Corporate Bonds’ Gruesome Body Dissection
Amid a wave of corporate debt downgrade and defaults through April, CEMBI inventor JP Morgan published research “defining and dissecting” the $1.6 trillion asset class, $300 million above US high-yield. It encompasses hard currency and Eurocleared issues in public markets only and quasi-sovereigns with partial and complete state ownership, although cases like Venezuela’s PDVSA are in the government instrument EMBI. The CEMBI covers half the universe and the size doubled the past five years. By region, Asia and Latin America dominate with respective 40 percent and 35 percent shares with Europe and the Middle East between 10-15 percent. Dollar and euro-denominated bonds account for 85 percent and 15 percent in turn and they must fall under foreign law jurisdiction. China’s presence at $35 billion is biggest in the dim sum market for non-convertible currencies. The Middle East/ Africa segment is 60 percent government-related and Latin America oil giants PEMEX and Petrobras top the quasi-sovereign list each with over $50 billion outstanding.
Hong Kong, Singapore and certain GCC sponsors are excluded from benchmarks with per capita-income levels above the cutoff. Islamic-style sukuks and credit-enhanced structures are also barred but Chinese bank Basel III Tier 1 placements feature despite local law rule since they settle in dollars. Fifty countries are in the CEMBI broad and Brazil and China are roughly tied with $135 billion in activity and along with Mexico and Russia comprise 45 percent of the roster. Turkey’s component has grown fastest to over $35 billion currently, and by industry financials remain one-third or $550 billion for the overall category. Oil and gas is next and the real estate has jumped 750 percent since 2009 in the CEMBI Broad to almost $70 billion. Russia financial at $70 billion was the largest combined classification but China’s equivalent has eclipsed it since the onset of international capital market sanctions.
New entrants have recently been scarce to meet the CEMBI’s $300 million and 5-year maturity requirements with the investment-grade portion off 10 percent to 60 percent on prevailing downgrade trends. Slowing economies and earnings and high leverage and currency mismatch, in addition to the singular Russian and Brazilian drags have eroded the decade long creditworthiness base. JP Morgan projects annual volume will fall $75 billion this year to $225 billion, with the former figure equal to remaining 2015 rollover needs. Russia interest has revived despite “fallen angel” status with the ruble recouping a chunk of 2014’s dollar loss, commodity price rebound, and double-digit yields. The central bank has offered refinancing facilities and cut interest rates another 200 basis points at end-April. Global emerging market company debt exposure is only one-third through external bonds, according to the bank, and the Moscow stock market has also bounced this year as Europe’s MSCI leader.
Petrobras before the scandal broke was the leverage leader at 5 times and still may be relegated to junk despite the belated release of certified Q4 earnings flirting with covenant breach. Construction firm contractors have defaulted on their obligations, and state banks at home and abroad will cover 2015 debt service but management will have to slash capital investment and sell core assets as pension fund law suits threaten to carve up remaining morsels.
