The febrile nature of the international bond markets was clearly demonstrated in early April when Costa Rica’s $1 billion, 30-year bond had investors flocking to submit orders.
Less than a week before the transaction closed, the country’s vice-minister of finance and director of public credit, Jordi Prat, had told delegates at the Inter-American Development Bank conference in Brazil that he expected the country to be able to tap the markets only in the third quarter of this year.
The reason for his projected timing was that a new government was about to be formed and he believed the new administration’s economic team would have to formulate its policy. Prat told delegates at a LatinFinance breakfast briefing during the IDB event that he believed a pre-deal roadshow would be needed to educate and interest potential investors.
However, within a week, lead managers Bank of America Merrill Lynch and Deutsche Bank had sold the bond at par to yield 7% and attracted bids from 300 accounts. Investors shrugged off the difficulties facing the sovereign – which was placed on negative watch by Moody’s in September last year because of its high debt burden and high fiscal deficits (5.3% in 2013) – and oversubscribed the deal by 4.5 times. Costa Rica is rated Baa3/BB/BB+ by Moody’s, S&P and Fitch.
More recently the country has been facing a falling currency. One of the main uses of proceeds from the bond deal is to service its dollar-denominated debts with the hard-currency sale, thereby alleviating pressure on the currency by eliminating the need for the central bank to buy dollars.
Usually such use of proceeds is seen as a negative (for example when compared with investment in infrastructure), but investors clearly shrugged off all concerns related to the issue. Just before the sale, Citi cut its growth forecast to 3.1% from 3.5% for Costa Rica after two of the country’s largest employers, Intel and Bank of America Merrill Lynch, announced job cuts totalling 3,000. Citi cut its forecast for 2015 GDP from 4% to 2.2%.
Bank of America Merrill Lynch and Deutsche Bank declined requests for interviews.
“The timing of the Costa Rica transaction is curious – just before a new administration,” says one investor, who says he passed on the transaction. “On the converse they are not a new issuer: they issued a few bonds last year and they are reasonably well known, so they didn’t have to go through the extended timetable that new issuers would need to do. The market obviously accepted the timing, and there may have been a little bit of value in the bond.”
Costa Rica issued a $500 million, 30-year bond in April 2013, which was priced to yield just 5.63%.Ashmore, a dedicated EM asset manager, has a policy of not commenting on its positions on individual credits, but Jan Dehn, head of research, says: “Costa Rica has clearly taken advantage of a temporary bounce in the market to do its bond issue. Good for them.
"But in the process it has also mortgaged itself to the sentiment of the market because the onus is now on Costa Rica to deliver. It runs a substantial fiscal deficit, which it needs to address – and will address – but it is unlikely to be able to do so without some pain. It will need to cut spending, which will cause growth to slow, which in turn will lead to lower tax revenues, and the government may then need to make further spending cuts.
"It is heading into somewhat more challenging – though by no means insurmountable – times ahead, so there will be attractive opportunities for this credit once it begins the adjustment process.”
|Jan Dehn, Ashmore|
Dehn says the strong demand is symptomatic of a volatile EM investor base: “EM has been rallying recently, but these rallies – just like the sell-offs – can be pretty violent and short-term and they tend to happen pretty quickly.
"When these windows present themselves, issuers – or their advisers – think that given the febrile nature of investor sentiment they should just issue immediately. And in this way best-laid issuance plans often get sacrificed on the altar of short-term opportunism.
"This is the environment we are in. It’s ultimately a symptom of the incredibly poor ability of many market participants to analyse credits and think strategically and dispassionately about EM.”
The policies of the world’s largest central banks in developed markets will clearly lead to inflationary pressures, according to Dehn, “but until the market actually sees the inflation, it is not going to trade it yet because conviction levels are so low. Forecasters have done terribly badly.
"Most investment banks were not even able to forecast US growth one quarter ahead. So with everything so myopic the technicals become very important and short-term dynamics dominate long-term views during periods like this.”
Perhaps this short-term perspective on the search for yield, when combined with liquidity-driven investment mandates, explains much of the exceptionally high demand for a 30-year bond issued by a weakening emerging market sovereign.