Emerging Distress Spreads as 60-Cents-a-Dollar Debt Triples

  • As many as 57 securities trade below 60 cents on dollar
  • Brazil worst hit with a third of all distressed notes

The number of emerging-market corporate Eurobonds considered in distress has more than tripled in the past six months.

Fifty-seven securities in the Bloomberg Emerging-Market Corporate Bond Index are trading below 60 cents on the dollar, a threshold that signals companies may struggle to repay the debt. That’s up from 16 in July. Brazil accounts for the largest volume, followed by Colombia and India.

Investor sentiment is deteriorating as developing-nation companies brace for $115 billion of dollar-bond redemptions in 2016 after loading up on debt at lower rates in the past decade. Refinancing will be harder at a time when their borrowing costs have risen to a four-year high and their dollar earnings are dwindling because of lower exports and a plunge in commodity prices. Sixteen companies defaulted on their notes last year, the most since 2009, and Fitch Ratings says the trend could worsen.

“The current distress levels are a sign that things will deteriorate further,” said Maarten-Jan Bakkum, a senior strategist at NN Investment Partners in The Hague with about $206 billion under management. “With emerging-market growth still slowing, commodity prices declining, currencies depreciating and financial conditions tightening, there are good reasons to be very cautious on corporate debt.”

In October, the International Monetary Fund warned that developing countries must prepare for an increase in corporate failures as central banks begin to raise interest rates. The volume of debt issued by non-financial firms in major emerging markets quadrupled between 2004 and 2014 fueled by quantitative easing from the developed world, the IMF said.

Refinancing Risks

Companies’ borrowing costs began to increase in May 2013 when the Federal Reserve signaled it would phase out its unprecedented bond-purchase program, with the average yield climbing from a low of 4.19 percent that month to 7 percent now. The yield has jumped 23 basis points so far this year.

“Emerging-market corporates have been able to access capital at relatively low rates and that’s clearly correcting now,” said Peter Kinsella, an analyst at Commerzbank AG in London. “The real risk is to refinancing and that’s going to be tested over the next couple of years as bonds come due.”

The strain is already beginning to show. About one in 20 bonds in the Bloomberg gauge is distressed now, compared with one in 33 notes last year and just one in 250 securities in January 2014. The count of bonds placed on negative outlook by the agency has increased to 16 percent for sovereigns and 23 percent for corporates.

Companies in Latin America with a large volume of dollar debt outstanding are most at risk of defaulting, according to John Bates, a senior vice president at PineBridge Investments in London, which has $78 billion in assets under management. Brazilian borrowers, including Petroleo Brasileiro SA and Vale SA, have $24 billion of debt due before the end of 2017, according to data compiled by Bloomberg.

Energy companies make up about 40 percent of the distressed bonds, reflecting the global oil glut that has sent prices to 12-year lows. China’s economic growth slowed last year to the weakest pace since 1990, hurting commodity exporters. Brazil and Russia are already mired in recession, with South Africa’s economy narrowly avoiding a contraction in the third quarter.

“With oil at 30, we are going to see an acceleration of deteriorating creditworthiness into 2016,” Bates of PineBridge said. The greatest threats lie in “geographies that are most exposed to commodities.”

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