Emerging bond defaults on the rise, no surprise
As may be expected, the crisis has increased the risk of default by emerging market borrowers. According to estimates by ING Bank’s emerging bond guru David Spegel, the default rate on EM bonds is running at over $6 billion in the first four months of 2012, already surpassing the 2011 total of $4.3 billion. He predicts another $1.3 billion of emerging defaults to come this year.
Spegel expects the default rate for speculative grade emerging corporates to rise to 3.25 percent by September, up from 3 percent at present. That doesn’t look too bad, given defaults ran at 13 percent after the 2008 crisis and hit a record of over 30 percent in the 2001-2003 period. But ING data shows some $120 billion worth of corporate bonds trading at “distressed” or “stressed” levels, i.e. at spreads upwards of 700 basis points. The longer such wide spreads persist, the higher the probability of default. A worst case scenario would see a 12.9 percent default rate by end-2012, Spegel says.
Many companies are having trouble rolling over maturing bonds (selling debt to pay off existing creditors). One reason might be the explosion in bond issuance this year. Data from Bank of America/Merrill Lynch shows bond sales by emerging borrowers, sovereign and corporate, totalled 14 billion in the first three months of the year, a quarter more than the same 2011 period. Clearly everyone is rushing to raise cash before U.S. Treasury yields rise further. (see what we wrote on this a few months ago)
Now look at ING’s figures on syndicated bank lending. Syndicated loans are a key funding source for EM borrowers but they have dropped 51 percent in the first three months of 2012 from the previous quarter to $105 billion. Coinciding with the surge in bond issuance and European banks’ problems, this suggests many former bank borrowers have turned to bond markets intead.
What about potential loan defaults? ING estimates $178 billion in syndicated loan repayments remain for 2012 and it is unclear how much of this will spill into bond market issuance. EM debt demand so far has been buoyant, with EPFR data showing inflows of almost $18 billion year-to-date to EM bond funds. Even lower-rated EM companies and countries have easily raised cash. But Spegel warns:
While the abilityof EM borrowers to find alternative sources of funding is positive, the rotation of borrowing from banks to bonds could potentially have negative implications for bond markets if the improving demand dynamics suddenly change direction in face of increasing supply.
A Hungarian default?
More on Hungary. It’s not hard to find a Hungary bear but few are more bearish than William Jackson at Capital Economics.
Jackson argues in a note today that Hungary will ultimately opt to default on its debt mountain as it has effectively exhausted all other mechanisms. Its economy has little prospect of strong growth and most of its debt is in foreign currencies so cannot be inflated away. Austerity is the other way out but Hungary’s population has been reeling from spending cuts since 2007, he says, and is unlikely to put up with more.
How did other highly indebted countries cope? (lets leave out Greece for now). Jackson takes the example of Indonesia and Thailand. Both countries opted for strict austerity after the 1997 Asian crisis and resolved the debt problem by running large current account surpluses. This worked because the Asian crisis was followed by a period of buoyant world growth, allowing these countries to boost exports. But Hungary’s key export markets are in the euro zone and are unlikely to recover anytime soon.
The other example is Argentina. It too recovered strongly from its 2001 crisis but its way out was default. Capital Economics writes:
There are arguments for why, in Hungary’s case, default might appear to be an attractive option. The economy runs both a current account surplus and a primary surplus (i.e. government spending is lower than receipts before interest payments are taken into account). This means that if the Hungarian government were to default and were to be barred from borrowing from abroad, it would still not be forced into drastic fiscal austerity or a painful current account adjustment via reduced domestic demand.
Moreover, the note says:
Sujata Rao, let me explain why this isn’t going to happen, a default that is. It would tarnish the PMs otherwise flawless reputation and image.
He rather resort to unorthodox financial strategies that slowly makes the people that can, move out of the country, and the rest will suffer the consequences of these strategies.
from MacroScope:
Greek debt – remember the goats
Greece's creditors have essentially let it off the hook by overwhelmingly agreeing to take a 74 percent loss. So what better time to remember one of the first times Athens got in trouble with paying its debts.
In 490 BC, the bucolic plains before the town of Marathon were the site of a bloodbath. Invading Persians lost a key battle against Greeks, who were led by the great Athenian warrior Kallimachos, aka Callimachus.
The trouble is, Kallimachos shares some of the difficulty with numbers that modern Greek leaders appear to have. Before launching himself upon the Persians, he pledged to sacrifice a young goat to the Gods for every enemy that was killed.
His troops slaughtered some 6,400 invaders. Unfortunately the Athenians didn't have that many young goats. So they had to spread the repayment and legend has it that it took them a century to honour the pledge.
Apparently, Zeus and the other Gods had not heard of the Institute of International Finance and were unwilling to take a 74 percent cut in goats.
from MacroScope:
Vultures swoop on Argentina
Holdouts against a settlement of Argentina’s defaulted debt are opening a new front in their campaign for a juicy payout more than a decade after the biggest sovereign default on record.
Lobbyists for some of the investors who hold about $6 billion in Argentine debt are in London to persuade Britain to follow the lead of the United States, which last September decided to vote against new Inter American Development Bank and World Bank loans for Buenos Aires.
Washington believes Argentina, a member of the Group of 20, is not meeting its international obligations on a number of fronts. Apart from the dispute with private bond holders, Argentina has yet to agree with the Paris Club of official creditors on a rescheduling of about $9 billion of debt. It has refused to let the International Monetary Fund conduct a routine health check of the economy. And it has failed to comply with the judgments of a World Bank arbitration panel.
In short, Argentina is not playing by the rules of the international game, says Rob Shapiro, a former U.S. under secretary of commerce, who is now co-chair of the Argentina Task Force America.
According to its website, the group’s aim is to “vigorously pursue” a “just and fair” reconciliation of the Argentine government’s default in December 2001 on some $95 billion of debt.
Its members and supporters include the delightfully named Montana Women Involved in Farm Economics (WIFE). Another is New York hedge fund Elliott Associates, which has bought distressed debt issued by a number of developing countries and sued them for repayment.
In 2000 Peru paid Elliott $56 million to settle a four-year fight after the hedge fund refused to accept the restructuring terms on offer.
Beneath the Greek bailout hopes…
Who’s tired of the ”Markets up on Greece, markets down on Greece” headlines of the past few weeks? (I am.)
Today it’s an up day, with world stocks hitting a six-month peak on hopes that Greece will secure a second bailout package next week (finally, really).
But beneath the optimism lies a dire Greek economic and fiscal situation.
The Greek economy slumped 7 percent in the last quarter of 2011, with the rate of contraction since Q4 2008 reaching a whopping 16 percent in cumulative, real GDP terms.
Weak growth is hampering efforts to consolidate the fiscal position. Goldman Sachs, in fact, expects the deep recession has fully offset budget consolidation efforts. Analysts at the bank write:
“The fiscal adjustment, which started off with an impressive deficit reduction of more than 5% of GDP in 2010 stalled in 2011… despite a significant fiscal effort.
They add:
What to do with Belize’s superbond
This year’s renewed euphoria over emerging markets has bypassed some places. One such corner is Belize, a country sandwiched between Mexico and Guatemala, which many fear is gearing up for a debt default. There is a chance this will happen as early as next week
Belize is a small country with just 330,000 people but back in 2007, it issued a $550 million bond on international markets. Known locally as a superbond for its large size (relative to the country’s economy), the issue earned Belize a spot on JP Morgan’s EMBI Global index of emerging market bonds.
As this index is used by 80 percent of fund managers who invest in emerging debt, many of them will have allocated some cash to hold the Belize bond in their portfolios. These folk will be waiting anxiously to see if Belize pays a $23 million coupon due on Feb. 20.
Never very liquid, the bond has taken a sharp lurch downwards since Feb.7 when Prime Minister Dean Barrow said in a pre-election speech that he would seek “instructions” from the electorate to “do something about the bond”. That unsurprisingly triggered panic selling and the bond now trades around 40 cents on the dollar, down some 20 cents since the start of February. The yield has risen sharply to 23 percent from 16 percent and and the Belize spread over U.S. Treasuries — the premium that investors demand to hold the bond — has blown out to almost 2000 basis points, higher than any other country in the EMBI Global index. That’s a rise of 400 bps since the day of Barrow’s speech.
Exotix, a frontier market-focused brokerage says:
What happens next? We think the government will pay the forthcoming 20 February coupon but clearly there is a risk that it won’t. But even if it does, that does not remove the uncertainty now hanging over the bond… The government has the money and it might be counterproductive politically to default just before a general election. However we do acknowledge that the bond’s domestic unpopularity and the low price make non-payment an easier option.
Regionally, there are some parallels with Ecuador which in 2008 defaulted on debt the government said had been contracted unlawfully by a previous administration. Investors pointed out at the time that Ecuador’s president Rafael Correa had the cash to pay but did not want to. If Belize misses the Monday coupon, it will not be for want of cash — the central bank has $240 million in its coffers.
Euro periphery: Lehman-type shock still on cards
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The passing of Greek austerity measures is fuelling a rally in peripheral debt today with Italian, Spanish and Portuguese yields falling across the curve.
However, one should not forget that peripheral economies are still under considerable risk of becoming the next Greece — rising debt and weak economic growth pushing the country to seek a bailout — as a result of tighter financial conditions.
Take this warning from JP Morgan:
Financial conditions have deteriorated far more in peripheral Europe than in the core. The drag from this on peripheral GDP is akin to that seen following the Lehman crisis.
JP Morgan uses analysis based on quantifying the impact of financial market developments and monetary policy actions on economic activity. The main variables the analysis uses is: the three-month LIBOR rate, the yield on investment grade corporate bonds, the spread of high yield corporates over that of high grade, real equity returns, the change in the real exchange rate and bank lending standards for businesses as reported in loan officer surveys.
According to JP Morgan’s calculations, the 838 basis-point rise in the peripheral HY spreads implies a drag of -2.2 percent of GDP relative to what it would otherwise have been, had the HY spread unchanged.
Greece’s interest burden, post-PSI, will remain huge
It seems Greece has finally reached a deal on austerity measures needed for a bailout. But what about PSI?
(ECB President Mario Draghi just said he heard it was close to a deal. It’s been close for a few weeks though…)
JP Morgan says Greek PSI is hardly going to change the heavy interest burden on the country and the issue of default will inevitably come up.
First of all, Greece’s interest payments are huge.
Greece paid 15.5 bln euros in net interest payments in 2011, 17% of total general revenues. This is the highest among all OECD countries and more than 3 times the OECD average of 5%. It is also more than double the 8% average for other peripheral countries in the euro zone.
The U.S. bank estimates the Greek PSI is going to capture 205bln euros of private bond holders (and perhaps a further 55bln euros if the ECB participated).
Of this 260 bln euros, around 85 bln or a third are held domestically, by Greek social security funds, domestic banks to be largely nationalised post PSI, and the Greek central bank.
Greek ars great but if they dont implement the reforms specially their own pensions funds that are tied to their own greek bonds, their not helping themselves in an already unsustainable situation. they should show some cooperation. If not It may be painful to extract a teeht but if necessary it may be better than keep constant pain within the E¸U and perhaps teh world. Does an economi as large as Argentina can hurt the world if isolated ?
Financial repression revisited
At a monetary policy event hosted by Fathom Consulting at the Reuters London office today, former Bank of England policymakers were discussing the pros and cons of “financial repression”.
Financial repression is a concept first introduced in the 1970s in the United States and is becoming a talking point again after the financial crisis, especially with a NBER paper last year written by economists Reinhart and Sbrancia reviving the debate.
In the paper, authors define financial repression as follows:
Historically, periods of high indebtedness have been associated with a rising incidence of default or restructuring of public and private debts. A subtle type of debt restructuring takes the form of “financial repression”.
Financial repression includes directed lending to government by captive domestic audiences (such as pension funds), explicit or implicit caps on interest rates, regulation of cross-border capital movements, and (generally) a tighter connection between government and banks.
Low nominal interest rates help reduce debt servicing costs while a high incidence of negative real interest rates liquidates or erodes the real
from MacroScope:
Are CDS markets the euro zone’s iceberg?
In an unfortunate turn of phrase at the height of his country's current debt crisis, Greek Finance Minister George Papaconstantinou on Monday compared his government's Herculean task in slashing deficits and debts as akin to changing the course of the Titanic. Sadly, we all know where the great "unsinkable" ended up almost a century ago and I'm sure, given the chance, Mr Papaconstantinou would have chosen another metaphor. But if the Greek economy (or perhaps the euro zone at large?) is to be cast as the Titanic, then what is its potential iceberg?
For some euro politicians, look no further than the sovereign Credit Default Swaps market. France's finance chief Christine Lagarde said as much last week when she questioned "the validity, solidity of CDSs on sovereign risk" and warned speculators to be careful as regulators took a "second look" at the market and European governments closed ranks. Lagarde, of course, is not alone. You can be sure CDS are being examined long and hard by Spanish intelligence services investigating the "murky manoeuvres" in the debt markets. But what is the exact charge against CDS?
CDS are ways to buy or sell insurance on the risk of debt defaults without needing to own the underlying bonds in the first place. It's a way of hedging your debts, if you like, without having to go through the often more complicated game of selling securities short (or selling borrowed paper). In essence, it allows you to take a bet on default without having to go to the trouble of owning the bonds you're insuring against. Some critics, not unreasonably, would view this as the epitome of the casino capitalism that has elicited so much public outrage over the past three years . The fear is this market has become the tail wagging the dog.
About 10-years old, CDS were for years seen as a valuable bellwether of sentiment on corporate default risk. But its opacity as an over-the-counter market came in for heavy criticism during the credit crunch, mainly because it allowed speculators with no interest in the underlying securities to sow panic in the real marketplace, particularly in banking stocks, and offered them the power to precipitate the very crises they were betting on. There were also cases, most notably in attempts by Kazakhstan's then biggest bank BTA to restructure its debts, where conflicts of interest were alleged. Some bondholders acting as creditors stood to gain more from forcing the bank default because they were substantial CDS holders too. What's more, Commerzbank points out, many even doubt the sense of sovereign CDS markets at all because it's far from clear who would pay out in the event of default. Insurer AIG was certainly unable to pay when the financial industry went south in 2008.
One defence of CDS is they merely allow a liquid market to anticipate future credit rating moves rather than outright defaults per se and, as such, are important not in their absolute but in their relative rankings of credit. Greek CDS prices last week indicating a one-in-three chance of default, for example, were wildly at odds with a consensus view such an outcome was highly unlikely. Yet, Commerzbank said that even the acceptance of sovereign CDS as a useful market signal still exposed some odd anomalies, such as German CDS trading cheaper than the US when the US and not Germany had control of its own printing presses.
Barclays Capital have burrowed deeper with a note called "Sovereign CDS: Cat or Canary?" They concluded that both CDS exposures and volumes are just fractions of the cash bond markets for the likes of Greece, Spain, Ireland, Italy and Portugal -- only between 2% and 10% on exposures and 1% to 12% on volumes, with Portugal showing the highest CDS to cash bond ratios. And although there was a correlation between CDS volumes and widening cash bond spreads, this was unsurprising and showed no cause and effect.
However, Barclays did point out the CDS market appeared skewed toward fear and volatility. "CDS activity drops quite a bit when spreads tighten. This would suggest that the CDS market tends to be dominated by players who are looking to buy protection," it said, adding that this was even more likely in markets like Greece where the absence of centrally-cleared cash repo markets makes many players reluctant to "short" the cash market.
