Emerging Markets Credit Overview: Decoupled or Deteriorating? June 2009 Jamie Nicholson-Leener Managing Director, Emerging Markets Credit Research (212) 538-6769 [email protected]ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES ARE IN THE DISCLOSURE APPENDIX. FOR OTHER IMPORTANT DISCLOSURES, PLEASE REFER TO https://firesearchdisclosure.credit-suisse.com
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Emerging Markets Credit Overview: Decoupled or …...Collapse in G3 imports affecting EM exporters China’s export driven growth (nearly 40% of China’s 2007 GDP was exports) contracted
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ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES ARE IN THE DISCLOSURE APPENDIX. FOR OTHER IMPORTANT DISCLOSURES, PLEASE REFER TO https://firesearchdisclosure.credit-suisse.com
Slide 2
Discussion Points
Investment Thesis for EM – an Historical Perspective
Current EM Vulnerability to Global Credit Crisis
Outlook for EM – Risks and Opportunities
Relative Value in EM Markets
Slide 3
EM Investment Thesis – Historical Perspective
From 2003 until the current credit crisis began, EM markets generally outperformed developed market benchmarks reflecting:
– High growth rates of underlying EM economies
– Sovereign upgrades as EM economies recovered from the late 1990’s (Asia crisis and Russia default) and 2001 (Argentina default) market turmoil
– Low starting base, reflecting late 1990’s / early 2000’s EM market turmoil
– Emergence as a dedicated asset class, attracting increased fund flows
– Greater appetite for risk
Slide 4
EM equity markets best performer until mid-2008
Total Return Relative Performance
75
100
125
150
175
200
225
250
275
300
325
350
375
400
425
450
47512
/31/
02
3/31
/03
6/30
/03
9/30
/03
12/3
1/03
3/31
/04
6/30
/04
9/30
/04
12/3
1/04
3/31
/05
6/30
/05
9/30
/05
12/3
1/05
3/31
/06
6/30
/06
9/30
/06
12/3
1/06
3/31
/07
6/30
/07
9/30
/07
12/3
1/07
3/31
/08
75
100
125
150
175
200
225
250
275
300
325
350
375
400
425
450
475
MSCI EM Equity Index MSCI World Equity Index EM Sovereign Index (CS-SBI) LATAM Corporate Index (CS-LACI) US HY Index (CS-HYIDX) EMEA Corporate Index (CS-EEI) MSCI US Equity Index EM Corporate Index (CS-EMCI) ASIA Corporate Index (CS-ABI) US HG Index (CS-LUCI)
Source: Credit Suisse
Slide 5
EM debt markets performed strongly through mid-2008
Total Return Relative Performance
90
100
110
120
130
140
150
160
170
180
190
20012
/31/
02
3/31
/03
6/30
/03
9/30
/03
12/3
1/03
3/31
/04
6/30
/04
9/30
/04
12/3
1/04
3/31
/05
6/30
/05
9/30
/05
12/3
1/05
3/31
/06
6/30
/06
9/30
/06
12/3
1/06
3/31
/07
6/30
/07
9/30
/07
12/3
1/07
3/31
/08
90
100
110
120
130
140
150
160
170
180
190
200 EM Sovereign Index (CS-SBI) LATAM Corporate Index (CS-LACI) US HY Index (CS-HYIDX) EMEA Corporate Index (CS-EEI) EM Corporate Index (CS-EMCI) ASIA Corporate Index (CS-ABI) US HG Index (CS-LUCI)
Source: Credit Suisse
Slide 6
“Riskier” asset classes performed well in this period
Higher yields and spreads over benchmarks
Low default rates due to favorable access to liquidity
Greater risk appetite increased fund flows into risky assets
Improving credit quality due to strong economic fundamentals and better balance sheets from diversified funding sources
But strong market environment also allowed “junkier” credits to issue debt with increasingly loose structures
Slide 7
EM corporates often outperformed US benchmarks
Source: Credit Suisse
10%
7%5% 6%
4%
-11%
13%
8%6%
2%4% 5%
-5%
5%
26%
14%
10% 9%
5%
-30%
27%27%
12%
2%
12%
2%
-26%
21%
2003
2004
2005
2006
2007
2008
2009
Note: EM includes Quasi Sovereign and SupranationalSource: Credit Suisse
Slide 8
EM distressed debt was outperformer as credits restructured
Source: Credit Suisse
Historical EM Distressed Returns
10Number of companies 298914212627
5.7%
71.9%
48.9%
6.1%
51.4%
-4.0%
-17.6%-9.5%
-40%
-20%
0%
20%
40%
60%
80%20
02
2003
2004
2005
2006
2007
2008
YTD
Slide 9
EM credit quality improved (but “junkier” credits also issued)
2009(Approx. 599 issues)
2004(Approx. 433 issues)
Source: Credit Suisse Source: Credit Suisse
HG48%
HY CCC+ and below
6%
NR5%
HY above CCC+41%
HG54%
HY above CCC+37%
NR3%HY CCC+ and
below6%
Slide 10
Strong new issuance trend in EM through 2007
Historical EM New Issuance – # of New IssuesHistorical EM New Issuance – Dollar Value
Source: Credit Suisse Source: Credit Suisse
0
20
40
60
80
100
120
140
160
180
200
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
YTD
In U
SD
bn
0
50
100
150
200
250
300
350
400
450
500
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
YTD
Slide 11
Many EM economies significantly improved since 2000
Implementation of orthodox economic reforms
Recapitalization of banking systems post 1990s crises
Strong increase in FX reserves
Reduction in inflation, providing flexibility for current rate cuts
Favorable credit markets allowed for longer term issuance
Slide 12
Ratings agencies recognized EM economic improvement
Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse5-7 A, 9-11 BBB, 12-14 BB, 15-17 B, 19-21 CCC
11.011.512.012.513.013.514.014.515.015.5
Jan-
99
Jan-
00
Jan-
01
Jan-
02
Jan-
03
Jan-
04
Jan-
05
Jan-
06
Jan-
07
Jan-
08
Jan-
09
S&PMoody's
Slide 13
EM economies generate higher growth
Sources: Credit Suisse.
F= Credit Suisse or IMF forecasts.
E= 2008 data which are a mixture of actual (for data already released) and estimates (for data not yet released)
GDP Growth YOY%
-6.0
-4.0
-2.0
0.0
2.0
4.0
6.0
8.0
10.0
2001
2002
2003
2004
2005
2006
2007
2008
E20
09F
2010
F
Total EMUSEurozone
Slide 14
EM fiscal ratios look better than many developed countries
Sources: Credit Suisse.
F= Credit Suisse or IMF forecasts.
E= 2008 data which are a mixture of actual (for data already released) and estimates (for data not yet released)
Fiscal Balance % of GDP
-14
-12
-10
-8
-6
-4
-2
0
2
2001
2002
2003
2004
2005
2006
2007
2008
E20
09F
2010
F
Total EMUSEurozone
Slide 15
EM spreads tightened significantly but have blown up since
Benchmark Spread
100
200
300
400
500
600
700
800
900
1,000
1,100
1,200
1,300
1,400
1,500
1,600
1,70011
/1/0
12/
1/02
5/1/
028/
1/02
11/1
/02
2/1/
035/
1/03
8/1/
0311
/1/0
32/
1/04
5/1/
048/
1/04
11/1
/04
2/1/
055/
1/05
8/1/
0511
/1/0
52/
1/06
5/1/
068/
1/06
11/1
/06
2/1/
075/
1/07
8/1/
0711
/1/0
72/
1/08
5/1/
088/
1/08
11/1
/08
2/1/
095/
1/09
100
200
300
400
500
600
700
800
900
1,000
1,100
1,200
1,300
1,400
1,500
1,600
1,700
EMEA Corporate (CS-EEI)
EM Corporate (CS-EMCI)
LATAM Corporate (CS-LACI)
ASIA Corporate (CS-ABI)
Source: Credit Suisse
Slide 16
What happened to EM decoupling?
Slide 17
When the crisis began, EM markets were hit hard
Total Return Relative Performance
35
40
45
50
55
60
65
70
75
80
85
90
95
100
105
5/30
/08
6/30
/08
7/30
/08
8/30
/08
9/30
/08
10/3
0/08
11/3
0/08
12/3
0/08
1/30
/09
2/28
/09
3/30
/09
4/30
/09
35
40
45
50
55
60
65
70
75
80
85
90
95
100
105
US HG Index (CS-LUCI)
EM Sovereign Index (CS-SBI)
ASIA Corporate Index (CS-ABI)
LATAM Corporate Index (CS-LACI)
EM Corporate Index (CS-EMCI)
EMEA Corporate Index (CS-EEI)
US HY Index (CS-HYIDX)
MSCI US Equity Index
MSCI World Equity Index
MSCI EM Equity Index
Source: Credit Suisse
Slide 18
Although crisis started elsewhere, EM economies are hard hit by three types of shocks:
A sharp and sudden drop in credit flows from G3 to EM countries (hitting countries with current account deficits and countries with banks that rely on wholesale funding)
An abrupt fall in commodity prices during 2H08 – typically with 50%-60% declines in dollar terms
A sudden collapse in G3 imports (badly affecting those EM countries that rely heavily on exports of industrial goods)
Slide 19
Sharp drop in credit flows affecting EMEA countries most
Many countries in the region generated large current account deficits
EMEA banks borrowed significantly in foreign currencies to fund a domestic credit boom
– Kazakhstan, Russia, Ukraine, Latvia domestic credit growth was 50% + annually up to 2007
– Real estate was often the asset class receiving the most credit flows
Political challenges often exacerbated the economic instability in these countries
Slide 20
Sharp drop in commodity prices affecting Latam and oil exporters
In Latam, fall in oil prices most affected Venezuela and Ecuador- 30% of Venezuela GDP is exports and 90% of exports is oil- 40% of Ecuador GDP is exports and 60% of exports is oil
Chile’s economy is most vulnerable to fall in copper prices- 45% of GDP is exports and more than 50% of exports is copper- Chile’s economic stabilization fund has helped mitigate this shock
In EMEA, Russia and Kazakhstan are most vulnerable to oil price decline
Brazil’s GDP is less affected by commodity exports as only 14% of GDP is exports (and largest exports are food commodities at @ 20% share)
Slide 21
Collapse in G3 imports affecting EM exporters
China’s export driven growth (nearly 40% of China’s 2007 GDP was exports) contracted sharply in 4Q08
- Exports fell 19% yoy in 1Q09
- Strong fiscal stimulus (5% of GDP) and bank lending are cushioning the downturn
Mexico’s economy is highly correlated to trade with the US
- Nearly 30% of GDP is exports, with 80% destined for the US
- More than 20% of Mexican exports are cars, trucks and auto parts
- Swine flu impact is exacerbating the current economic downturn
Slide 22
EM markets also affected by trading technicals
Reduced trading liquidity increased EM volatility
Significant selling pressure from HY and hedge fund investors, which sold EM positions first
Currency volatility (and speculation) caused derivative losses (particularly in Latam)
But strong recovery in risk orientation is currently benefiting EM market performance
Slide 23
Outlook for EM: Risks and Opportunities
Slide 24
Outlook for EM growth, especially Asia, is better than developed world
Source: Credit Suisse
6.9%
4.3%
1.1%
4.0%
0.6%
4.3%
-2.5% -2.7% -3.0%
-4.3%
-5.6%
-0.7%
-8.0%
-6.0%
-4.0%
-2.0%
0.0%
2.0%
4.0%
6.0%
8.0%
Non-Japan Asia Latin America US EEMEA Euro-15 Japan% C
hang
e
Slide 25
Outlook in a “good” scenario for global growth:
Latin America would look set to outperform EMEA, with respect to real GDP growth and credit spreads, under the influence of:
– A bounce in commodity prices
– Decent financial sector health
The most export-oriented Asian and European economies would probably also do well, as global trade would likely recover faster than global output
Slide 26
Outlook in a “bad” scenario for global growth
All EM countries would be hit once again– EMEA countries would be hampered by weak banking systems and those of
Western Europe– Commodity-producing EM countries would again suffer negative terms-of-
trade shock– Global trade could further contract
But since Asia has the most capacity to stimulate domestic demand, this EM region should outperform in a “bad” global growth scenario
Slide 27
EM investors need to be selective
Source: Credit Suisse
7.1%6.1%
4.8% 5.1%
2.5%
0.7%
5.7%
1.3%
2.8%
-2.0%-2.7% -3.0%
-5.2%-6.0%
9.0%
4.9%
8.0%
-0.5%
-8.0%
-6.0%
-4.0%
-2.0%
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
China India Indonesia Poland Brazil Korea Turkey Russia Mexico
% C
hang
e
Slide 28
Rating agency outlook is still quite negative
Non-Japan Asia3%
4%23%
27%
Europe6%
5%33%
17%
US & Canada6%
5%32%
34%
Latam
3%
4%32%
26%
Negative Outlook and Review for downgrade
Positive Outlook and Review for upgrade
S&P
S&P
S&P
S&P
Moody’s
Moody’s
Moody’s
Moody’sSource: Moody’s, S&P
Slide 29
Risks and Opportunities
Strong rebound in EM financial markets does not mean we are out of the woods in terms of economic fundamentals or corporate performance
Banking system health and access to credit are still critically important
In EM corporates, weaker disclosure, corporate governance and local bankruptcy laws could all negatively affect performance and recovery value
Highly liquid EM credits with favorable underlying fundamentals will likely weather volatile markets in good shape
Slide 30
Despite perception of high risk, EM volatility is lower than US equities
0.0
10.0
20.0
30.0
40.0
50.0
60.0
70.0
Oct-1999Oct-2000
Oct-2001Oct-2002
Oct-2003Oct-2004
Oct-2005Oct-2006
Oct-2007Oct-2008
MXEF Index
MXUS Index
5.0
15.0
25.0
35.0
45.0
55.0
65.0
Oct-1999
Oct-2000
Oct-2001
Oct-2002
Oct-2003
Oct-2004
Oct-2005
Oct-2006
Oct-2007
Oct-2008
MXEF Index
MXUS Index
Source: the BLOOMBERG PROFESSIONAL™ service
Slide 31
But EM corporate bonds are more volatile than US HY Risk vs. Return of Various Markets
Local currency and sovereign debt dominate EM fixed income
Local
= $4.3tn*
Total EM Debt = $5.5 tn*
Source: BIS
International
= $1.2tn
*Excludes Local debt <1yr maturity, including Local<1yr total=7.1 trillion, local debt data availability varies by country so total local debt is understated
-All values in trillions of USD as of December, 2008
Strongest market recovery has been in EM high yield
Performance by asset class – YTD 2009
Note: Corporates exclude Quasi Sovereign and SupranationalSource: Credit Suisse
-8%
16%
29%
14%
6%
12%
-15%
-10%
-5%
0%
5%
10%
15%
20%
25%
30%
35%
CS-EMCIDistressed
CS-EMCI HG CS-EMCI HY CS-HYIDX (USHY)
CS-LUCI (US HG) CS-SBI
Slide 36
EM corporates have outperformed sovereigns YTD
Corporate vs. sovereign returns – 2009 YTD
Note: Corporates exclude Quasi Sovereign and Supranational
Source: Credit Suisse
EMEA LATAM ASIA
Slide 37
While EM corporate spreads offer pick-up to US, EM sovereigns trade through similarly rated corporates
Benchmark Spread Differential
(700)
(600)
(500)
(400)
(300)
(200)
(100)
-
100
May
-06
Jul-0
6
Sep-
06
Nov
-06
Jan-
07
Mar
-07
May
-07
Jul-0
7
Sep-
07
Nov
-07
Jan-
08
Mar
-08
May
-08
Jul-0
8
Sep-
08
Nov
-08
Jan-
09
Mar
-09
(700)
(600)
(500)
(400)
(300)
(200)
(100)
-
100
CS-SBI 'BB' - US HY 'BB'
CS-SBI 'BBB' - US 'BBB'
Benchmark Spread Differential
-
100
200
300
400
500
600
700
800
900
1,000
May
-06
Jul-0
6
Sep-
06
Nov
-06
Jan-
07M
ar-0
7
May
-07
Jul-0
7
Sep-
07
Nov
-07
Jan-
08
Mar
-08
May
-08
Jul-0
8
Sep-
08
Nov
-08
Jan-
09M
ar-0
9
-
100
200
300
400
500
600
700
800
900
1,000
CS-EMCI 'BB' - US HY 'BB'
CS-EMCI 'BBB' - US 'BBB'
Source: Credit Suisse Source: Credit Suisse
Slide 38
Lower-rated EM sovereigns appear to offer better relative value to US HY
Arg
Bgr
Bra
Col
DomSlv Idn
Jam
Kor
Lbn
MexPan
PerPhl
Pak
PolHun
RurZaf Tur
Ukr
Ury
Ven
A A- BBB
+
BBB
BBB
-
BB+
BB BB-
B+ B B-
100
1000
10000
6 7 8 9 10 11 12 13 14 15 16 17
Benc
hmar
k sp
read
(bps
)
LUCI
HYSBI
Source: Credit Suisse
Slide 39
Lower-rated EM sovereign CDS appears to offer better relative value to US corporates
EM CDS versus USD corporate CDS
ID
VEUA
RO
TRZA
RUPL PH
MXMY
KOPAHU
CZ
KZ
COPECLBU
BR
AR
AA AA-
A+ A A- BBB+
BBB
BBB-
BB+
BB BB-
B+ B B-
CC
C+
CC
C
CC
C-10
100
1000
10000
3 5 7 9 11 13 15 17 19
CD
S sp
read
IG -US corp
HY -US corpEM Sovereign
Source: Credit Suisse
Slide 40
Conclusion: Differentiation is important
While risks are prevalent, many EM economies and EM corporates are in good shape to weather further market volatility
However, the best relative value is among the riskier EM credits
Slide 41
Disclosure AppendixAnalyst CertificationI, Jamie Nicholson, certify that (1) the views expressed in this report accurately reflect my personal views about all of the subject companies and securities and (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report.Important Disclosures Credit Suisse's policy is only to publish investment research that is impartial, independent, clear, fair and not misleading. For more detail, please refer to Credit Suisse's Policies for Managing Conflicts of Interest in connection with Investment Research: http://www.csfb.com/research-and-analytics/disclaimer/managing_conflicts_disclaimer.htmlCredit Suisse’s policy is to publish research reports as it deems appropriate, based on developments with the subject issuer, the sector or the market that may have a material impact on the research views or opinions stated herein.The analyst(s) involved in the preparation of this research report received compensation that is based upon various factors, including Credit Suisse's total revenues, a portion of which are generated by Credit Suisse's Investment Banking and Fixed Income Divisions.Credit Suisse may trade as principal in the securities or derivatives of the issuers that are the subject of this report.At any point in time, Credit Suisse is likely to have significant holdings in the securities mentioned in this report.As at the date of this report, Credit Suisse acts as a market maker or liquidity provider in the debt securities of the subject issuer(s) mentioned in this report. For important disclosure information on securities recommended in this report, please visit the website at https://firesearchdisclosure.credit-suisse.com or call +1-212-538-7625.For the history of any relative value trade ideas suggested by the Fixed Income research department as well as fundamental recommendations provided by the Emerging Markets Sovereign Strategy Group over the previous 12 months, please view the document at http://research-and-analytics.csfb.com/docpopup.asp?ctbdocid=330703_1_en. Credit Suisse clients with access to the Locus website may refer to http://www.credit-suisse.com/locus. For the history of recommendations provided by Technical Analysis, please visit the website at http://www.credit-suisse.com/techanalysis. Credit Suisse does not provide any tax advice. Any statement herein regarding any US federal tax is not intended or written to be used, and cannot be used, by any taxpayer for the purposes of avoiding any penalties.Emerging Markets Bond Recommendation DefinitionsBuy: Indicates a recommended buy on our expectation that the issue will deliver a return higher than the risk-free rate.Sell: Indicates a recommended sell on our expectation that the issue will deliver a return lower than the risk-free rate.Corporate Bond Fundamental Recommendation DefinitionsBuy: Indicates a recommended buy on our expectation that the issue will be a top performer in its sector.Outperform: Indicates an above-average total return performer within its sector. Bonds in this category have stable or improving credit profiles and are undervalued, or they may be weaker credits that, we believe, are cheap relative to the sector and are expected to outperform on a total-return basis. These bonds may possess price risk in a volatile environment.Market Perform: Indicates a bond that is expected to return average performance in its sector.Underperform: Indicates a below-average total-return performer within its sector. Bonds in this category have weak or worsening credit trends, or they may be stable credits that, we believe, are overvalued or rich relative to the sector. Sell: Indicates a recommended sell on the expectation that the issue will be among the poor performers in its sector.Restricted: In certain circumstances, Credit Suisse policy and/or applicable law and regulations preclude certain types of communications, including an investment recommendation, during the course of Credit Suisse's engagement in an investment banking transaction and in certain other circumstances.Not Rated: Credit Suisse Global Credit Research or Global Leveraged Finance Research covers the issuer but currently does not offer an investment view on the subject issue.Not Covered: Neither Credit Suisse Global Credit Research nor Global Leveraged Finance Research covers the issuer or offers an investment view on the issuer or any securities related to it. Any communication from Research on securities or companies that Credit Suisse does not cover is a reasonable, non-material deduction based on an analysis of publicly available information.Corporate Bond Risk Category Definitions In addition to the recommendation, each issue may have a risk category indicating that it is an appropriate holding for an "average" high yield investor, designated as Market, or that it has a higher or lower risk profile, designated as Speculative and Conservative, respectively.Credit Suisse Credit Rating Definitions Credit Suisse may assign rating opinions to investment-grade and crossover issuers. Ratings are based on our assessment of a company's creditworthiness and are not recommendations to buy or sell a security. The ratings scale (AAA, AA, A, BBB, BB, B) is dependent on our assessment of an issuer's ability to meet its financial commitments in a timely manner. Within each category, creditworthiness is further detailed with a scale of High, Mid, or Low – with High being the strongest sub-category rating: High AAA, Mid AAA, Low AAA – obligor's capacity to meet its financial commitments is extremely strong; High AA, Mid AA, Low AA – obligor's capacity to meet its financial commitments is very strong; High A, Mid A, Low A – obligor's capacity to meet its financial commitments is strong; High BBB, Mid BBB, Low BBB – obligor's capacity to meet its financial commitments is adequate, but adverse economic/operating/financial circumstances are more likely to lead to a weakened capacity to meet its obligations; High BB, Mid BB, Low BB – obligations have speculative characteristics and are subject to substantial credit risk; High B, Mid B, Low B – obligor's capacity to meet financial commitments is very weak and highly vulnerable to adverse economic, operating, and financial circumstances; High CCC, Mid CCC, Low CCC – obligor's capacity to meet its financial commitments is extremely weak and is dependent on favorable economic, operating, and financial circumstances. Credit Suisse's rating opinions do not necessarily correlate with those of the rating agencies.Credit Suisse’s Distribution of Global Credit Research Recommendations* (and Banking Clients)
Global Recommendation Distribution**Buy 2% (of which 97% are banking clients)Outperform 22% (of which 87% are banking clients)Market Perform 57% (of which 91% are banking clients)Underperform 19% (of which 91% are banking clients)Sell 1% (of which 80% are banking clients)*Data are as at the end of the previous calendar quarter.**Percentages do not include securities on the firm’s Restricted List and might not total 100% as a result of rounding.