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Tim Hall: A Global Credit Snapshot

With a low rate environment looking to persist well into next year, it looks like a perfect storm for issuers is taking shape – particularly in emerging markets, where yield hungry investors are searching for higher returns. We speak with Tim Hall, who previously served as Global Head of DCM at Credit Agricole CIB, about the global credit outlook, how DM and EM market shocks – like Brexit or the recent attempted coup in Turkey, respectively – measure up, and what a low rate environment means for the sustainability of institutional investing.

Sep 9, 2016 // 11:19AM

What are some of most influential factors impacting your outlook on global markets this year?

In the primary markets, it is currently a perfect storm for issuers. Credit spreads are being driven in by central bank stimulus in many countries, particularly in Europe as the ECB continues and has even broadened its bond purchasing programme to include select EUR corporate issues. Books on most new issues in USD and EUR across asset classes are well over-subscribed, and concessions and spreads are incredibly tight. For borrowers who focus on fixed rate all-in costs, the underlying level of yields on benchmark securities in many markets – including US Treasuries and Eurozone government bonds – are at record lows. This indeed makes now a perfect time to issue debt in the capital markets, even if such issuance might be opportunistic. 

How does Brexit fit into your outlook? What have you been hearing from clients?

In the run-up to Brexit, people took a ‘wait and see’ approach as primary volumes slowed to a trickle, in both the EUR and USD primary new issue markets. Indeed, Brexit was certainly topical all spring and early summer until the vote, but now that the outcome has been determined, life will go on. For me personally, the outcome of the referendum was not what I had expected or hoped.  Sentiment towards European banks – especially UK banks – turned quite sour very quickly, and the outlook for the UK also faltered, most visible of course in the harsh depreciation of Sterling.  As far as primary markets post-Brexit, the dollar new issue market opened up almost immediately, and fortunately, the Euro market followed but to a lesser extent. The first segment to show signs of life was the public sector, as a wave of USD and EUR issuances were triggered once underlying treasuries settled down after a substantial “flight-to-quality” rally. Although the primary credit markets have been active, the sentiment is slightly less favourable probably because of the lead-up to the quiet summer period anyway.

Nevertheless, the dynamics of new issues clearly show that appetite remains voracious for euro and dollar denominated credit.  And of course, aside from Brexit, there is the on-going affect of a lack of Street liquidity and subdued secondary market activity, pushing investors towards the primary market as the only viable way to establish meaningful positions. It is well accepted now that the ever-growing amount of regulatory constraints on banks is curbing banks’ interest in holding and trading securities, due to the negative consequences on capital of holding risk-weighted assets.   As a result, investors are finding it very difficult to build positions in bonds in the secondary market, so the only alternative is the try to get sizeable chunks of new issues. 

So in conclusion, although there are numerous and rather complicated technical implementation points on how and when the UK leaves the EU, I don’t think Brexit will have a significant effect on the global primary debt markets.  Other matters have and will continue to be much more influential.

When you look at volatility resulting from something like Brexit, how do these kinds of shock events compare to what we are seeing in emerging markets more broadly – like an attempted coup in Turkey or similar political shock events, for instance?

I suppose although the outcome of Brexit was in fact a real possibility, the political mess it triggered in the ensuing two weeks was not at all anticipated.  But in retrospect, this did sort itself fairly quickly and without a great deal of disruption given the unexpected sequence of events. This contrasts quite distinctly to emerging markets generally, where such disarray could lead to a variety of outcomes one of which is unlikely to be a smooth transition to a new government. But let me return to this in a minute. In Europe generally – and in the USA in the current election year – we are witnessing the rise of the extremities of both parties, i.e. right wing and left wing populism.  Brexit is to some degree part of that narrative, and who knows if the UK will be the last country to call a “remain or exit” referendum. But the change in sentiment in some European countries has been orderly, albeit shocking to many. The issue in emerging countries, as I alluded to above, is generally that the smooth transition to a new way of thinking is often not tolerated, creating a variety of outcomes with the most extreme being (or close to being) significant unrest or even civil war. If we look at Turkey, it is hard to tell what really happened, although the aftermath of a failed coup will clearly be a suppression of civil rights and a more authoritarian government. Regardless, Turkey remains a key emerging markets country located in a strategically important place between Europe and Asia, bridging the gap between a secular society (as advertised) and a “creeping” religious autocratic mind-set.

Investors rather quickly determined a price for the increased political risk (and related negative economic effects), and I expect Turkish issuers will be back in the primary markets shortly albeit at new levels that more appropriately reflect the outlook of the country. As always, this will occur, and it will happen rather fluidly and quickly. One of the biggest changes that has occurred during my years in the business is, in the past, when an emerging market country had a cough, the entire EM asset class caught a cold. The discrimination now is much more noticeable and very real amongst buyers, as concerns tend to be contained to sentiment around a specific country or a country / regional event rather than to the broader emerging markets as a whole.  

The Middle East is a market that has seen a strong shift from loans to bonds this year. Do you expect this trend to continue? Is there any danger of crowding out?

The primary market in the MENA continues to be dominated by FIs and GREs, and DCM fees are quite low across nearly all segments and countries, making it a league-table volume game for banks, not a place to really make money in DCM.  Moreover, it often takes a great deal of balance sheet commitment to even get considered for a primary role, and these often-large loan deals aren’t particularly remunerative in themselves.   Although I did not check the primary flows per se, my instinct is that most of the increase in bond activity this year has been principally sovereign-driven, as many countries - particularly in the GCC - have had their fiscal situation erode quickly and dramatically because of the decline in oil prices.  There will likely be a well-advertised knock-on effect into MENA banks, as sovereigns withdraw liquidity (i.e. savings) from their local banks in order to fund their budgets.  So there is little doubt that there will be more sovereign issuance, as well as issuance by regional banks, both state-owned and private sector.  However, MENA remains a region with limited amount of corporate private sector issuance.  Some of the large global banks can monetise their balance sheet commitment to regional borrowers in ways other than just bond issues, but most banks without a broad product focus simply have to swallow the pain of poor remuneration on lending and DCM fees that are often lower than in Europe or the USA.  The competitive landscape for non-regional banks tends to be dominated by those banks with global emerging markets franchises and strong USD capabilities, with other products to “reduce the pain” of lending.   

As far as the availability of credit in the region, there seems to be no significant reduction yet amongst international banks in spite of the rather poor returns on lending, simply because there continue to be only a handful of opportunities which are often concentrated in the largest and most influential borrowers, including sovereigns.   History has generally shown that issuers in the region will generally opt for the cheapest financing, whether from banks or the capital markets, with little regard for investor diversification or taking advantage of the current rate environment to lock-in long-term fixed rates.  As the supply in both loans and bonds remains rather limited, I do not see any sort of crowding out in the near future because there is plenty of on-going appetite for MENA loans and bonds in both the bank and institutional markets.  Even a significant increase in GCC sovereign bond issues is unlikely, in my opinion, to alter the outlook, as a case can be made from investors’ perspectives that there is a relative value benefit to buying these sorts of high-tier EM issues vis-à-vis similarly-rated developed market issues. As a final comment, in fact infrequent or debut regional sovereign issues provide benchmark levels that ”open the door” for other non-sovereign issuers whether state-owned entities or private sector issuers, so the fact that they are issuing (or will issue) is a positive generally for the region.

Argentina seems to be the major turnaround story this year, with a slew of activity in the country’s DCM markets following the landmark sovereign deal earlier this year.  What are your thoughts on Argentina, and additional primary supply from this country? 

I am not an expert on Argentina, but clearly the standoff between the holdouts and the government lasted much longer than anyone anticipated, and this curtailed international issuance by Argentine issuers of all types for many years. The country has tremendous potential – natural resources, a strong agribusiness sector, and companies that have performed quite well despite a politically unstable environment and a mismanaged economic environment.  Investors showed just what they thought by “reloading” aggressively in April when Argentina returned to the international capital markets for the first time in 15 years with overwhelming success, even though the country continues to face problems and has a rather clear history of defaulting on its sovereign debt.  At a price, plenty of investors were willing to give Argentina another go.  Personally, I am very optimistic about Argentina and Argentine issuers, as there are a number of companies with strong international footprints that will likely take the decision to hit the international bond market now that the sovereign has set the benchmark level.

Outside of emerging markets, is the future for fixed income one of flattening and negative yield curves? Will this have an impact on EMs?

The cause of record-low rates and flattening yield curves is a combination of central bank intervention in terms of unconventional monetary policy and a creeping view that the world generally will face a prolonged period of slow growth, excess labour force capacity and low inflation (or worse). This is the cocktail that brings us to where we are today in places like the Eurozone, the USA, the UK, Japan and many other developed markets. Relatively speaking, this arguably puts more hope in emerging markets as the future catalyst to lift the world out of its rather drab outlook, although currency volatility and commodity-price weakness have not allowed the emerging markets as an asset class to power ahead as it otherwise might have. And this has been compounded by EM country specific events ranging from poor economic policies, isolated political problems and on-going wars. Still, for investors that have the flexibility and a knowledge of emerging markets, there are relative value plays favouring emerging markets bonds since, depending on the region or country, yields offer attractive pick-ups vis-à-vis developed markets. 

From an issuer’s perspective, the opportunity to borrow at historically low yields for long periods is extremely attractive.  However, investors simply will not find this environment sustainable. Rates will need to “normalise” at some point, or there will be additional pain ahead for those institutional investors that have guaranteed future returns, e.g. pension funds with defined benefit obligations and insurance companies.  

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