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Emerging-Market Credit-Linked Note Sales Boosted as Investors Seek Yield
Investors are seeking higher returns from credit-linked notes tied to the debt of some of the world’s lowest-rated countries.
Banks issued $1.07 billion of notes linked to the bonds of countries including Ghana, Venezuela, Indonesia and Turkey in the last month. The notes pay coupons of as much as 19 percent, according to data compiled by Bloomberg.
Demand for emerging-market credit-linked notes has increased as the International Monetary Fund estimates developing-nation economies will grow 6.8 percent this year, compared with 2.6 percent for advanced countries. The notes are used by investors who aren’t able to trade the underlying securities for reasons including regulation and cost.
“Credit-linked notes are probably the most efficient way of playing the debt of certain emerging markets,” said Jim Craige, who helps manage $12 billion of emerging-market assets at Stone Harbor Investment Partners in New York. “Most CLNs related to local market trades are to get around tax issues, or where you can’t set up a local custody account. You’re basically using the balance sheet of a bank for a small fee.”
Banks typically build fees into the notes, where costs vary depending on the size and maturity of the securities and how easy the underlying debt is to trade, said Eric Debray, the London-based co-founder of TFS Structured Products, a unit of broker Cie. Financiere Tradition SA. “With less liquid underlyings the notes can be more costly to structure.”
Venezuela, Ghana
Exprinter International Bank NV in the Dutch Antilles sold $623 million of notes linked to Venezuela government bonds, offering yields of as much as 14.7 percent. The cost of insuring 10-year Venezuelan debt with credit-default swaps has jumped 17 percent this year to 1,123 basis points, the highest in the world, according to data provider CMA. Credit swaps are used to bet on or hedge against a borrower’s ability to repay debt.
Citigroup Inc. issued 5 million Ghanaian cedis ($3.5 million) of three-year notes linked to that country’s debt that pay a 19 percent coupon. Ghana is rated B by Standard & Poor’s, five levels below investment grade, and a step higher at B+ by Fitch Ratings. In February, Citigroup issued $10 million of notes linked to Ukraine, which pay 22.25 percent, the highest coupon this year.
Exprinter, based in the Caribbean island of Curacao, was the biggest issuer of emerging-market notes in August, followed by Barclays Capital which sold $129 million of notes linked mainly Indonesian debt, Bloomberg data show.
High Coupons
Sales of emerging-market notes picked up in the last two months amid record-low yields on developed-world debt, said John Terzis, an associate in emerging markets sales at Citigroup in New York.
“Business has definitely picked up in the last two months as coupons are very high,” Terzis said. “There is more risk appetite from real-money accounts, who are sitting on a lot of money and are trying to put it to work.”
Ten-year U.S. Treasury yields fell to a 19-month low of 2.42 percent on Aug. 25, before rebounding to 2.70 percent after a U.S. government report last week showed companies added more jobs than economists forecast. German benchmark 10-year bond yields have risen to 2.32 percent from a record low 2.087 percent on Aug. 31.
Credit-linked notes haven’t found favor with everyone. Kevin Daly, a London-based emerging market debt portfolio manager at Aberdeen Asset Management, said it can be difficult to get out of trades because of the lack of counterparties.
“Credit-linked notes are too illiquid for us,” Daly said. “The problem with a CLN is that you have one bid for it. Basically you have to go back to the bank that sold it to you. If there is a big rally in cash you are still at the mercy of the counterparty to get out.”
Counterparty Risk
To compensate for counterparty risk, credit-linked notes typically pay more than the underlying debt, boosting returns for investors willing to buy the securities. Standard Bank issued at par a $50 million five-year note on Aug. 25 based on Turkish government debt paying 11.25 percent. That compares with a yield of 8.72 percent on similar-maturity Turkish bonds.
Deutsche Bank sold 17 billion rupiah ($1.9 billion) of 15- year 11 percent notes linked to Indonesian government debt on Aug. 24. Indonesia’s 11 percent bonds due 2025 yield about 8.8 percent.
“Turkey and Indonesia are the next emerging-market countries to pick up,” said Gavin Redknap, emerging markets strategist at Nikko Asset Management in London. “You are getting a nice pick-up over the cash with the CLN.”
Investors have also bought notes on Greece, Colombia and Egypt in the past month, Bloomberg data show.
To contact the reporter on this story: Sarfraz Thind in London at Sthind3@bloomberg.net
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