Emerging market debt softer on increased risk aversion; Korea Highway sells $500 million bonds

By Reshmi Basu and Paul A. Harris

New York, May 17 - Emerging market debt was softer Tuesday on increased risk aversion in the U.S. credit markets.

Meanwhile in the primary market, JSC Bank of Moscow sold $300 million of 5.5-year eurobonds (Baa2//BB+) at par to yield 7 3/8%. BNP Paribas and JP Morgan were the bookrunners.

State-run Korea Highway Corp. priced $500 million of 10-year senior fixed-rate notes (A3/A-/A) at 98.938 to yield a spread of 115 basis points more than Treasuries.

A trader added that the was later seen bid at the same 115 basis points spread as it was issued at.

"In a market as soft as this one it was probably an okay deal," he said.

"What people are not realizing, though, is that the existing Korea Highway '14 has blown out about 15 basis points over the past couple of weeks, which basically is a testament to how much appetite there is for supply in this market."

Citigroup, JP Morgan and UBS Investment Bank were the managers for the Rule 144A/Regulation S offering.

OJSC Gazprom, via its special purpose vehicle Gaz Capital SA, will issue dual tranches of euro-denominated and dollar-denominated notes (Baa3/BB-/BB). .

ABN Amro and Credit Suisse First Boston is running the Rule 144A/Regulation S deal.

In trading Gazprom's existing bonds were up one point on news that its board rejected the proposal to merge with Rosneft, according to a market source.

In addition, South Korea's National Agricultural Cooperative Federation (NACF) returned to the market on Tuesday with a $250 million to $400 million offering of 10-year lower tier II bonds.

The bonds are talked at mid-swaps plus 100 basis points and are expected to price on Thursday.

Barclays Capital, BNP Paribas and JP Morgan are the bookrunners for the Regulation S offering.

NACF postponed the offering on March 16, citing market conditions.

The prospective issuer is umbrella organization for Korea's regional cooperatives and has headquarters in Seoul.

EM debt softer

Overall emerging market debt prices were lower as the high-grade corporate market suffered through another round of sell-offs.

"Once more high grade, especially, is just melting down again," said a sellside source. "We've been holding in pretty well considering that," said the source.

Tuesday's slew of mixed economic data in the United States made it harder to pinpoint Tuesday's price drivers, said sources. U.S. data showed higher wholesale prices, slower industrial production and rebounding housing construction.

The Labor Department reported that the producer price index rose 0.6% in April, signaling higher energy costs. Also Tuesday, industrial production fell 0.2% last month, including a 2.3% drop in utility output, according to the Federal Reserve. In addition, the Commerce Department estimated that housing starts increased 11% in April to a 2.04 million seasonally adjusted annual rate, after falling the previous month.

"[U.S] Treasuries have held up very firm in light of the reports we got this morning on inflation on the PPI side," said Enrique Alvarez, Latin America debt strategist for think tank IDEAglobal.

"That in itself is odd," remarked Alvarez.

"It still seems to be that we have more of the carry over of the same story as far as hedge fund losses and sort of the imbalances in the CDO and CDS market.

"That is starting to become an old story with no new developments, but it seems to maintain its overhang in the market," he said.

Alvarez added that higher beta credits in Latin America saw more selling than in recent sessions. During Tuesday's session, the Brazil C bond was down 0.438 to 100.437 bid while the bond due 2040 fell 0.55 to 113.70 bid. The Russia bond due 2030 slipped 1/8 of a point to 107¼ bid.

Venezuela lower on contract worries

Investor concern over Venezuela pushed prices lower. Venezuela's national assembly will look into contracts signed with private oil firms in the 1990s.

The Venezuela bond due 2027 slipped 0.95 to 96¾ bid.

Ecuador down

Meanwhile, Ecuador bonds also took a beating. The Ecuador bond due 2030 slid 1¾ points to 77¾ bid.

"And in Ecuador, slowly but surely they continue to move in the wrong direction as far as economics and possibly fiscal effects moving forward, so I think that's also why you're seeing selling."

Credit woes hit Asian markets

The Asian high-yield market is performing better than one would expect, but that's not saying much, according to the trader.

"The market continues to degenerate because of incessant rumors of structured credit problems, as well as a pretty heavy calendar building over then next couple of weeks.

"Of course it remains to be seen whether those deals will come to the market or not," he added.

Furthermore, Asian sovereigns have eased over the past few days, he said.

The trader spotted the Philippines five-year default swap at 435 basis points on the bid side. At Friday's close, it was 410 basis points, meaning the instrument has widened 25 basis points this week.

He quoted the Korea five-year default swap at 43½ basis points bid. On Friday, it was 40.

"It hasn't moved as much as you would expect," he said.

Meanwhile news that North Korea is moving toward a nuclear test is not scaring away investors, he remarked.

"It's weighing on the market," he said.

"People are largely ignoring it, but if the situation moves from headline to event it will catch up very quickly."

The sellside source said that the news has been broadcast over and over, so the risks are known.

"How many times have we heard that story?

"I think that at this point if you buy Korea you already have yourself comfortable with that risk."

The source also said that subject of the nuclear test did not come up during the Korea Highway deal.

Nonetheless, it has implications for all of Asia, especially Northern Asia.

"There are no buyers of Korea. Usually there are no sellers of Korea but there are buyers, so there are bids.

"Fortunately right now there are no sellers of Korea because real money accounts haven't gotten nervous yet," he said.

"But at this point, since there are no buyers, it won't take a lot of paper coming out to really spook the market and push valuations out a lot."

Hard to find to direction

Furthermore, it is difficult to identify exactly what the market is looking for overall, given that the current market woes in the United States are not data specific, said Alvarez.

"They pertain to risk aversion and credit quality coming from the Ford and GM situation, so I think that's going to be a situation that is going to linger for some time until we see some definition from the ratings agencies on GM," he added.

More importantly, market participants will need to see how that story unfolds in the U.S. credit market and the resulting rippling effects for higher risks such as Latin America.

The credit market story is creating a cautious tone in emerging markets. The flare-ups will continue, depending on new developments, noted Alvarez.

"It's more of a barrier to higher levels in the market because overall, fundamentals into the market remain relatively positive.

"Treasury levels still favor the market. Nonetheless, the market is taking everything with a grain of salt and exercising caution due to this overhang of the U.S. negative sentiment on the credit side," he added.

Alvarez added that it is difficult to judge if emerging market debt is relatively expensive.

"It depends on what your appetite is for risk. We are at about 400 basis points over Treasuries on the EMBI, which is much cheaper than where we were in early March/late February," noted Alvarez.

"That being said, that depends on how much risk aversion ultimately will come back to the market."

And that depends on whether the market is at an expensive level or not, he added.

"If you judge - 3.98% versus 4.12% 10-year Treasuries in the U.S. - it's not specifically expensive in my view because the fundamentals are there.

Or more specifically, if you look at 457 over in Brazil versus 4.12% Treasuries, there's still some relative value there.

"But then again it depends on what comes up further on the U.S. side," remarked Alvarez.

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