A Strong Debut for Sri Lanka Sovereign Bond
The country needs capital to pay for massive reconstruction needed in the wake of a quarter century of armed conflict, but the timing of the bonds was well chosen to make the most of the approval in August of a $2.6 billion loan from the International Monetary Fund and positive comments from both Fitch and Standard & Poor's. Indeed, the latter actually revised its outlook on the sovereign rating to positive from neutral during the marketing of the bond, adding further to the strong sentiment. Since the end of the war, there has also been a return of private sector capital inflows.
According to sources, the offering attracted more than 250 accounts and $6.8 billion of demand—13.5 times the amount of bonds available—even though analysts argued that the deal was not exactly cheap. Still, the joint bookrunners—HSBC, J.P. Morgan and Royal Bank of Scotland—were able to tighten the guidance quite significantly during the marketing.
The long five-year deal (it matures in January 2015) was launched during Asian trading hours on Wednesday following a roadshow that included both Europe and the US, as well as Asia, and an initial yield guidance of 7.75% was communicated to investors in the Asian evening. On Thursday this was tightened to 7.4%-7.5% and the deal was eventually priced at the tight end of that range. The bonds were reoffered to investors at par, meaning the coupon was also fixed at 7.4%.
The yield translates into a spread of 505.9bp over the September 2014 US Treasury, but more importantly, market watchers said, was the fact that it came very tight versus its existing bond, which traded at a yield of 7.1% at the time of pricing. The outstanding bond has only three years left until maturity, and one source noted that a 30bp spread between a three-year and a five-year deal equals a "very flat curve". Looking at the US Treasury curve, the equivalent spread is about 85-90bp.
The new bonds also traded up to about 102.5 in the secondary market on Friday, but part of the reason for that would have been that the bond wasn't very liquid. A massive 78% of the deal was allocated to fund managers and many of them are expected to stash the bonds away in their portfolios for the medium term. The rest of the offering was split between banks (8%), retail investors (7%), insurance and pension funds (4%), and others (3%).
Based on geographies, US investors took 45% of the deal, EU-based accounts bought 31% and the remaining 24% went to Asia.
Calyon fixed-income analyst Bryan Lai argued that the pricing was too tight in relation to the Philippines and Indonesia, which are far more liquid, suggesting a yield above 9% would be more suitable - especially in light of the fact that the Sri Lankan government has been forced to borrow quite extensively from the IMF, which means it can be viewed as a distressed credit. Still, he acknowledges that Sri Lanka deserves to trade inside Pakistan, whose 2016 bond was quoted at about 9.2% at the end of last week, and that scarcity value is overshadow the valuation metrics at this point.
"The risk of a sell-off in credit markets will always affect high-yield [bonds] first so my take on the very aggressive 7.4% pricing is still towards the downside. This deal is purely working on the scarcity value and the pricing in of future improvements that Sri Lanka is expected to derive," he said.