* Sovereign set for bond market return
* Some predict yields below 7%
* Default memories still vivid
By Davide Scigliuzzo
NEW YORK, June 11 (IFR) - Ecuador's pending bond issue will
help gauge how emerging market risk gets repriced in an
increasingly frothy market, especially if the serial defaulter
can get away with a yield under 7%.
The country, which defaulted on US$3.2bn of foreign debt in
2008, is meeting investors in the US and UK this week ahead of
what's expected to be its first bond in close to a decade.
The deal has generated considerable interest, not least
because the sub-7% yield predicted by some would be a coup for a
Caa1/B/B rated sovereign with such a troubled credit history.
"In addition to a poor track record in debt repayment,
Ecuador faces refinancing risks going forward," said Sarah
Glendon, the lead analyst for Ecuador at Moody's.
"To the best of our knowledge, the authorities do not
currently have sufficient resources to repay the bond coming due
in 2015, although the government has strong willingness to repay
this bond, and a successful return to the market will increase
the likelihood of repayment."
That USD650m 9.375% note is seen as a key reference for
pricing on the new issue, which is expected to carry a 10-year
It was trading at a cash price of 107.5 to yield 4.2%
mid-market, or 370bp over US Treasuries, before details of the
investor meetings were announced Monday.
Based on that, investors said, the sovereign could price a
new 10-year as tight as 6.5%.
"Anything with a 7% handle would see a lot of demand," said
Jim Barrineau, co-head of emerging market debt relative at
"It would still look cheap compared to other credits in the
Borrowers are benefiting from the distortions brought about
in part by accommodative monetary policies in Europe, the US and
Looking at prior pricings in the region, for example, Mexico
paid mid 7% yields on 10-year money in 2002 when it carried a
higher Baa3/BB+ rating.
It is a similar story for Brazil, which printed 10-year
bonds in the low 7s in 2009 when it carried ratings of
Yet in a global rally that has lifted even the riskiest
credits, yields of 7% or lower make sense, as investors venture
further down the credit spectrum to boost returns.
Rwanda's (NR/B/B) 6.625% 2023s climbed to a record 104.75 on
Tuesday to yield 5.93% mid-market, while Pakistan's (Caa1/B-/NR)
8.25% US$1bn 2024s were quoted at 107.25 mid-market to yield
And while similarly rated Venezuela (B2/B/B) and Argentina
(Caa1/CCC+/CC) have bonds trading in the double digits, Ecuador
has strengths that separate it from its high-beta neighbors.
"Ecuador's scarcity value and index inclusion puts them in a
different category, closer to double B credits," said Siobhan
Morden, head of LatAm strategy at Jefferies, who thinks Honduras
is perhaps a better comparable. That Central American sovereign,
rated B3/B, now has 10-year bonds trading in the high 6s.
Though some accounts are reluctant to reward one of the few
sovereigns that was unwilling - rather than unable - to pay its
debt, many believe technicals will prevail.
"There is the issue of what yield the bond could come at,
and then there is fair value," said Matthew Murphy, a portfolio
manager at Boston-based Eaton Vance, which owns some of the
sovereign's 2015s but was not involved in the 2008 default.
He reckons fair value for Ecuador's new issue would be at a
spread of around 650bp over US Treasuries, equivalent to a yield
of roughly 9% for a 10-year tenor.
But he said strong demand for high-yielding bonds in
emerging markets could push pricing tighter.
"Most of the work we are doing is to understand [Ecuador's
President Rafael] Correa and get into his mindset," Murphy said.
"If the country needs capital he will be pragmatic and do
what is necessary, but there is always the risk of him changing
Many in the market are torn between turning their back on a
sovereign that selectively defaulted just six years ago and
welcoming Ecuador's positive changes and efforts to make amends.
"It is hard to forgive Ecuador's track record," said Morden
"It carries a clear stigma, especially when it is the same
president, but you have to recognize their economic performance
is better and they are making attempts to improve investor
relations. They have agreed to an Article IV review [with the
International Monetary Fund], which is more than Argentina is
Investors hit by the 2008 default are less forgiving.
"I still remember the default vividly. We were invested in
Ecuador at the time and I certainly remember how they deal with
bondholders," said one US-based portfolio manager.
"There isn't much to have an investment thesis on. I know
there is a price for everything, but as long as Correa is
president, Ecuador should have no place in this market."
And reforms introduced in 2008 - including the stipulation
that sovereign debt can only be used to fund infrastructure
investments or refinance existing debt at better terms - have
done little to improve perceptions.
"I don't think anyone who has been in the market for a while
believes those provisions would be worth the paper they are
written on if Ecuador were in a stress situation," said
Barrineau at Schroders.
Should the skeptics carry the day, Ecuador may pay more than
7% for the new bond - though the government could find cheaper
Since the 2008 default, Ecuador has relied on China and the
domestic market to finance its budget deficits, while also
receiving bilateral loans from CAF and the IDB.
The government's outstanding debt with China rose to
US$4.6bn as of August 2013, with annual interest payments
ranging between 6% and 7%, according to Moody's.
Still, diversification of funding sources may be worth a
premium at a time when the government is thought to be keen to
wean itself off a reliance on Chinese loans.
(Additional reporting by Paul Kilby; Editing by Marc Carnegie)