Emerging market fund managers are shocked (shocked!) to discover that the International Bank of Azerbaijan (IBA) has defaulted on its bonds. Admittedly those bonds were not explicitly guaranteed, but the lender is 95% owned by the Azeri government and everyone knows state ownership is an implicit guarantee. Right?
Wrong – again. No written guarantee means no guarantee, as Azeri policymakers are well aware. They have had enough of pouring money down the black hole that is IBA and decided to make bondholders wear some of the pain.
This should be no surprise to anyone with even a nodding acquaintance with the history of quasi-sovereign borrowings.
Indeed, for a warning of the fate of those who invest in non-guaranteed bonds in government-owned banks, investors in IBA needed look no further than across the Caspian Sea to Kazakhstan, where BTA Bank defaulted on its external obligations not once but twice.
By comparison with those restructurings, IBA bondholders are getting off extremely lightly. Holders of BTA’s debt lost 70% of their investment in 2009 and 55% in 2012. Azeri authorities have offered to convert IBA bonds into sovereign risk at the price of a 20% haircut and a maturity extension.
That seems generous, given that it had been common knowledge for many months that IBA was a failed bank. Even before the release of results showing a loss of more than $1 billion last year and heavily negative capital ratios, markets were well aware that the only thing supporting the lender was state handouts – of which it had already received $8 billion.
Equally, it was no secret that Azerbaijan’s prospects are looking increasingly bleak. The economy has yet to emerge from a recession sparked by the collapse of oil prices; analysts are predicting a long-term decline in energy production and billions of dollars have been frittered away on vanity projects such as Champions League sponsorship and hosting Formula One.
Why, then, were investors so keen on IBA bonds that, right up to the default date, were trading at par?
(Most) fund managers are not stupid. But they do have incentives to accentuate the positives when it comes to high-yielding, index-eligible frontier market bonds in a no-yield environment.
So instead of focusing on Azerbaijan’s dismal outlook, they took comfort from the fact that it had $33 billion in its national oil fund, Sofaz. Azeri policymakers, understandably, were looking at that equation the other way round.
Predictably, bondholders are now swearing they will never buy Azeri risk again. This is clearly bunkum. If any proof were needed, take the fact that – at the time of writing – rumour had it many were seriously considering swapping into new IBA bonds rather than Azeri sovereign risk to avoid a haircut.
Markets won’t learn this lesson because they don’t have to. And the next dodgy frontier market bond that comes along will be met with the same enthusiastic reception – with or without a state guarantee.