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Capital Markets Weekly: Three emerging market defaults likely without triggering wider flight from asset class

22 May 2020 Brian Lawson

Emerging markets

The key development this week has been the negotiation between Argentina and its bondholders to find a mutually acceptable basis for debt restructuring.

On 19 May, Economy Minister Martín Guzmán stated that there was a "big chance" Argentina's revised deadline of 22 May for a deal - which coincides with the end of the grace period on its unpaid interest - is "extended so that …we can eventually make the amendments that are necessary …to achieve a sustainable deal". He made clear that "negotiations will continue". He previously had announced on 15 May that there had been "positive dialogue" with bondholders. Argentine media have published three counterproposals from bondholders, which sought to shorten Argentina's grace period to one from three years and reduce the degree of capital loss.

Temporary formal technical default nevertheless looks increasingly likely unless bondholders agree a temporary payment extension of the interest payments whose grace period expires on 22 May, but local media suggest that bondholders would not be able to seek wider acceleration of Argentina's market liabilities for several months, and in any case would be unlikely to do so while negotiations continue.

Sentiment towards Argentine debt has been improving. Having traded in late April at over 4000 basis points over comparable US treasury bonds, on 15 May Argentina's EBMI+ spread breached 3000, closing 6.7% tighter at 2837 basis points. During the week it reached a low of 2690, suggesting positive investor sentiment over the scope for a mutually acceptable deal.

Province of Buenos Aires failed to make a USD110 million payment of principal and interest on dollar and Euro-denominated debt by the expiry of the grace period on 14 May. According to Latin Finance on 18 May, it now has a two-month period to agree a debt restructuring deal with its creditors to resolve the technical default, after which they can seek the acceleration of outstanding issues. The Province is widely expected to align its position with the outcome at sovereign level. Its stance caused little market surprise: it was consistently viewed as unlikely to service bondholders until the sovereign-level position is been clarified.

Jamaica based Caribbean telecommunications company Digicel also faces imminent default. On 19 May the company gave bondholders an extra day to accept proposals to reduce its USD7 billion of debt involving the write-off of USD1.6 billion. The Irish-owned company already has obtained support from the majority of its bondholders for restructuring, but reportedly has met resistance from holders of its higher-ranked 2023 notes: it has improved an original offer to exchange the 2023 debt for 2027 liabilities at 95% of nominal value, versus 85% in an earlier proposal, to obtain their consent. Digicel undertook another debt restructuring only a year ago, extending the maturities of USD3 billion of its liabilities in due in 2020 and 2022 by two years. Moody's has advised that the latest distressed restructuring will count as a default event under its criteria.

More positively, Abu Dhabi completed a USD3 billion tap of its recently issued package of five, ten and 30-year debt sold in April. According to Reuters, the tap gained some USD20 billion of orders. It placed USD1 billion at each maturity, at 135 and 150 basis points over US Treasuries and at 3.25%, in line with the earlier tranches: the final pricing was 30-35 basis points below initial guidance.

Hong Kong Land has made its first bond sale for six years, a USD600 million offering. The company, which operates prime real estate in Hong Kong's Central district, has not been badly affected by prior disturbances in Hong Kong, and has maintained a strong balance sheet with a low gearing ratio of just 9% in April 2020. However, the company has made a sizeable, USD4.4 billion commitment to the West Bund development project in Shanghai, of which it plans to retain 78%.

Other debt

Kingdom of Belgium launched a USD1 billion 10-year deal on 18 May, with initial price guidance of mid-swaps plus 37 basis points area. On 19 May it announced that it had priced USD1.5 billion at a 36-basis point margin with a 1% coupon. The Kingdom's Debt Agency announced that proceeds were swapped into Euros at a cost of 0.043%.

On 18 May it also auctioned 10, 11 and 30-year Euro-denominated debt, sold at 0.024%, 0.096% and 0.728% respectively, with coverage ratios of 2.83, 1.92 and 1.74 times the volume offered respectively.

The UK launched its second syndicated gilt for COVID-related funding. It placed GBP7 billion of 0.5% 2061 debt priced at 0.5852%, bringing total sales in the financial year since April to GBP98.8 billion. UK buyers took 93% of the deal, which gained 159 orders worth GBP53.1 billion. A third syndicated sale is planned for the first half of June. Sir Robert Stheeman, CEO of the UK DMO, highlighted the very positive response to "two, back to back, and large syndications in consecutive weeks".

French debt agency Agence France Trésor announced on 18 May that it plans to "examine…the prospect of a syndicated issue" of a 20-year bond. The discussions will be held with its primary dealers: it has not specified a timeline for issuance.

Romania has mandated banks for the sale of long five-year and 10-year Euro denominated benchmark issues.

Unédic, the body managing French unemployment payments, has launched the largest ever social bond, a EUR 4 billion offering designed to support its COVID-19 response. The November 2026 issue gained EUR7.75 billion of demand excluding bookrunner interest. Proceeds will be used to extend standard unemployment insurance programmes and support an exceptional job retention scheme, involving subsidized part-time work for over 12 million private sector workers.

Asian Infrastructure Investment Bank has launched a five-year dollar benchmark, with initial price guidance of mid-swaps plus 24 basis points. According to Reuters reports, it is also planning the sale of CNY5 billion (USD703 million) of three-year Panda bonds within China's domestic market.

The issuance follows the Beijing-based entity announcing plans on 3 April to establish a USD5 billion facility for COVID-19 related funding, which it grew to USD10 billion on 17 April, claiming that requests had far exceeded the initial amount provided.

Implications and outlook

While there is a high likelihood of Argentina experiencing technical default on 22 May, barring a last-minute deal to defer the overdue payment, recent market performance clearly indicates that investors have become more positive on the prospects for negotiated settlement. This is likely to entail some fine tuning of both the grace period and overall capital haircut. Overall, the tone of Argentina's public comments has been encouraging, suggesting that direction in the negotiations is positive.

Although the Province of Buenos Aires has triggered formal default, this caused little surprise, as a provincial level settlement is highly likely to reflect the eventual outcome at sovereign level.

Digicel has been facing debt sustainability problems for an extended period, after the company undertook rapid growth through borrowing, while withdrawing a previously planned IPO. As such, its potential default has been widely forecast and is causing little market impact.

Elsewhere, Belgium's use of dollar funding, closely after Finland undertook a similar exercise, has been shown to reflect an effective arbitrage, with proceeds swapped back into Euros at directly comparable cost to Euro-denominated auction costs, while tapping a distinct investor base.

The UK's second syndication was less dramatically impressive than its prior ten-year offering, but GBP53 billion "exceeded previous records for a long conventional gilt syndication", according to the UK's DMO. The far-higher domestic participation reflects the long maturity, with natural support from UK pension funds and life insurers seeking to balance long-dated liabilities.

Posted 22 May 2020 by Brian Lawson, Senior Economic and Financial Consultant, Country Risk, IHS Markit

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