Outlook 2020: Lighter EM issuance eyed after strong 2019; credit positive, with risks to downside

By Rebecca Melvin

New York, Dec. 31 – Emerging markets debt heads into the new year on solid footing. The economic backdrop is favorable, with positive global growth prospects, low rates and lower recession risk. But issuance may be lighter in 2020 than in 2019 given a few country-specific pitfalls and following strong deal flow this year, according to market sources.

Issuance volume could be curbed by a potential Argentina default, a ratings agency downgrade of Mexico’s sovereign and Petroleos Mexicanos SAB de CV’s debt, and a drop in Chinese property sector issuance, expected to occur due to policy changes in China, according to the 2020 outlook of BofA Merrill Lynch Global Research.

Following a 23% increase in EM corporate debt issuance for 2019 to $423 billion, there could be a 15% decline in 2020, mainly due to lower supply from Asia, which is predicted to total $215 billion, according to BofA’s research team.

The research team also predicted a 12% increase in issuance from Emerging Europe, Middle East and Africa, to $96 billion, and a 5% decrease in Latin America, to $60 billion for 2020.

To some extent, however, lighter issuance might also be chalked up to the typical ebb and flow of EM debt volume from year to year.

As of Dec. 18, year-to-date EM issuance, including hard-currency sovereign bonds and corporate bonds, stood at $602.74 billion in 1,038 deals, according to Prospect News’ data.

The tally is up 40% from 2018’s total volume of $431.26 billion in 763 deals. It is also up – albeit significantly less so – from 2017, when total volume was $589.28 billion in 1,242 deals. The $589 billion 2017 total, which is in the ballpark of this year’s volume, was up significantly from $451.60 billion of issuance in 684 deals for 2016. The four-year trend points to a range of higher and lower issuance for the asset class.

This past year’s most active months for EM issuance were April, September, October and November. All four months saw more than $60 billion in issuance, with November representing the single biggest flow, or more than $68.32 billion in 132 deals.

In terms of the year’s biggest deals, the $12 billion bond debut of Saudi Arabia’s state oil giant Saudi Arabian Oil Co. (Aramco) made a splash in April and the $12 billion of bonds that Qatar priced in March were another mouthful.

In addition to Aramco’s deal, April’s offerings included CSN Resources SA, a subsidiary of Brazil’s Companhia Siderurgica Nacional (CSN), which priced $1 billion of notes in two parts, including $600 million of new seven-year notes with a 7 7/8% coupon and a $400 million tap of its existing 7 5/8% notes due 2023.

Peru-based Alicorp SAA’s local-currency deal S/. 1.64 billion of 6 7/8% notes due 2027, which was marketed internationally, priced at par.

The proceeds of the nuevo sol-denominated notes will be used to repay bridge financing of its recent acquisition of Intradevco.

And Panama also priced as did GTLK Europe Capital DAC for the CIS region.

May was light in terms of issuance. It had half the amount of volume of the highest months, or $33.6 billion in 62 deals. But that month included deals by Latvia, Guatemala and Kenya, and corporate issuance from Saudi Telecom Co., with a 3.89% sukuk due 2029, and Marfrig Global Foods SA, with a 7% note due 2026.

In September, when the market regrouped following the typical summer slowdown, Abu Dhabi sold a $10 billion bond, Armenia priced $500 million of bonds, South Africa priced $5 billion, Ecuador priced $2 billion, Bahrain priced $2 billion, Uruguay sold $750 million and Kazakhstan sold €1.15 billion of bonds.

Also notable among sovereign issuance was the number of times that Turkey tapped the international debt market, coming to investors six times for a total of $9.75 billion and €1.25 billion of notes in 2019.

Turkey first accessed to market on Jan. 10, pricing a $2 billion issue of 7 5/8% notes due 2029. It accessed a second time in January, with a euro-denominated issue, and again in February, March, July and November.

China was absent from the market for much of the year until November and has since brought at least $4 billion and €4 billion in international notes.

Saudi Arabia was only a slightly smaller presence this past year compared to 2018, bringing $10 billion and €3 billion in notes in three deals, compared to its single, $11 billion blockbuster that priced in the spring of 2018. Egypt was also a significant issuer, bringing $6 billion and €3 billion in notes, respectively, this past year.

Among corporate credits, China’s Tencent Holdings Ltd.’s offering in five tranches for $6 billion was significant.

Positive backdrop

Low borrowing costs after rate cuts undertaken by the U.S. Federal Reserve, the European Central Bank and China boosted activity, as did a relative lull in U.S.-China trade tensions, culminating in the so-called phase one U.S.-China trade agreement in December.

Many market players anticipate a positive economic backdrop continuing for 2020. Low rates globally encourage both issuers to issue and investors to look at higher-yielding assets.

“Given low rates, we expect high issuance in 2020, and we look forward to debut issuers coming to market,” BofA analyst Kay C. Hope wrote in the bank’s 2020 Outlook, published on Nov. 21.

Among the names expected to come to market are VEON Ltd., which is an EM-focused provider of mobile and fixed-line telecommunications services; Sasol Ltd., a Johannesburg-based mining, energy and chemical company, and Israel Electric Corp. Ltd., which is based in Haifa, Israel.

VEON most recently issued a bond that was smaller than the market was expecting, BofA’s Hope wrote. Meanwhile, Israel Electric, which last issued in U.S. dollars in 2018, could be looking for additional financing for its two new combined-cycle units at Orot Rabin. Sasol might take advantage of low rates to lock in longer term financing now that its ethane cracker is on-stream, Hope said.

“We wouldn't exclude Puma Energy issuance either, as the company has significant bank debt maturities in 2020-2021,” Hope wrote of another potential issuer. Puma is a Singapore-based oil and gas products and services company.

“Our sense is that existing bonds will continue to perform as asset sales are announced and debt is repaid – this could afford Puma an opportunity to extend maturities on debt at the same time,” Hope wrote.

Tempered predictions

But 2020 predictions are also tempered. BofA predicts that emerging market GDP will average above 4.5% in 2020; however, growth rates are below their historical averages in several larger economies like Mexico, Russia, India and China, the bank noted.

Alejo Czerwonko, emerging markets strategist for the Americas from the UBS Chief Investment Office, recently said, “We continue to recommend an overweight to EM hard-currency bonds, and prefer a basket of EM currencies in our FX strategy, as the environment remains supportive of carry trades.” But investors will face “consequential choices,” Czerwonko said, suggesting the U.S.-China trade deal will be limited, fiscal stimulus will be limited and global growth will be limited.

“Policymakers, electorates and investors face complicated choices in 2020,” Czerwonko said in a UBS On-Air Podcast. Nevertheless, with U.S.-dollar sovereign bonds remaining attractive, spreads should remain sideways and there will likely be total returns of 2% to 4% for the asset class in 2020, the strategist said.

Moody’s Investor’s Service was somewhat more negative about 2020. In a Nov. 21 report, Moody’s wrote that growth in emerging markets slowed considerably in 2019 and the outlook has tipped over to negative due to uncertainties around trade, politics and policy.

Trade focus

The U.S.-China trade dispute that dictated market moves throughout 2019 will remain the biggest driving force in 2020, most market watchers agree. But J.P. Morgan Asset Management sees U.S.-China trade tensions easing, and it has reduced its forecast for the probability of a recession to 25% from 40%, with its focus shifting from defensive to more focused risk seeking.

The combination of overwhelming central bank easing and the de-escalation in trade tensions has provided a powerful backdrop to the markets, according to JPMorgan.

The United States and China agreed to a phase one trade pact in December, fueling some optimism that global growth will pick up in 2020. The trade front is still a significant – if not the most significant – risk ahead. And if the United States were to put tariffs on Europe or Latin America, the global economy would shift downward, UBS’ Czerwonko said.

Nevertheless, EM financial assets, including currencies, stocks and bonds, are expected to outperform developed markets as growth continues to fuel markets.

For 2019, the return for EM bonds outpaced that of investment-grade bonds. According to a Bloomberg Barclays index in mid-December, emerging market bonds had returned 8.3% as central banks from India to Mexico cut interest rates to bolster growth. That beat the 6.5% return in investment-grade debt.

Emerging markets in general should benefit from favorable fundamentals and loosening central bank policies. Low inflation and loosening monetary policy are supporting higher quality emerging markets debt. There is less potential for currency appreciation in the near term, and many are constructive on the medium-term outlook for emerging markets credit and local rates markets for 2020.

Argentina eyed

By December, Argentina’s bonds had regained modestly from a major sell-off in the fourth quarter. But the nation’s primary in August and national election in October, which returned a Peronist to power, threw bonds and the country’s other financial assets into a tail spin.

2019 was exceptional, with the exception of Argentina, according to the BofA Global Research outlook. For many it was unexpected that left-wing, Peronist Alberto Fernandez snatched victory away from incumbent and market friendly candidate Mauricio Macri. In fact, many had predicted that Macri or another centrist candidate would win the election.

The last time the Peronists held power, the government nationalized companies, expended deficits and defaulted on its debt; and there are fears that this new leadership may lead to another major default.

While recession risk is in focus globally, BofA’s Global Research team doesn’t expect a recession to materialize in any of the larger emerging market economies except in Argentina.

After the primary election in August, the sell-off included a 25% drop in the peso, dissipating foreign-exchange reserves and Argentina was forced to impose capital controls. The country’s central bank forced exporters to repatriate earnings within five days. In addition, Argentinian residents were limited to $10,000 in foreign-exchange purchases per month, while non-residents were limited to $1,000.

Some funds were down for the last quarter due to losses related to bond holdings in Argentina, Ecuador and Lebanon, all of which have suffered political and financial crises this past year. India and South Africa also had national elections and there is ongoing pollical instability for Venezuela and Russia. This means that investors will need to be selective.

While emerging markets corporate debt is expected to have positive returns in 2020, the risks are to the downside. Lower GDP growth, political volatility, policy changes, lower commodity prices and trade issues are all in the mix, as are the possibility of a strengthening dollar and growing bond defaults in China.

There are a number of countries to watch but a handful “could have a disproportionate impact on performance,” according to BofA.

Regarding Argentina, BofA said, “We expect a sovereign debt reprofiling or restructuring to occur which will likely have a spill-over effect on the corporate and provincial sector, only part of which is already priced in. Some companies may be forced to extend and/or restructure their debt particularly in the utility sector. In Mexico, a second downgrade of Pemex to high yield is very likely.”

BofA has an underweight stance on Argentina corporates as the market awaits policy measures from the Fernandez Administration, which took the reins in December. It expects Argentine GDP to contract 2.0% in 2020 from an estimated 2.6% contraction in 2019. Corporate bond prices range from 38 to 95, and valuations are attractive after a year of underperformance, while the option-adjusted spread stands at about 719 basis points.

The Argentine corporate sector was the worst performing EM country in 2019, and the only country with negative returns. But some believe that after the sharp drop in equity and bond prices, the corporates are generally better positioned to withstand the volatility with low leverage and strong liquidity, and this is reflected in prices that are higher than the sovereign.

However, BofA’s underweight stance is driven by concern that a potential sovereign default would be followed by further price declines and heightened market volatility.

In mid-December, the ICE BofAML Argentina index showed total returns of minus 14.2% year to date. This followed declines of 14.75% in 2018. Argentina provinces have largely underperformed the corporates, with return of minus 29.0% year to date and option adjusted spreads of 3,290 bps, compared to minus 2.9% and 1,225 bps by the corporates.

Credit, country selection

Careful credit and country selection will be crucial given that valuations across many counties are tight. In addition, there are more idiosyncratic stories going into 2020 than a year ago, and it is difficult to predict when those stories will spark volatility.

The most important “stories” to watch currently are those countries that have experienced political unrest and protests, including Chile, Peru, Bolivia, Colombia and Hong Kong. Other stories that should be watched are Turkey, South Africa, Hong Kong, India and Ukraine, BofA Research said.

In BofA’s view, success in the EM corporate market in 2020 will be dependent on keeping tabs on the macro and political themes.

Meanwhile, demand from crossover investors is a bigger factor right now. The investor universe now includes more investors from Europe, where yields are ultra-low, and from Asia, where investors are looking for diversification outside of Asia.

These market players are looking for higher yield and tend to be more reactive to volatility. In particular, they are looking for well-known and high-quality names in both United States and EM credits.

The number of crossover investors was steady in 2019. But observers are concerned going into 2020 that significant selling from crossover investors could be sparked over a potential downgrade of Pemex to high-yield status by a second rating agency.

Heavy selling by crossover investors occurred when a ratings downgrade occurred with Petroleo Brasileiro SA a few years ago. The Mexican energy company has about $100 billion of debt outstanding, of which 80% is in the form of bonds. It received its first cut to high-yield status by Fitch Ratings in June of this year, and it is now rated Baa3/BBB+/BB+ with a negative outlook from all three agencies.

BofA thinks oil companies such as YPF, Pan American Energy and Tecpetrol have the resources to withstand a default and subsequent market turbulence. The most vulnerable issuers are regulated utilities including generation, distribution, transmission and the provinces.

Defaults in China

Changes in policy in China are being watched, and there are many that expect a greater number of bankruptcies to occur among China state-owned issuers as the central government steps back from intervening to support struggling entities.

Fears that bondholders will be subject to more numerous bankruptcies and evidence of a greater occurrence of bankruptcies are occurring just as JPMorgan Chase & Co. has said it will start to phase in Chinese government debt into its benchmark emerging-market indexes, potentially ushering in a fresh overseas influx into the world’s second-largest bond market.

JPMorgan will begin including China government issues on Feb. 28, and they will be phased in by 1% per month for 10 months. China’s weight will be capped at 10% of the JPMorgan GBI-EM global diversified and narrow diversified indexes.

Goldman Sachs Group Inc. analysts earlier estimated that such a move could lead to about $3 billion of inflows into China’s bond market a month.

Bloomberg Barclays, another index provider, began adding Chinese bonds to its global benchmark in April.

China’s Panda Green Energy Group Ltd. began an offer to exchange its $350 million of 8¼% senior notes due 2020 for new 8% notes due 2022 on Dec. 17.

The company is offering to exchange each $1,000 principal amount of existing notes for a like principal amount of new notes plus capitalized interest. Notes must be exchanged in minimum principal amounts of $200,000 and integral multiples of $1,000 in excess thereof. Fractional amounts will be paid in cash.

Formerly United Photovoltaics Group Ltd., Panda Green is a Hong Kong-based investment holding company focused on the development, investment and operation of solar power plants in China.

This company raised red flags last year when it was said to negotiate the extension of the maturity of a convertible bond that it had sold to a unit of the Qindgao local government in China. The announcement prompted a rating downgrade to only a few notches above default. This new attempt to extend the maturity of another bonds is now resulting in a further rating downgrade to almost “default.”

There is growing concern now as situations like this begin to proliferate. “Panda Green is showing little consideration for any basic financial sustainable principles,” Gimme Credit analyst Cedric Rimaud wrote in a note published on Dec. 19.

The company’s new exchange offer will most likely trigger a technical default, with S&P already lowering the rating to CC from CCC+ on the news. It is possible that bondholders do not participate in the exchange, Rimaud wrote.

“How foreign creditors would be treated is always a question in overseas capital markets,” Rimaud said in the note.

© 2015 Prospect News.
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