Emerging Market debt gets frothy as deal flood continues

Sept 21 (IFR) - As emerging markets borrowers continue to stampede into the primary markets, bankers are wondering just how long the central bank-fuelled party will last. Given where recent deals have been priced and subsequently traded, some are even beginning to mention the "B" word.

"It feels very much like an asset bubble," said one emerging markets banker in London. "You can't justify these valuations on paper."

"I am not sure if I have seen it better than this," added one veteran Latin American banker. "It feels like a bubble, but I can't say it is going to stop any time soon."

The credit rally since Mario Draghi signalled his intention to save the eurozone has been startlingly intense, with the iTraxxSovX CEEMEA index, for example, tightening by more than 140bp since June, when it was 350bp.

Moves by the US Federal Reserve and the Bank of Japan, together with Draghi's promise to buy the bonds of troubled eurozone sovereigns, have added to the momentum, with only the occasional negative headline reining in the rally.

"It's one-way traffic," added the London banker. "Throw any scrap of meat into the water and the piranhas are having a feeding frenzy. Valuation models have gone out the window."

Another dimension to the emerging markets at present is the supply-demand imbalance. Even though emerging markets issuance volumes are at a record level - US$314bn for the year so far as of September 13, according to ING - the amount of cash searching for yield is huge and growing thanks to quantitative easing.

"The imbalance between supply and demand has been building like a pressure cooker. As the macroeconomic backdrop was uncertain, that cash wasn't being invested as fast as it could have been. But now the ECB has taken the lid off the pressure cooker and new issues are pricing way inside fair value," said the banker. "It's insane."

CONCENTRATED LIQUIDITY

Liquidity is particularly concentrated in the primary markets, with order books reaching multi-billion dollar levels. Zambia's recent debut international offering, for example, saw a US$12bn book with 420 accounts putting in orders.

The African sovereign's US$750m 5.375% 10-year offering is a prime example of a new issue that seemed completely out of sync with the issuer's fundamentals. Zambia, which is rated B+/B+, priced the bond at 98.108. Within hours of trading, it was being quoted at 101.50-101.75.

A three-point move would usually indicate that the issue was mispriced. But even rival bankers said it was a tightly executed trade. It was simply a matter of investors clamouring for rare African paper and ignoring the ratings. The bond's yield has compressed by 50bp in less than a week to reach 5.14% on Thursday.

"This is the reality," said one banker in London. "I don't know where all of this is going."

There have been plenty of other instances of new-issue prices and secondary levels that at any other time would be considered anomalies: Eurasian Development Bank, a part-Russian, part-Kazakh owned supranational, pricing inside Sberbank; Ukraine tapping a 9.25% 10-year bond at 7.461% just two months after printing the original; and Mexichem repricing the curves of other Latin American industrial names after generating a record US$17.5bn book for a dual-tranche offering.

And while some of last week's new issues saw less frenzied buying, especially smaller deals from lower-rated credits, sentiment remains buoyant.

"We are all living on steroids," said one senior DCM banker in New York.

BULL MARKET ACCESS

One consequence of the rally is the revival of mandates from borrowers that would only find access in a bull market. Mongolia's Xac Bank, for example, is hoping to get a deal away, having failed to do so earlier in the year. The deal is a bellwether of investor appetite towards high-yield credits.

Paraguay and Bolivia are also making noises about issuing. Paraguay has been contemplating an international bond since 2009, but has never emerged with a transaction. If Bolivia succeeds, it will be the country's first international offering in more than 90 years.

Some bankers argue that, although markets are frothy, they've yet to hit boiling point.

"The market is clearly very hot at the moment, but there's still a lot of cash to be put to work. It doesn't feel like we would overrun the supply - investors still think a lot of stuff is good value out there. I don't think we are there [in bubble territory] yet," said one syndicate official in London.

One capital markets official reckons the rally could last for a few months yet, as long as Spain doesn't send the eurozone back to the brink.

"While liquidity remains strong and rates low, technical factors will continue to overwhelm fundamentals," he said. "The rally could last to year-end."

The emerging markets rally could be dented if Treasury yields begin to climb substantially. Then the desperate hunt for yield would disappear. In the meantime, as one syndicate banker said, the message to borrowers is clear. "Print, print, print."

(This story will be published in the Sept 22 issue of the International Financing Review, a Thomson Reuters publication)

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