Reuters: Bankruptcy News: EM sub-bond boom raises same old questions

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EM sub-bond boom raises same old questions Oct 26th 2012, 09:26 By Helene Durand and Sudip Roy Fri Oct 26, 2012 5:26am EDT LONDON, Oct 26 (IFR) - The boom in emerging market subordinated bank debt issuance is increasing concerns that investors are prepared to ignore the asset class's inherent risks in their quest for yield. This year has seen record sub-debt issuance by banks from Latin America, Central and Eastern Europe and Asia, as regulators in those countries move to implement Basel III rules and lenders seek to boost their capital buffers in a cost-effective way. Such deals from Asia, Latin America and CEEMEA total more than USD32bn so far this year, according to Thomson Reuters data, far exceeding the pace of recent years. Volumes are expected to grow further, with new countries such as South Africa likely to join the flow. However, for many investors either the asset class and some of its more complex features are new, or they have not been exposed to emerging markets credits and their intricacies before. "With more and more issuers trying to access the market, I personally don't feel comfortable that end-investors know the credits and instruments they are buying and have had time to do the work," said a London-based fund manager. "The grab for yield in the high-net worth networks is huge and that is what is driving the demand for these trades." Another London-based institutional investor agreed. "We try to avoid this sort of stuff," he said. "Anything that roadshows in Asia appears to be sucked in a bottomless pit of demand but I don't think investors are getting rewarded for the risk they're taking. Some of these deals would only be possible in the institutional market if they came 200bp-300bp wider." PRIVATE BANK BID The private bank bid in Asia and Switzerland has been a driver behind many of the emerging markets trades, especially the more complex ones which offer juicier yields. For example, 82% of a USD1bn perpetual non-call 5.5-year Upper Tier 2 priced for Gazprombank last week - the first of its kind from Russia - went into private bank hands in places such as Asia and Switzerland (although the order book was more balanced between institutional and private bank accounts). The deal comes with language that could see coupons deferred if the regulator deems that the bank is in trouble, while the issuer also has the option to skip coupons if it has not paid a dividend in that financial year. Similarly, a USD1bn perpetual non-call 10.5-year hybrid Tier 1 for compatriot VTB - again, the first from the country - saw 77% go to private banks, with Switzerland, Russia and Asia counting as the main drivers. The deal allows the issuer to change the terms of the bonds to make them compliant with Basel III, which could dramatically worsen the risk profile. NO ONE'S MUG Some bankers, however, say the level of investor understanding, especially within the private banking community, is greater than many assume. "Asian private banks know these products extremely well," said one banker. "Private bank accounts in Asia and Switzerland are no one's mug, even in a rally," he added. "They understand the risks and know what they are buying." What they may lack, though, is knowledge of the credits themselves. That's why, said the banker, Russian borrowers have undertaken extensive roadshows ahead of their deals, with senior management taking time to meet investors in conjunction with capital markets practitioners and bank capital structurers. Still, in a country such as Russia where the political and regulatory environment can be unpredictable, risks have to be carefully scrutinised. "We've seen how regulators in Europe were able to make capital loss-absorbing even when it wasn't originally meant to, so there is a good chance that regulators in EM countries would use these powers should they need to," said one investor. "Also, while governments will try and protect local retail investors, I don't think they'll give two hoots about shafting the Asian private banks." SENIOR WITH A SPREAD? It is not just in the more exotic hybrid space that questions arise. Huge inflows in emerging market funds - more than USD30bn this year, according to EPFR Global - mean that investors have been prepared to go down the credit curve and into what they believe is a fairly vanilla product in order to pick up incremental yield. "Do emerging market investors value the subordination properly? I wonder," said a DCM banker. "In a low-yield environment, the incremental appeal of sub over senior even at 75bp-80bp is too good to refuse." Last week Sberbank priced at an even tighter differential. Its USD2bn 10-year bullet Lower Tier 2 transaction came just 40bp wide of the bank's senior curve. Amazingly, Sberbank priced the sub debt 100bp inside where it sold a senior 10-year note in January. "This was beyond every rational explanation of what you can get done in EM," said a banker. "Essentially it had the dynamic of a senior trade." For many European institutional investors, this "Tier 2 is only senior with a bit of extra spread" argument will sound very familiar and evoke bitter memories, as this was how some European banks' subordinated debt that ended up suffering huge losses was sold. "For many of these investors in Russia, Turkey, Brazil, they're making a play on the macro and ownership of these banks," said a Zurich-based fund manager. "However, while things look fine now, they could look a lot different in two, three years and you could see tensions build you hadn't expected." Regulators and governments have made it clear: subordinated debt will not be protected and any investors should value these deals on that basis, one investor said. "I am not so sure this risk is well understood by some of the newer investors to the asset-class," he added. (Reporting by Helene Durand and Sudip Roy; Editing by Matthew Davies and Julian Baker) Link this Share this Digg this Email Reprints

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