Frontier borrowers re-enter debt markets to beat Fed

The world's less developed states are reappearing in international debt markets, putting up with slightly higher borrowing costs in a race to beat a growing aversion to risk that could shut them out for some time.

Kenyan President

   The uptick in yields may, however, make local corporate borrowers reluctant to tap the markets, even where their governments have set a benchmark with a sovereign deal.
   Kenya, Mozambique and Armenia are among frontier, or less developed, emerging market sovereigns announcing dollar bond plans before an expected tapering of the U.S. Federal Reserve's bond-buying programme which had boosted risky assets.
   Many frontier sovereigns have launched international debt in recent years, taking advantage of historically low yields due to the Fed's monetary stimulus.
   Rwanda's $400 million 10-year bond launch in April at a yield below 7 percent - lower than Spanish borrowing costs at the height of the euro zone crisis - represented the top of that market, investors say.
   But expectations that the U.S. Federal Reserve will scale back that programme has pushed up frontier debt yields by around 200 basis points and kept borrowers away for several months.
   Now the countries are worried that yields may go up even more if the Fed starts its tapering as early as this month, as many market participants are expecting.
   "From a backward-looking perspective, yields are higher - going forward, we do not know," said Michael Ganske, head of emerging markets at fund manager Rogge Global.
   "Just because U.S. Treasury yields went up, as an issuer you do not say 'I am not going to issue any more'."
   As a result, even debut borrowers Mozambique and Armenia are checking out dollar bond markets.
   Kenya said last week it was about to choose lead managers for a debut dollar bond of up to $2 billion, even though the country's president and deputy are awaiting trial by the International Criminal Court over post-election violence in 2007.
   Frontier borrowings this year have come from Africa, emerging Europe and the Middle East, while in Asia, Bangladesh and a state-owned Sri Lankan bank are planning launches and Bolivia is one of several from Latin America.
FRONTIER HUNGER
   Tiny U.S. treasury yields encouraged investors to seek out higher-yielding assets elsewhere in the past few years, and even traditionally high-yielding emerging markets gained safe-haven appeal during the euro zone crisis, boosting the prices of their bonds and depressing yields, which move inversely to prices.
   Frontier borrowers entered international markets to feed that hunger for yield, often for the first time, and in doing so avoided higher borrowing costs in their own currencies.
   But Fed chairman Ben Bernanke's comments in May about tapering of the U.S. central bank's monetary stimulus triggered a rise in bond yields across the board, also pushing up frontier debt yields.
   This has rattled investors. According to estimates from Lipper, a $180 million frontier bond fund distributed by Danish broker Saxo, for example, enjoyed strong inflows in Jan and Feb, which dwindled to almost zero in June and July.
   Reflecting the broad rise in yields, Rwanda's bond, which also suffers from being too small to enter emerging market bond indices benchmarked by many investors, is trading at 9 percent. =>.
   
   RATING PREMIUM
   Frontier borrowers with higher credit ratings, like Nigeria, have fared better than those with lower ratings, like Rwanda or Zambia, as investors become reluctant to take on the largest of risks.
   B-plus-rated Zambia sold a debut dollar bond  a year ago, with bids worth more than 15 times the amount on offer. But that bond has performed poorly this year.
    "Before, it was a much easier ride for some of these credits (borrowers) presenting themselves for the first time to investors in an environment of very cheap money chasing few attractive higher-yielding opportunities, said Giulia Pellegrini, JP Morgan strategist for sub-Saharan Africa.
   "Now...you will have to make a stronger case, but the appetite will still be there to pick up some yield."
   Kenya, like Zambia a B-plus-rated credit, will need to offer yields nearer 8 percent or even higher for its proposed large 10-year bond, investors say, compared with Zambia's issue yield of 5.625 percent.
   Political risk, however, is seen unlikely to hurt demand for Kenya as president Uhuru Kenyatta and his deputy William Ruto have said they will cooperate with the ICC, and this year's elections passed without violence.
   "The one thing investors had always been worried about in Kenya were the elections," said Stephen Charangwa, fixed income fund manager at frontier fund Silk Invest.
   "That major event risk has come off the table."
   In Zambia, several corporates were expected to follow the fledgling government dollar bond, but that now looks less likely. "It's too expensive for local corporates - that window has probably closed," said Razia Khan, Africa economist at Standard Chartered.
   Frontier sovereigns are still seeing healthy demand for their debt. Nigeria enjoyed subscriptions of four times the issue size for its recent two-tranche dollar bond  and Ghana and Bolivia  are among other recent frontier borrowers.
   But the days of the 15-times subscription for Zambia appear to be over. As Kevin Daly, emerging debt fund manager at Aberdeen Asset Management, said:
   "That was in another world."