Euroweek Japan report, September 2013: emerging market samurais

Euroweek Japan report, September 2013

Emerging market sovereigns have started to return to the samurai markets, first under the protection of a JBIC guarantee but increasingly as stand-alone credits. They are attracted by diversity of funding, and keen appetite from Japanese investors hungry for yield. How far down the credit curve will investors be willing to go? By Chris Wright

There was a time when emerging market sovereigns were frequent issuers in the samurai markets – a time that came to an end following the Latin American crises of the early 2000s. But after a decade in which many were absent, they are venturing back, and finding a willing audience waiting for them.

“If you go way back, the samurai market was initially very much a supranational and then a sovereign market,” says Vince Purton, head of debt capital markets at Daiwa. “People who look at the market now will say, quite rightly, that most transactions are FIG, but that is not how the market has always been. And we detected a year or so back that there was growing interest from a lot of investors in re-evaluating the sovereign sector.”

Partly, this represented diversification on the part of investors wanting to add to the many foreign banks in their portfolio. Since many sovereigns do still have name familiarity in Japan dating back to when they were more regular issuers, they were a logical way to achieve that diversification if they wanted to come back.

And emerging market sovereigns tend to pay well, relatively speaking. “People have started looking at these kinds of names to enhance their portfolio and achieve better yields,” says Hiroyuki Kinoshita, head of debt syndicate at SMBC Nikko Capital Markets in Tokyo. “Last year yen rates were very, very low, and investors have a problem getting yield.”

Additionally, JBIC’s Gate initiative, applying partial guarantees to lower-rated credits, helped investors gain comfort. “The Gate initiative offered partial guarantees on some of those traditional names who have temporarily slipped out of the investment grade category,” says Purton. “That brought some sub-investment grade credits back into the market for the first time in a decade or so, and it encouraged investors to look at standalone investment grade sovereigns as well. The JBIC initiative has succeeded on all levels.”

Seeing this coming, banks like Daiwa began setting up sovereign non-deal roadshows around the IMF annual meeting in Tokyo last year. “That was very much a matter of putting feelers out into the market,” Purton says. One example of a credit Daiwa took out to the market was Slovakia: encouraged by the feedback it received, it then went ahead and issued. “There’s always been latent demand, and it was pushed to the fore by the JBIC initiative and the need for improved portfolio diversification,” says Purton. “Everything came together at that time.” This article looks at four borrowers who have taken advantage over the last 18 months: Poland, Mexico, Tunisia and Turkey.

Not all sovereigns needed to be rehabilitated: some with strong and improving credit ratings have been regular issuers throughout, Poland – with 13 samurai tranches since their 2003 debut – being the obvious example.

Bogdan Klimaszewski, deputy director in the public debt department of Poland’s Ministry of Finance, intends to keep it that way. Poland produces a debt management strategy covering periods of four years, which includes a defined role for foreign issues, including the yen market. “Of course the first international markets for us are the euro and US dollar market, but almost every year we are active in yen and Swiss francs,” he says. “In yen, because of the investor quality and our task of broadening the investor base, we have been present every year except 2010,” a year in which pretty much nobody else in its peer group was able to issue either.

“We treat our presence in Japan as part of the marketing process of all of our treasury securities: not only those issues in yen, but in our local currency, and those issued in euros and US dollars.” This is a message that comes up frequently among sovereign issuers: that Japanese investors are equally interested in global benchmarks, or even in local currency debt if there is a decent yield to be had, as they are in yen issues.

Yen in itself does not represent a large proportion of Poland’s funding: less than 2% of total state treasury debt as of June 2013, or 5.2% of total foreign currency-denominated debt. Nevertheless, as one of four core markets in foreign funding, it has become important, and the participation of Japanese investors in all currencies is more significant. “There are several accounts with a huge portfolio who come to the Polish local treasury market and buy our treasury bonds,” he says, citing feedback from Poland’s primary dealers.

Poland is also representative in having typically opted for samurais over other fundraising methods. It has twice issued based on EMTN documentation (in 2004 and 2008), Klimaszewski says, but generally prefers samurai. “All of our samurai issues were public,” he says. “Under EMTN, there were only private placements. So from our perspective, it is much more efficient to issue under samurai procedures and documentation, because it is much more adjusted to the needs of Japanese institutions, like insurance companies, trust banks, city banks and regional banks. The documentation is much better recognised for those institutions than, for example, EMTNs.”

Poland is able to achieve some striking tenors in yen. “We are quite well known on the yen market, so to achieve a longer tenor is not as difficult as it is for some countries who have just entered,” says Klimaszewski. In 2012, Poland raised Y56 billion of five-year paper, and Y10 billion of 15-year. Issues in 2011 came at four years and a 15-year EMTN private placement.

Poland has had no need of a JBIC guarantee – “we achieve satisfactory yields without any involvement from other institutions to guarantee our liabilities. There’s no need” – but not everyone has that luxury. And Mexico represents an interesting example of a borrower graduating from needing a guarantee to getting by without one. Mexico launched JBIC-guaranteed transactions in 2009 and 2010, and followed with non-guaranteed deals in 2012 and 2013. The country is rated Baa2/BBB/BBB+.

As with Poland, part of the attraction for Mexico is diversification. “For a few years we have tried to reinforce the diversification of our investor base, and have emphasised that we seek a regular presence in the key international markets,” says Alejandro Diaz de Leon Carillo, deputy undersecretary for public credit at the Ministry of Finance. “Mexico was a frequent issuer in yen for many years – almost a decade – which reminded us of the virtues of a diversified investor base.”

Coming back to the markets after a long time away, JBIC was vital. “JBIC has done a very good job in putting together the Gate programme,” de Leon says. “It allows an issuer like ourselves to go in gradually and to build a stronger and more regular presence in the samurai market. It was very important for the first two transactions to have a guarantee format: it was almost a decade without Mexico being a frequent issuer in yen. There was a lot of credit history that was lost, and investors literally were unaware of, because we were absent for so long.” He believes that JBIC also then helped to provide interest in the later, non-guaranteed deals, the first of which came in 2012.

Mexico’s latest transaction, a three-tranche Y80.6 billion deal in

July, tells us a lot about how useful the market can be for an issuer. By April, year to date, Mexico had already issued Eu1.6 billion of 10-year money – a deal that attracted Eu4 billion of demand – and $1.5 billion in a tap of outstanding 30-year paper. Then, as Ben Bernanke’s comments on tapering sent world markets into a spin, volatility rose around all emerging markets. “That market was not only changing the levels we could finance ourselves at, but increased volatility, and new issue premiums increased significantly,” he says. Yet in late July, through Daiwa, Mizuho and Nomura, it priced Y48.6 billion of 1.16% three-year paper, at 80 basis points over yen swaps; Y15 billion of 1.39% five-year, at 88 over; and Y17 billion of 1.54% six-year funds, at 93bp over. Notably, all levels were well inside where the borrower had raised funds a year previously. The deal was characterised by greater appetite within Japan than the previous year, when more went offshore, something that bookrunners characterised as Abenomics at work.

“Being able to go and issue in the Japanese market achieved significant goals for us,” says de Leon. “First, having a large and meaningful transaction; second, expanding the tenor of our issuance – and it is not easy for a BBB issuer such as ourselves to go beyond five years in Japan; and then to achieve low spreads and yields even in the midst of volatile markets. It was the lowest coupon ever for Mexico in these tenors. Our six year tenor spread was within last year’s five. And this year’s five was inside last year’s three.”

The improvement, even in such difficult markets, was not just about developments in Japan. Mexico is something of an emerging market sweet spot since President Enrique Pena Nieto has put the country on a reformist path. “Clearly the administration has put in the heart of the discussion a very ambitious reform agenda, with meaningful consequences for the economy,” says de Leon. “The consequences of that being discussed, and the fact that this is our second time around in the market with a non-guarantee format, and that we have gone frequently to the Japanese market to touch base with investors and keep them informed – it all helped.” Mexico has also had to work on building the dialogue: de Leon has been there five times in the last two and a half years.

The range of tenors and tranches helped Mexico hit a wide range of investors: banks in the three-year, insurance companies in the six. All told, it has achieved the diversification Mexico wanted. “We have been able to broaden our investor base with the samurai market.”

Purton says the market has “shown itself to be fairly focused on the three to five year area this year” – Slovakia, for example, made its debut in those two durations – but notes occasional reverse inquiry at longer tenors. “Mexico launched a 6 year tranche, for example, and we did a private placement for another sovereign at a super-long tenor.”

Like Poland, Mexico prefers samurai to the alternatives. “We are always trying to look into new ways to improve or further diversify our investor base, and we remain open to other formats,” he says. But it’s the samurai route that stacks up for sovereigns now, in stark contrast to SSAs, who have all but abandoned samurais for EMTN and uridashi.

Also like Poland, Mexico has noticed interest from Japanese investors in its other paper: both dollars and euro benchmarks, and local peso bonds. “They have been a growing presence there.”

The fact that Mexico was able to raise funds on such good terms when other G3 markets were in turmoil says a lot about Japan’s appeal as a diversifier. “I think other credits would look at what Poland, the Slovak Republic and Mexico have done and say: this makes sense, particularly in an unpredictable global environment,” says Purton. “We saw in June the samurai market was seeing two trades a week at the same time that the markets were effectively closed in dollars and euros. There will be times when the yen market is closed and those are open, but the message is: you must diversify your sources of investor support, by market, by tenor, by currency – and samurais help you to do that.”

The market has shown renewed appetite for strong names within the BBB rating band, as it used to in the 1990s. Mexico is actually split between BBB from international agencies and A- from Japanese, but “we can go down to strong BBB credits too as standalone issuers,” says Purton, who says one credit Daiwa is helping prepare an issue right now is exactly that. “Two or three years ago, single A ratings were a must but now we can go down to BBBs once again.” Kinoshita agrees that the Mexico deal, at BBB, was “a big change, and a very positive surprise in the market.”

One borrower that might test that appetite is Tunisia. The country has a long-standing close relationship with Japan, which has helped to fund development projects there since the 1970s; correspondingly, Tunisia was a frequent samurai issuer from 1995 to 2007, borrowing five times, all of them unguaranteed. “The sovereign was an investment grade issuer then,” says Monia Saadaoui, managing director in the external finance department at Banque Centrale do Tunisie, the Tunisian Central Bank. “Unfortunately, that’s not the case now.”

Since those issues, a huge amount has happened in Tunisia: the revolution that kicked off the Arab Spring; a painful transition to democracy; and discord in its two neighbouring states, Egypt and Libya. So when Tunisia came back to the market in December 2012, it had to do so with a JBIC guarantee, an issue that it then followed with another for Y22.4 billion in July.

Tunisia had to pay up for its funds, with pricing wider and volume smaller in July than in the December deal, but it did gain 10-year funding, with a 2.04% coupon and a spread of 100 basis points over yen swaps. (The previous transaction, also 10 years, was for Y25 billion at 1.19% and 45 bp over swaps.) While the greater cost is very clear, it has to be remembered just what sentiment towards emerging markets was like in July, and in particular in North Africa: Tunisia’s opposition leader Mohmed Brahmi had been shot dead on July 25, leading to anti-government protests, while Egypt was also extremely volatile at the time. “Our roadshow was in the second week of July,” Saadaoui recalls, “at the same time as problems in Egypt. There was some confusion between Egypt and Tunisia in the region.” She and the central bank’s governor spent three days in Japan meeting five investors per day, some insurers, some asset managers and some banks; they found investors who were prepared to take the risk, with the JBIC guarantee. “To be honest with you, we were surprised by the positive feedback from the Japanese investors.”

Furthermore, Tunisia had been downgraded twice between the December and July deals; today it stands at Ba2/B, clearly too low to come in its own name now, but an interesting candidate if it were to be upgraded back to the BB level it occupied before the December deal. Saadaoui is hopeful the country will stabilise by the end of this year, with a clear roadmap for the remaining transition to democracy and the finalising of a national constitution; if that brings an upgrade, then maybe Tunisia will be in a position to leave JBIC guarantees behind.

Perhaps the next borrower to make the leap from JBIC’s Gate program to issuance in its own name will be Turkey. The country issued its first samurai in 1992 and used to be a regular fixture in the market, raising Y860 billion in 19 bonds between then and 2000. After that, crises and defaults in the early 2000s, particularly in Latin America, effectively closed the samurai market for many emerging market sovereigns. “Therefore Turkey postponed its issuance plans in the Japanese market for some time,” says a Turkish treasury official. “However, the Gate programme enabled us to reach Japanese investors again.”

In 2011 it returned, with a record-breaking Y180 billion 10-year bond, the biggest ever under JBIC guarantee, equivalent to US$2.3 billion at the time of issuance. It followed it with Y90 billion in 2012. It has since followed with a 20-year private bullet for Y18.4 billion in January this year, with a coupon of 2.68%. “We think this deal was an important step between the guaranteed deals and a prospective standalone public deal,” the official says.

“We perceive the Gate program as a step towards establishing our presence in the samurai market with our own name and credit,” he says. “Turkey became a full investment grade country as of May 2013. We hope to issue on our own in the Japanese market in the medium run.” Gate, he says, allowed Turkey to put its name in front of Japanese investors again after a 10-year break, and to re-build relations with the investor base. “Our short term objective is to keep our activity in this market whether with a guarantee or on a stand-alone basis, depending on the market conditions. To this end we are closely monitoring the market for any opportunities.” As with other borrowers, Turkey sees diversification of funding sources as key, and the country makes annual roadshows with senior treasury and central bank officials annually. It also plans a shelf registration, which would be a natural stepping stone to uridashi issuance, “when annual issuance volumes justify it.”

Also like other borrowers, Turkey has made an effort to be assessed by Japan’s credit rating agencies: it has worked with JCR since 1994 and began working with R&I last year. This can be crucial. Kinoshita points out that, although Mexico is rated BBB, Japan’s JCR puts it as A-. “That was supportive for investors who need a single A rating from agencies.”

Other emerging market sovereigns have also had positive experiences in samurai. Slovakia made its debut in June, with an issue of Y25.8 billion of 0.72% three-year notes, and Y4.2 billion of 0.99% five-year. In going without a guarantee, this was the first debut sovereign samurai to go solo since Hungary in 2004. (It didn’t go perfectly: the leads, Daiwa and SMBC Nikko, also marketed a 10-year tranche but cancelled it. That said, marketing more maturities than are eventually sold is not uncommon in samurai deals). Indonesia raised Y60 billion in a 10-year deal in November 2012, using a guarantee, but with a growing sense that it could probably get a deal away without one. Qatar – through state-owned Qatar Petroleum rather than the sovereign itself – raised Y85 billion in 10-year funds in August 2012, in a rather odd deal in which the issuer opted for a JBIC guarantee despite the guarantor having a lower rating than the issuer, which was done so as to help with familiarity with the credit. And, in another format, National Bank of Abu Dhabi launched the first MENA uridashi issuer in February with a $16.6 million 15-year transaction.

It remains to be seen what impact Abenomics and the Bank of Japan’s monetary easing will have on issuers like these. “Probably it could result in an acceleration of the inflows of Japanese investors towards our local currency debt,” says Klimaszewski. But Poland’s approach has not changed: this year, as ever, it went to visit Japanese partners and to explain developments in the Polish and global economy. He says that, if conditions look suitable, Poland will probably issue in October or November as it generally does, with whatever is raised dedicated to next year’s funding requirements for the state.

De Leon in Mexico says of Abenomics: “I think that, overall, we have probably received more attention in the sense that some investors are looking into different types of instruments now, and because Japan’s policies may reduce the local supply. We have seen a lot of interest.” He recalls being in Tokyo on a non-deal roadshow earlier this year. “The number and names of investors who were represented was a positive surprise. The reforms in Japan are conducive for yen investors to look into new names and new issuers. In our case, it is fortunate Mexico started this process a few years ago, so we are already at a stage where we are ready to issue frequently in Japan.”

Kinoshita believes one impact of Abenomics has been on tenor. “After the Bank of Japan announcement, yen rates became very volatile, and borrowers in the yen capital markets found it difficult to issuer longer tenor,” he says. “Five years has been the most popular tenor in the samurai market in recent years, but this fiscal year, people have gone shorter, to three years, because of the volatility.” That said, he thinks positive sentiment towards Japan has led to “people being in risk-on mode, which I think makes investors look at samurai products more positively.”

There remains a theory that a samurai can be a stepping stone to other types of Japanese securities. “We have seen that in practice,” says Purton. “Once you’ve done a samurai, 12 months later you can set up a shelf programme. Once you have a shelf, it makes you much more suitable to be considered for uridashi.” That said, most uridashis in yen tend to be structured, which does not always suit sovereign issuers. “Although in theory they are eligible, in practice you don’t see that type of structured product appealing to them.” But occasionally there are opportunities in plain vanilla Yen targeted at retail investors – Poland has done a couple of retail targeted Samurais in recent years , for example – or at specific institutional accounts.

Whether or not samurais lead to other funding structures for sovereigns, their impact has been impressive. “Sovereign samurais are not a flash in the pan,” says Purton. “This is an asset class that could well rise again. It may still be junior to the FIG side in terms of overall numbers for the foreseeable future, but it is going to offer interesting and important diversification.”