Weekly Bond Update: Record sub-Sahara issuance poses high risk
- Recent years have seen record eurobond issuance by sub-Sahara African countries
- On average USD government bonds from sub-Sahara pay approx. 6% yield
- Strong US dollar and interest rate hikes might increase repayment risk
- Sectors such as oil & gas offer better risk-return opportunities
By Althea Spinozzi
When we talk about emerging markets we normally think about the usual names: China, Mexico Brazil, Indonesia, India, Mexico, Turkey and others. However how do we categorise those countries that normally don’t get the EM label?
I am referring to the world’s least developed region: sub-Saharan Africa – an area that normally doesn't get much attention from investors. However, in the past few years eurobond debt issuance coming from these countries has steadily increased and countries that ten years ago weren’t issuing international bonds at all are now taking advantage of favourable financing conditions and placing debt on the international market.
As per table 1 above we can see that eurobonds issued by sub-Saharan governments had reached their peak in 2014, and even though this year we are well below the USD 14 billion total issuance of 2014 , 2017 is still the second-highest level for issuances. Despite this, Ghana is currently working towards placing 3-year maturity domestic dollar bond and Nigeria is planning to sell $5.5bn of eurobonds by year end, signalling that there might be further bond issuances coming in the next few weeks, meaning this year might even break the 2014 bond issuance record.
Investors hungry for yield aren’t deterred by the fact that they are putting money in the hands of governments that are facing deep challenges. Investors seem to be merely attracted to the higher yield compared to many other issuances available at the moment. The reality is that the majority of these economies are very sensitive to external shocks as they are founded on one single commodity, have poor government policies and are often affected by corruption. Nonetheless, an increase in USD borrowing since 2013 makes these countries sensitive to a stronger US dollar and very possible interest rate hikes.
Eurobond debt issuance from 2013 to 2016 by sub Saharan countries:
The country that has borrowed the most in USD between 2013 and 2016 is Ghana followed by Ivory Coast and Kenya. Just to give an idea of what these countries offer in term of yields: Ghana January 2026 offers approx. 6.5% yield, Ivory Coast June 2033 offers approx. 6% yield and lastly Kenya June 2022, offers approx. 6%.
All these bonds have performed quite well in 2017 but is this trend sustainable?
The reality is that in the majority of the cases, African countries borrow money to invest on infrastructure. Unfortunately, returns for these projects will not be able to pay the debt fast enough in order to extinguish existing debt. This is the main reason why as soon as the bonds are near maturity, African countries tend to refinance their debt in order to pay existing bonds thus they delay the repayment period giving them time to achieve long-term debt sustainability. The problem that I see is now that refinancing conditions in USD are getting more and more expensive due to interest rate increases, these countries may not be able to meet their obligations.
It is fair to argue that the majority of these countries are oil-exporter and that in the last few days there has been a rally in oil prices following the Saudi crackdown. However, even though higher oil prices could help these countries to meet their obligations in the short term, it will not be enough to offset a stronger US dollar and higher interest rates.
As a group, sub-Saharan government bonds are actually on the brink of default. And once one country shows some weakness, investors are going to flee these products, putting pressure all over the region.
Instead of looking at this highly risky and volatile region, investors should explore opportunities within sectors on the way to recovery such as the oil industry. Since 2014's fall in oil prices, companies in this sector had to restructure their current operations in order to survive lower oil prices. Even though the industry remains weak at the moment, Opec’s World Oil Outlook sees rising oil demand until 2030 which means that crude production will need to go up and oil prices will be supported. Geopolitical risks always poses threats and surprises in this industry and indeed, seem to have been on the rise recently with the Saudi crackdown, North Iraq versus the Kurdish regional government and Venezuela not being able to invest in oil production as the country is near bankruptcy. All of this is supportive for oil production and prices.
This brings us back to one of our trade ideas published a few weeks back: Vallourec, the French pipe-maker. Vallourec’s restructuring is on track and the company is working to close plants in Europe and expanding in China, while the company’s US mills are running at full capacity. The company has only EUR-denominated debt, however, the bonds with 2022 maturity and 6.625% coupon at the moment offer an indicative yield of 5.5% and the bonds with 2024 maturity offer approximately 5% but they are trading well below par.
Vallourec is just one example: the point is that there are many opportunities out there which are more compelling than the sub-Saharan story.
— Edited by Clare MacCarthy
Althea Spinozzi is a sales trader at Saxo Bank