Weekly Credit Risk Monitor /
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Weekly Credit Risk Monitor

    Stuart Culverhouse
    Stuart Culverhouse

    Chief Economist & Head of Fixed Income Research

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    Tellimer Research
    9 January 2020
    Published byTellimer Research

    In Focus: We downgrade Iraq-Kurdistan complex on US-Iran risks

    Recent events, following the assassination of Iran’s Major General Qassim Soleimani by the US on 3 January and Iran’s subsequent – but expected – retaliation, have an element of ‘this time is different’, causing us to review our Iraq/Kurdistan recommendations. See page 2 for more background.

    We downgrade our recommendation on Iraq sovereign bonds to Sell from Buy. Iraq’s 2028 bonds fell by c5pts between last Thursday and Monday, with the yield jumping to 7.7% (it has since eased to 7%, as of this morning). We think Iraq will underperform the market due to exacerbation of tensions, concerns over regional conflict, and the threat of further US sanctions. Downside may be protected by (currently) strong debt service capacity, demonstrated willingness to pay, and belief that escalation will be checked. Higher oil prices may also provide some compensation, although this is less relevant if Iraqi oil production is disrupted. Moreover, against this geopolitical backdrop, investors may not be able to rely on IMF support either if it is blocked by the US.

    We downgrade our recommendation on DNONO 23s and DNONO 24s to Sell from Hold. The cash position remains strong, but DNONO bonds are, arguably, the most liquid in the Kurdistan Oil & Gas space and, therefore, could be more exposed to selloffs if regional risks were to escalate further. The North Sea operations have not yet reached the scale when they could financially mitigate Kurdistan risks.

    We reiterate our Hold recommendations on:

    • DNONO 20s: We expect DNO to be FCF-flat to slightly negative on a pre-acquisition basis in FY 19, reflecting high capex and delays in payments from Kurdistan at the end of the year. However, we expect the company to report cUS$450-500mn cash reserves in FY 19 covering US$140mn DNONO 20s bonds.
    • GENLLN 22s: Genel’s only debt is the US$300mn bonds due 2022. We estimate the company will maintain a sizable liquidity cushion and report US$200-250mn cash at the end of 2019 assuming capex is not put on hold due to delays in payments from Kurdistan.
    • GULFKY 23s: Gulf Keystone’s only debt is represented by US$100mn bonds due 2023. Even with the increased capex, dividend payments and share buyback, and delays in payments for oil on behalf of Kurdistan, we expect the company to report over US$100mn in cash in FY 19, which is sufficient to fully cover the company’s debt.
    • OILFLO 22s: Oilflow’s bonds sold off at the end of 2019 on concerns that Kurdistan will have to deliver 250,000boepd to Iraq’s oil marketing company in 2020. We believe that OILFLO bonds are, in fact, relatively well protected. We estimate that with Brent at US$60/bbl, it is enough for Kurdistan to export 12% (c13,000boepd) of the contracted (under the OILFLO transaction documents) 3.5mmboe monthly shipments to fund interest and US$20.8mn monthly amortisations starting in January 2020.

    We reiterate our Sell recommendations on:

    • HKNENG 24s: HKN Energy is in the middle of an ambitious capex, which according to our estimates, will result in negative free cash flows in FY 19. With US$129mn cash reported in H1 19 and up to US$120mn to be paid for opex and capex if investments remain on track, the company is very sensitive to payment delays, which effectively means that August -December 2019 invoices have not been paid yet. Because of still relatively low production and substantial investments underway to ramp it up, HKN has low tolerance to any further payment delays.
    • SNMCN 23s: ShaMaran achieved remarkable production growth in 2019, but because of its relatively small (26.7%) non-operating interest of the PSC, low liquidity (US$20mn cash in Q3 19), expensive debt and high capex, the company’s liquidity is very tight. Therefore, the company is least able among peers to withstand payment delays.

    Recap of the week’s key credit developments

    US-Iran escalation and what it means for Iraq/Kurdistan: We think the impact on Iraq (and by extension, its bonds) is negative, unless there is a quick negotiated resolution or truce, which seems unlikely. In our view, if there is going to be kinetic military action between the US and Iran (and its proxies), we regard Iraq as a more likely arena than Iran itself. Moreover, the threat of US sanctions on Iraq if it expels US troops (or the seeking of compensation payments) adds another layer of risk to bondholders and the country’s financial position. The expulsion of US troops from Iraq might also leave space for the return of ISIS (Daesh).

    We had upgraded the Iraq sovereign to Buy from Hold following the IMF Annual Meetings in October. However recent events have an element of ‘this time is different’, with the risk of an (unpredictable) escalation and concomitant negative impact on Iraq. We therefore downgrade our recommendation on Iraq’s bonds to Sell from Buy.

    For Oil & Gas companies operating in Kurdistan, these recent political developments have added a new layer of uncertainty to protest-stricken Baghdad, threatening to destabilise the security situation in the region and increasing geopolitical risks. We expect bond prices to drift lower ignoring the conflict-driven rally in oil prices. We downgrade DNONO 23s and DNONO 24s to Sell and reiterate our recommendations: Hold DNONO 20s, GENLLN 22s, GULFKY 23s and OILFLO 22s and Sell HKNENG 24s and SNMCN 23s. See our recent report on Iraq sovereign here, Kurdish corporates here and background here.

    Turkish banks: On 23 December, Vakifbank announced that the US$500mn VAKBN 6.875% subordinated bond will be redeemed next month. Vakifbank had until 3 January to exercise the call on the bond, which was the first Basel 3-compliant Tier 2 security to be issued by a Turkish lender. Most Turkish banks’ subordinated bonds have tightened since the Vakifbank announcement.

    The US$250mn Albaraka Turk (ALBRK) 10.5% security is callable at the end of November. This is the next call date for a Turkish bank subordinated bond we track and is clearly many months away. While this means that we do not have the very near-term catalyst of another potential call, it also means, we think, that spreads may continue to tighten as the market may ignore the possibility of other Turkish lenders choosing not to exercise a call option (at least for now).

    For all but four callable Turkish bank bonds, the mid YTC is lower than it was prior to the Vakifbank announcement. Following Vakifbank’s decision, the difference between mid YTC and mid YTM is still greatest for the Odeabank 7.625% security. The ODEABK 7.625% bond is priced at c74.4 and yields just over 21% to the 2022 maturity. This security remains well over 1,300bps off the tights. As Odeabank is majority-owned by Bank Audi in Lebanon, what happens with Lebanese sovereign bonds, and by extension Lebanese banks, may have implications for this bank. We note recent performance has been surprisingly resilient. We cannot exclude some form of intervention by the Turkish regulator, to safeguard domestic financial stability, should the situation in Lebanon take another turn for the worse. See our recent report here.

    Venezuela (VENZ): The political situation in Venezuela seemed to take another twist over the weekend after Juan Guaido’s re-election as leader of the National Assembly was blocked by forces aligned with the Nicolas Maduro government. Then on Tuesday, Guaido and his supporters managed to push through National Guardsmen to enter the National Assembly. Guaido was sworn in as speaker, continued to claim the presidency and called for new protests against Maduro starting on Thursday. These events are probably market neutral to negative, in our opinion. They perhaps show that Maduro isn’t ready to go yet; he could still remain in power for some time to come. They could, however, bring forth another round of US sanctions against the Maduro regime, and ever tighter sanctions raise investor hopes of his imminent demise. See our recent report here