carry trade may not be over

While there appears to be some stability in the market, the unwinding of the global carry trade may not be over, according to an investor.

Part of May's bloodshed in emerging markets was blamed on the pressure from investors unwinding positions where they had borrowed at low rates to invest in riskier high yielding credits. With the prospect of more expensive funding, they dumped the credits they had bought with cheap money.

"I really don't think there are many people who think of that [carry trade] as their investment strategy," said the investor.

"I think what happens is that through various intermediaries the provision of liquidity ends up being put into all sorts of different investments.

"The carry trade doesn't get unwound until funds actually move," added the investor.

"At least that was our experience in '94 where they telegraphed for a long time that rates were actually going to be moving.

"But as long as there is a supply of cash in the system, the marginal investors don't think they should or have to care about what the Fed might do.

"The reality is that people who are investing in some of the asset classes don't see the linkages through the financial system," noted the investor.

"The carry trade gets unwound when the funds move and not particularly before that. "

Split market

Looking ahead, Outrider's Hope told Prospect News that one real issue for emerging market debt is the real bifurcation in the market between the good credits and the bad credits,.

"It's hard to see the Russian sovereign from a credit standpoint having great difficulty in a way that a lot of the rest of the EMBI could," said Hope.

"We have this weird world where roughly half of emerging market bonds today are investment-grade. Much of the other half has serious fiscal problems.

"It's oil and water in the sense that emerging market investors have a very clear choice.

"They can be high beta or low beta. What is going to be the determinant of performance in the coming 12 months and three years is whether you make the right call on high beta credits, notably Brazil because it is so big and a key component of the index," Hope added.

Other high beta credits include Turkey and Venezuela.

A host of issues such as the upcoming Fed hike rates, rising oil prices, China's efforts to cool down its economy and geopolitical concerns will shape the face of EM debt.

Other stories that will move the market are what steps the Brazilian government will take to jumpstart its economy.

The issue will be "whether they can stay fairly conservative on the fiscal front with the increasing unpopularity of the government," said Hope.

Adding more pressure to President Luiz Inacio Lula da Silva was the release Tuesday of employment data - one of two sets of key Brazilian economic data that investors are watching this week.

Brazil's jobless rate increased in April to its highest level in more than two years. Unemployment rose to 13.1% from 12.8% in March and 12.4% a year ago for the countries' six largest metropolitan areas.

Coming up on Thursday's is Brazil's first quarter GDP.

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