If economists fret when governments crowd out corporate borrowers, Hungary offers an example of what happens when the government retreats and corporates rush into the debt markets. In theory, the result should be pleasant. The reality, at least in Hungary, is less simple.
The Hungarian government's deficit surged throughout the 1990s, rising from nothing at the beginning of the decade, to Ft378 billion ($2.1 billion) in 1995 the equivalent of 6.9% of GDP. Last year the government began to cut spending while economic growth boosted tax revenues, so much so that the deficit declined to Ft225 billion (3.3% of GDP), while domestic financial savings surged to Ft580 billion.
"Conditions for corporate bonds have improved dramatically in the past year, both in the widening of the institutional investor market and the limited supply of government bonds," says Domonkos Koltai, a corporate finance executive at ING Barings.
But significant regulatory hurdles need to be overcome before a corporate bond market can take off, says Koltai. And there needs to be some consensus about inflationary expectations for a yield curve to take shape. Moreover, investors are inured to government debt and need to develop a taste for corporate offerings.
Despite these obstacles, Hungary's first large corporate bond deal came in February. Pannon, one of Hungary's two digital cellular providers, sold a total of Ft24 billion in three-, four- and five-year floating-rate notes. The bonds offered investors three percentage points over consumer price inflation, with coupons adjusted semi-annually and deferred until maturity.
"The market is broader and deeper than anyone ever expected," says Pannon chief financial officer Ernst Kramer. "When we started this procedure in December last year, most of the banks didn't think even Ft7 billion was feasible."
In fact, the Ft24 billion offering received Ft30.5 billion in bids with a mix of investors that compounded Pannon's surprise. "We expected 50% from abroad and 50% domestically. The [buyers] ended up being 90% Hungarian," says Kramer.
It's not just contracting government borrowing and rising domestic savings that have improved conditions for corporate borrowers: corporates are now more creditworthy, largely because of the $15 billion in foreign direct investment that has come into Hungary since 1990. After a slow start, many of the newly-established companies are now working at full capacity. Pannon, for instance, is far ahead of its business plan with 200,000 cellular subscribers. Exports, many of which are manufactured by joint venture companies, are up from $10 billion in 1990 to a projected $17 billion for this year.
In fact, even before the government started retreating from domestic markets, sophisticated corporates were already crowding into its turf, especially in the international financial markets. This trend is epitomized by Matav, the telephone utility that holds a monopoly on long distance and international services until 2002 and provides local services to 80% of population.
Matav is a red chip turned blue. It was riddled with inefficiencies in 1993 when the government sold a 30% stake in it to Magyarcom, a consortium of Deutsche Telekom and Ameritech International. At that time, the company was borrowing in the international markets at 250 basis points over Libor, according to Janos Csak, Matav's aggressive 34-year-old treasurer.
The early days were tough for Matav's new foreign owners. Management became bogged down in negotiations over the transfer of assets to a handful of local telephone companies. Instead of expanding the company, executives discovered to their frustration that they first had to eliminate a number of superfluous subsidiaries. Having paid $280 a share when they bought into the company in 1993, the foreign shareholders watched as Matav shares slumped to $150 in the market the following summer.
The falling share price didn't trouble Matav's lenders. In September 1994, after a roadshow for bankers in the syndicated loan market describing its aggressive new business plan, the company cut its borrowing costs to 150 basis points over Libor. As Csak puts it, bankers responded to the "huge growth opportunity, and also the significant efficiency gain opportunity".
Matav was soon able to borrow abroad even more cheaply than the government. "In the first transaction, we were new guys in the Euro-syndicated loan markets," says Csak, "so we asked for the same price paid by the Hungarian government for the same maturity and similar size. Later, as we increased the awareness of Matav's name and the strength of the company, we were able to negotiate even better terms than the government."
The sub-government rates defied the received wisdom that no company is safer than the sovereign within which it exists. Csak explains: "Financial institutions were more ready to finance a visible company where they know where the money goes rather than current account financings, which is the case in sovereign deals."
MagyarCom bought another 37% of the company at $220 a share in 1996 and restructuring has been proceeding well ever since. The number of Matav's lines has doubled since 1993, and 1996 revenues were up nearly 10% in real terms over 1995.
Couple that good news with the prospect of a public offering in the next year, and the market now values Matav's shares at around $350 each. Matav has continued to outpace the government in credit markets as well, pushing its borrowing costs down to 30 basis points over Libor last November.
Csak says that Matav is now the benchmark for Hungarian corporate borrowers. It accounts for almost 10% of capital investment into the country and its debt, which is mostly in foreign currency, totals $750 million just under 8% of Hungary's gross foreign borrowing.
Matav may soon shift its focus to the domestic market. Its forint borrowing is already rising, says Csak, which is natural since most of its revenues are in forints. He becomes even more excitable than normal when he is asked about prospect of pioneering a forint yield curve. "On the institutional market, there is a visible appetite for fixed-rate funds," he observes.
The Hungarian government has recently benefited from this, issuing two Ft5 billion fixed-rate, five-year bonds the first time it has raised such long-term funds for four years each below 16%. Both deals were heavily oversubscribed. For potential borrowers like Csak, these rates are tantalizing. Short-term rates were 35% two years ago, and even at that level, the government had difficulty selling domestic debt longer than six months.
Csak says that Matav is considering following the government's lead by launching a fixed-rate issue. But he declines to elaborate beyond venturing that "sooner rather than later, more and more fixed-income bonds will come in forints first for small amounts, which will define the margins over the treasuries. Then as inflation forecasts reach a consensus, more and more paper will come."
Pannon, by contrast, did not want to do a fixed-rate issue because interest rate expectations have been changing too rapidly. Istvan Racz, Credit Suisse First Boston's senior economist for the region, shares this caution. "For one year, I think everyone is satisfied with the prospect that inflation is going down substantially. Beyond that it is difficult to take a firm view."
The real test of Hungary's corporate bond market will come in the months ahead, says Koltai. "The big question will be whether there are any more new issues after Pannon in the first half of the year. If not, you can say it was a one-off and the markets need to mature."
While the market was eager for the Pannon issue, regulators almost killed the bond, note Koltai and Kramer.
On January 1, Hungary's conservative State Banking Supervision Agency took control of the more market-savvy State Securities Supervision Agency. The banking agency's staffers believe non-bank corporates should not issue public debt in excess of their shareholders' equity.
Under that interpretation, the Pannon bonds would have been illegal, since the Ft24 billion issue far outweighs the company's Ft9 billion in equity. The Pannon issue squeezed into the market only because it was registered in the final hours of 1996.
"Whereas the securities side [of the State Securities and Banking Supervision Agency] was fully supportive, the banking side made it very clear that we would not have got their approval if we had not filed in December," says Koltai. "I don't think there is much of a chance" the situation will change anytime soon, he says. "It is very clear that their interpretation is that you simply cannot do it. It's such a new piece of legislation, there is not much of a chance to have it amended."
Investors' lack of understanding about credit will also hinder the growth of a corporate bond market, says Koltai. The Pannon issue, for instance, was guaranteed by ING Bank. In a market weaned on government debt, there are "still relatively few investors that are sophisticated in credit analysis. They are sophisticated players on the yield curve, but they don't have understanding of anything that has any credit risk."
Matav's Csak is eager to get on with the education process. "This is the very first time that I think a normal spread rank among corporations will build up in forints." Success will mean that "spreads will reflect creditworthiness rather than gut feelings and guesses".