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Issues in Emerging Markets
Investment grade borrowers from emerging markets continue to generate positive demand.
Notably, the Kingdom of Saudi Arabia sold a new six-year dollar-denominated Sukuk issue and 10-year conventional dollar bonds with initial price forecasts of 135 and 180 basis points spreads over comparable US Treasuries. It placed $5 billion with demand in excess of $26.5 billion, including $7.5 billion for the Sukuk tranche: prices were tightened by 30 basis points for both parts, resulting in a coupon of 5.268% for led the Sukuk and a coupon of 5.5% on the longer tranche. The issuance is expected to help fund a $3 billion tender offer for 2023 bonds, along with $12.5 billion of debt maturing in 2025 and 2026.
Also on October 18, Emirates NBD won $1 billion in demand for a $500 million five-year issue at a price of 5.745%, 155 basis points over US Treasuries and 20 basis points narrower than the original forecast.
Investment-grade Lithuania also sold EUR1.2bn of new debt, including a EUR900mn new issue with a maturity of 5.5 years at a price of 120 basis points over mid-swaps with a coupon of 4.125 % and an entry fee of 99.26% and EUR 300 million tap of its previous 10-year deal with a spread of 135 basis points. Earlier reports indicated a demand of almost EUR 2 billion. After its completion, Latvia instructed the banks to make another sale in euros.
Broader SSA debt restructuring talks
In addition to Ghana’s ongoing negotiations with the IMF, which we have forecast will likely result in a renegotiation of its debt under the G20 Common Framework, Nigeria and Kenya have been in focus.
The former was prompted by Nigeria’s Finance, Budget and National Planning Minister Zaineb Ahmad, who in an interview with Bloomberg TV stated that the country was considering debt restructuring, both internationally and domestically. Their statement mentioned that the ministry had appointed a consultant to study “restructuring and negotiations to extend repayments for longer periods”. This Day newspaper added that it stressed the need to use 65% of projected 2023 revenue to cover debt service in 2023. Although Nigeria’s debt has been rising rapidly, driven by poor tax collection and heavy spending on subsidies, its debt-to-GDP ratio is modest (just over 23% in mid-2022), but debt service costs are projected by the World Bank to be around the to exceed government revenue by next year.
Nigeria had already shown some signs of debt problems by seeking broader extension of official DSSI debt relief to sub-Saharan Africa, but had not previously used the term “restructuring”. The proposal to extend maturities seems to indicate that it does not seek capital discounts but instead extends the duration of its liabilities.
A later statement by Nigeria’s Debt Management Office (DMO) has denied that a reorganization was planned, claiming instead that it intends to manage its debt through “debt maturity spread” and “refinancing short-term debt with long-term debt”. , suggesting that it also explores bond buybacks and exchanges as liability management tools. The subsequent statement said “Nigeria remains committed and will honor all of its debt obligations,” but that it will seek to apply liability management tools to its international obligations, including bilateral and concessional loans.
According to a Bloomberg report Oct. 20, Kenya is planning negotiations to extend loans from the Export-Import Bank of China for the construction of a rail link between Nairobi and the Port of Mombasa. Transport Minister-designate Kipchumba Murkomen warned that the Belt and Road Initiative project “will never break even” and that it will be “impossible” to repay the loan from the project’s proceeds. He cited a 50-year term as the target for renegotiations, compared to the current 15-20 year terms.
Under recently elected President Ruto, users of the line were given more flexibility in transporting goods to Mombasa, ending a previous policy that forced them to transport them to inland hubs before shipment. Even then, the line is unprofitable with passenger and freight revenue of 15 billion Kenyan shillings and operating costs of 18.5 billion. Exim lent KSH 500 billion (US$4.13 billion) to the project. A KSH 1.3 billion (US$930,000) penalty was reportedly imposed on Kenya’s Treasury Department in early October for non-payment of debt service obligations, following earlier problems with non-payment by AfriStar, the Chinese-owned railway operator.
Bank Capital “Extension Risk”
Banco Sabadell failed to call an Additional Tier 1 deal (its €400 million 6.125% issuance) on its first call date, which falls in November. The bank announced its decision ahead of October 23, the deadline for notification of the request, “taking into account the cost of replacing AT1 instruments under current market conditions.”
On November 23, the instrument’s coupon is reset to the five-year swap rate (currently 3.08%) plus a yield margin of 6.051%, implying a new coupon of around 9.13%. The issue was already trading at a discount of 10 percentage points
Their decision didn’t stop the Bank of Nova Scotia from issuing an AT1 deal, $750 million in 60-year, non-callable, five-year notes at 8.625% versus 8.75% of the early guidance. If not called, the bonds would revert to the 5-year US Treasury yield plus 438.9 basis points.
Later in the week, Ireland’s Permanent TSB also sold €250m of AT1 perpetual debt, callable at 5.5 years, with the unusually high coupon of 13.25%, a record for the sector, versus the coupon of 7.9% needed to sell similar instruments at the end of 2020 The problem is to strengthen its balance sheet ahead of the €6.8bn purchase of loans from Ulster Bank, mainly through the sale of shares to the seller NatWest Group.
Our opinion
Both the Kingdom of Saudi Arabia and Emirates NBD enjoyed healthy demand, further confirming strong investor sentiment towards stronger GCC borrowing given the positive deadweight 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 a major restructuring at this time. Even after the projected growth this year, the debt-to-GDP ratio is unlikely to go well beyond 30%. Its main problems stem from overspending on subsidies and ineffective tax collection. However, the growing burden of debt service costs versus modest tax revenues requires policy attention. Kenya’s position is more strained (with a debt-to-GDP ratio of 67% in mid-2022), but far more so than Ghana’s.
So far, Banco Sabadell’s decision not to call an AT1 instrument is an isolated event and could well be temporary. Nonetheless, it has brought investors’ “extension risk” back into the focus of investors: the possibility that banks will not call AT1s and subordinated debt in deteriorating market conditions, resulting in investors holding longer (and potentially perpetual) maturity instruments, where possible, in accordance with normal market practice, although originally expected to do so. Nonetheless, the subsequent offer shows that it did not block the new issues but may have contributed to the record coupon paid by Permanent TSB.
Banco Santander had previously opted to miss an AT1 call opportunity in 2019 before redeeming the issue shortly thereafter, and both Deutsche Bank and Lloyds Bank also missed first call dates in 2020, but the previous norm was to use the first-call facility.
Sabadell’s decision highlights the growing “extension risk” in AT1 instruments as interest rates rise. As banks face higher funding costs, there is a greater temptation to keep such instruments uncalled and allow them to switch to less favorable post-call coupons. Sabadell has stressed that it may call the issue at a later quarterly call date, but difficult refinancing conditions increase “extension risk”. Investors face the risk of severe losses if the practice spreads further, which would hamper the future issuance of AT1 capital instruments.
This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, a separately managed division of S&P Global.
