Capital Markets: Emerging markets continue generating mixed signals

Emerging Markets Issuance
Investment grade EM borrowers continue to achieve positive demand.

Most notably, the Kingdom of Saudi Arabia sold a new six-year dollar sukuk issue and ten-year conventional dollar debt, with initial price guidance on October 18 of 135 and 180 basis point margins over comparable US Treasuries. It placed USD5 billion with demand exceeding USD26.5 billion, of which USD7.5 billion was raised for the sukuk tranche: prices were tightened by 30 basis points on both tranches, resulting in a 5.268% coupon for the sukuk and a 5.5% coupon on the longer portion. The issue is to help finance a tender offer for USD3 billion of 2023 bonds, along with USD12.5 billion of liabilities maturing in 2025 and 2026.

Also on October 18, Emirates NBD received USD1 billion in demand for a five-year USD500 million issue at 5.745%, 155 basis points above US Treasuries and 20 basis points tighter than initial guidance.

Investment-grade Lithuania also sold EUR1.2 billion of new debt, consisting of a new 5.5-year issue of EUR900 million at 120 basis points over mid-swaps with a coupon of 4.125% and discount price of 99 .26%, and a EUR300 million tap from its previous 10-year deal at a spread of 135 basis points. Previous reports claimed a demand of almost EUR2 billion. After its completion, Latvia mandated banks for a further Euro-denominated sale.

Wider SSA debt restructuring discussions

In addition to Ghana’s ongoing negotiations with the IMF, which we predicted would likely lead to renegotiation of its debt under the G20 common framework, Nigeria and Kenya were in focus.

The former was triggered by Nigeria’s Minister of Finance, Budget and National Planning, Zaineb Ahmad, who said on a Bloomberg TV interview that the country was considering debt rescheduling, both international and domestic. Her statement mentioned that the Ministry had appointed a consultant to “explore restructuring and negotiation to stretch the repayments to longer periods”. This Day newspaper added that she stressed the need to use 65% of projected 2023 revenue to cover debt service in 2023. Although Nigeria’s debt has risen rapidly, reflecting weak fiscal consolidation and heavy spending on subsidies, its debt stock as a proportion of GDP is modest (just over 23% in mid-2022), but its debt service costs are estimated by the World Bank projected to exceed government revenue by next year.

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Nigeria has already shown signs of debt distress by seeking a broader extension of DSSI’s official debt service relief to the sub-Saharan African region, but has not used the term “restructuring” until now. The suggestion that he wants to extend maturities seems to indicate that he is not looking for capital reductions, but rather to extend the term of his liabilities.

A subsequent statement by Nigeria’s Debt Management Office (DMO) denied that restructuring was planned and instead claimed that it wanted to manage its obligations using “spreading debt maturities” and “refinancing short-term debt through long-term debt”. , suggesting that it is also exploring bond buybacks and swaps as liability management tools. The subsequent statement asserted “Nigeria remains committed and will meet all its debt obligations”, but that it would seek to apply liability management tools to its international obligations, including bilateral and concessional loans.

According to a Bloomberg report on October 20, Kenya plans to negotiate to extend the term of Export-Import Bank of China loans for the development of a rail link between Nairobi and Mombasa port. Transport Secretary-designate Kipchumba Murkomen has warned that the “Belt and Road Initiative” project will “never break even” and that it will “become impossible” to repay the loan from revenues from the project. He mentioned a term of 50 years as a goal for renegotiation, against the current term of 15-20 years.

Under recently elected President Ruto, users of the line have been given greater flexibility in how they transport goods to Mombasa, ending a previous policy of forcing them to be transported to domestic hubs before shipment. Even then, the line is unprofitable with passenger and cargo revenue of 15 billion Kenyan shillings, against operating costs of 18.5 billion. Exim has lent KSH500 billion (USD4.13 billion) to the project. In early October, the Kenyan Treasury was reportedly fined KSH1.3 billion (USD930,000) for non-payment of debt service obligations, following previous non-payment issues from AfriStar, the Chinese owner of the railway operator .

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Bank capital “expansion risk”

Banco Sabadell failed to record an Additional Tier 1 transaction (its EUR400 million 6.125% issue) on its first call date, which falls in November. The bank announced its decision ahead of the October 23 call notice deadline “taking into account the cost of replacing AT1 instruments under current market conditions”.

On November 23, the instrument’s coupon will reset to the five-year swap rate (currently 3.08%) plus a yield margin of 6.051%, implying a new coupon of approximately 9.13%. The issue has already traded at a price discount of 10 percentage points
His decision did not prevent the Bank of Nova Scotia from issuing an AT1 deal, USD750 million of 60-year non-callable five-year debt at 8.625%, versus 8.75% early guidance. If not called, the bond would recover to the 5-year US Treasury yield plus 438.9 basis points.

Later in the week, Ireland’s Permanent TSB also had EUR250m of perpetual AT1 debt salable after 5.5 years at the unusually high coupon of 13.25%, a record for the sector, compared to the 7.9% coupon that it needed to sell similar instruments at the end of 2020 The issue is to strengthen its balance sheet ahead of the purchase of EUR6.8 billion of loans from Ulster Bank, which is mainly financed by the sale of shares to the seller NatWest Group .

Our assumption

Both the Kingdom of Saudi Arabia and Emirates NBD enjoyed healthy demand, further confirming strong investor sentiment towards stronger GCC credits, given the positive windfall effects on their finances from higher energy prices. The healthy appetite for investment-grade EM risk also extended to Lithuania’s two-part sale.

Nigeria’s debt stress should not require full-scale restructuring at this time. Even after projected growth this year, its debt-to-GDP ratio is unlikely to significantly exceed 30%. Its major problems stem from excessive spending on subsidies and ineffective fiscal restraint. However, the growing burden of its debt service costs against modest fiscal revenues requires policy attention. Kenya’s position is more strained (with the debt-to-GDP ratio at 67% in mid-2022), but is much stronger than Ghana’s.

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Banco Sabadell’s decision not to call an AT1 instrument whenever possible is so far an isolated event and may well be temporary. Nevertheless, it has revived investor focus on “extension risk”: the possibility that banks will not call up AT1 and subordinated debt in deteriorating market conditions, leaving investors to hold instruments of longer (and potentially perpetual) duration despite their initial expectation that they would be called whenever possible, in accordance with normal market practice. Nevertheless, subsequent supply shows that this did not block new issuance, but may have contributed to the record coupon paid by Permanent TSB.

Banco Santander previously opted to miss out on an AT1 call event in 2019, before redeeming the issue shortly afterwards, and both Deutsche Bank and Lloyds Bank also missed the first call dates in 2020, but the norm so far has been to call the first call opportunity.

Sabadell’s decision highlights the growing “extension risk” on AT1 instruments as rates rise. As banks face higher refinancing costs, there is a stronger temptation to keep such instruments uncalled and allow them to switch to less favorable post-call coupons. Sabadell emphasized that it may raise the issue on a subsequent quarterly call date, but the difficult conditions for refinancing do increase the “expansion risk. Investors face the risk of heavy losses if the practice becomes more widespread, which could affect the future issuance of AT1 will hinder capital instruments.

Posted October 25, 2022 by Brian LawsonSenior Economic and Financial Consultant, Country Risk, S&P Global Market Intelligence

This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.


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