Euro Bond: An Analysis

The new Euro Bonds issued by Pakistan for $500 million have been a subject of many misgivings. It is important that these misgivings should be clarified. In what is stated below, we point out the misgivings in bold face followed by our response.

Why Bonds were issued: Many critics have questioned the reasons behind the bond issue. At the outset, it is necessary to state that the bond issuance was part of a plan that envisages regular presence of Pakistan in the international capital market, as it provides a relatively cheaper source of financing compared to the cost of domestic financing. This year, there was an additional reason for issuing the bond to cover the forthcoming maturity of a bond in March 2016, which was issued in 2006. A team of Citi Bank, Standard Chartered and Deutsche Bank was appointed as Joint Lead Managers for the transaction that advised on the design, terms and conditions and timings of the issue. The Road Shows for the issue were held in London, Los Angeles, Boston and New York. Detailed briefing on the state of economy in Pakistan was given to some 80 leading investors from around the world.

Who were the Bond investors: It is alleged that bonds have been sold in a clandestine fashion to unknown entities and individuals. This is a false assertion. Top class investors such as Ashmore, Wellington, Aberdeen, Black Rock, JP Morgan, Morgan Stanley, Payden and Regal and Babson have purchased the bonds. These are very high quality global fund managers with funds in management running up to trillion dollars. Furthermore, 87% of the subscription for Bond has come from investment funds, 12% from banks and financial institutions and 1% from pension funds. In terms of geographical spread, 38% of subscription is from North America, 38% from UK, 12% from Europe and 12% from Asia.

Bonds have been sold at high interest rate: The competitive pricing for a bond is determined by comparison to the cost of domestic borrowings. In the most recent auction of Pakistan Investment Bonds (PIBs), the 10-year PIB was sold at an average cut-off yield of 9.33%. Thus a bond cost of 8.25% is significantly better – by 108 BPS – from that of the PIBs. The proceeds of bonds will go in reducing domestic borrowings and would not lead to increased expenditures. This will reduce the debt servicing cost in the national budget.

Debt burden on the country is rising: Some analysts have also remarked that issuance of the debt will lead to enhanced debt burden. This is not a correct observation. The new bond is a substitution of domestic borrowing. To the extent of the proceeds from bonds, domestic debt will automatically be retired, as SBP will reduce government debt by the same amount. Besides, the new issue will protect loss of reserves due to forthcoming payment of last bond of similar amount due in March 2016.

Economic progress not favorably priced by the Market: On the day of pricing of the bond markets were extremely volatile. A favorable decision by the Federal Reserves for the bond eventually turned out to be a source of more uncertainty for the market. In a jittery, weak and listless market, investors were shying away from new issues and several countries and even A-rated investors decided to stay away from the market as they thought their issues will not be subscribed. However, despite these unfavorable conditions, Pakistan succeeded in attracting twice the amount in subscription. There was indeed an option to walk-away from the deal but it was not clear whether markets would improve any time soon. Even though Pakistan has not received any premium on its previous pricing it has held on to its previous price, and received the targeted investment. Country’s reserves have been secured by covering the maturity of $500 million falling due bond in March 2016. More importantly, and contrary to assertion made by some critics, the investors widely appreciated Pakistan’s positive story and lauded its reforms efforts. It was repeatedly noted that Pakistan represents perhaps the only good story among the emerging markets.

Reasons behind market volatility: The market was gripped in a state of uncertainty in the aftermath of Federal Reserves decision and continued weakening of global growth and commodity prices outlook. The reasons cited by Fed in its decision regarding impact of the Chinese slow-down was a source of renewed concerns whether China will recover any time soon or whether full story behind Chinese slow-down has been revealed. It has also been reported that a major Gulf country has divested a sizeable portion of its global investments to meet its domestic needs. Additionally, Chinese authorities have moved to tighten currency controls to prevent outflow of foreign funds. These developments have pushed investors to fly for safety and avoid investments. Under such circumstances, success of the bond is quite evident. That the investment community has generally termed the bond a success is reflected in the comments published in the IFR Asia Briefing for September.

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IFR Asia DCM Briefing - September 25 2015

The IFR Asia DCM Briefing will not be published on September 28, due to a public holiday. It will resume on September 29.

Pakistan’s positive growth outlook helped it face a risk-off backdrop to raise US$500m even as deals from higher-rated corporates in Europe were being pulled because of market jitters.

But the bearish environment and reportedly modest book size prevented it from increasing the size of the issue.

“The EM weakness that is playing out right now – such as China and the EM currency weakness – that was not going to go away,” said a banker on the deal. “Given the positive feedback on the roadshow, investors were saying they understood markets were weak but this was something they wanted to get involved in.”

The final price of 8.25% for the 10-year print also reflected a lack of momentum to tighten from initial thoughts announced in the low 8% area.

“Everything is weak for risk assets. The fact that they could actually do a deal that is Single B, in this market, is actually quite amazing,” said a Singapore-based private bank investor.
The appeal lay in Pakistan’s improving economy, stable secondary bonds and extending curve. Standard & Poor’s raised Pakistan’s outlook to positive in May due to improved economic growth prospects. The country is also a beneficiary of the fall in the price of oil, its largest import.

Pakistan’s existing US$500m 7.125% March 2016s have traded above par since February 2014, up from a low of 75 cents in 2012, according to Thomson Reuters data.

One Hong Kong-based asset manager said the uncertain global environment prevented him from participating in the 144A/Reg S bond, but said the final pricing was still attractive.

“The initial start was about 50bp above its existing 2024s, and I thought they’d tighten at least 15bp, which is why we decided to pass this time,” he said. “I think 50bp is good value. They would have done really well if markets were better.”

Initial buy inquiries were spotted at 101.9/101.7.

The private bank investor added that at a 175bp–200bp premium, Pakistan looked more appealing than B1/B+/BB– rated Sri Lanka.

The 144A/Reg S bonds are expected to be rated on par with the sovereign at B3/B by Moody’s and Fitch. Standard & Poor’s rates the sovereign B–.

The last time Pakistan issued a conventional US dollar bond was in April 2014, when it returned after a seven-year gap with a US$1bn five-year bond priced to yield 7.25% and a US$1bn 10-year bond priced to yield 8.25% with ratings of Caa1/B–.

Citigroup (B&D), Deutsche Bank and Standard Chartered were joint bookrunners.
 

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