Buying back EM bonds puts welcome bid into stressed sector

[February 09, 2016]  By Claire Milhench

LONDON (Reuters) - From Mexican homebuilders to Kazakh oil firms, more emerging market companies are buying back their dollar bonds from the market, often paying juicy price premiums that have put a welcome bid into the stressed emerging debt sector.

The buybacks are good news for bondholders. Bond prices have fallen as investors have fled the sector -- some $32.6 billion exited EM bond funds in 2015, according to EPFR Global -- and yield spreads on EM corporate bonds have ballooned by 100 basis points in the past year.

"In periods of volatility and market dislocation it provides a welcome bid for the bonds, and helps set a floor for pricing," T Rowe Price EM corporate bond fund manager Samy Muaddi said.

Buybacks are also popular with companies, who see an opportunity to reduce their hard currency debt on the cheap. Servicing this debt has become more expensive following a sharp depreciation in many emerging currencies.

But in a market where new debt issuance has shrunk to multi-year lows, the trend also risks depleting an already limited pool of assets, some investors warn.

Bond buybacks by EM corporates rose to $22 billion in 2015 from $12 billion in 2014, according to JPMorgan, with companies as diverse as Brazilian and Russian banks, Indonesian real estate firms and Chinese coal miners all tendering for debt.

This year investors expect to see more activity from "quasi-sovereign" state-owned companies, following buybacks by Kazakhstan's Kazmunaigaz (KMG) and Azerbaijan's state oil company Socar [STOAR.UL].

Both those tenders had government support, despite the strains placed on the two countries' public finances by low oil prices. That had led to a period of underperformance for quasi-sovereigns, especially in the energy complex.

The premium offered by KMG's $3.4 billion jumbo buyback in November provided an immediate boost to its bond prices, worth around 10 points on some issues, and has raised hopes among investors that other quasi-sovereigns might follow suit.

"For companies to be able to reduce their debt through the support of the government is a positive thing. It's one of the reasons we think quasis in the energy space are an attractive place to be," said Shamaila Khan, an EM corporate bond fund manager at Alliance Bernstein.

SIGNIFICANT KICKER

The price of KMG's 2043 dollar-denominated Eurobond leapt from around $74 before the tender was announced to almost $88 afterwards.

"The price that KMG paid for its debt is what really got people excited -- that gave a significant kicker to many funds that were invested," said Aaron Grehan, deputy head of EM debt at Aviva Investors. He was holding KMG bonds and decided to sell the majority of his holdings back to the company.

But T Rowe's Muaddi held on to his KMG bonds, taking the view that there was still value in them.

This illustrates the fund manager's dilemma.

Companies with the ability to undertake a big buyback tend to have strong balance sheets, and so must offer tempting premiums to persuade bondholders to sell. But the investor has to weigh that against a shrinking supply of quality credits.

"Typically the kind of company able to do this would be in a strong financial position and with the impact from commodity prices and general economic stress, there's a small pool of stronger credits versus two or three years ago," said Grehan.

"But if there's a significant financial gain from that tender process, then you have to strongly consider it."

Muaddi said the overall supply of EM dollar-denominated bonds is expected to remain very limited as credit spreads are at their widest levels since the global financial crisis. This makes it expensive for companies to issue new debt.

Another downside for bondholders is that companies do not always offer premiums as good as KMG's. In Socar's case, its 2017 bonds were already trading above par, and it offered just $1,020 for every $1,000 tendered.

Some investors also expressed reservations about companies without state backing reducing their cash cushions, saying it might be good for the bonds that were the subject of the buyback but not for any remaining debt.

"In some cases they have been buying back short-dated bonds, then the long-dated bonds trade at a bigger discount," said Rob Drijkoningen, global co-head emerging markets debt at Neuberger Berman.

(Editing by Catherine Evans)

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