Weekly Credit Risk Monitor /
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Weekly Credit Risk Monitor

  • We round up the week's key developments in the world of sovereign and corporate credit

  • In focus: Coronavirus – The international policy response

  • Also in the news: Ukraine government reshuffle, Nigeria downgrade, South Africa economy, Alternatifbank and more

Stuart Culverhouse
Stuart Culverhouse

Chief Economist & Head of Fixed Income Research

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Tellimer Research
5 March 2020
Published byTellimer Research

In focus: Coronavirus – The international policy response

This week saw the coordinated international policy response to the coronavirus (COVID-19) that markets had recently been demanding. A surprise out-of-meeting 50bps rate cut by the US Fed led the way on Tuesday, following an otherwise underwhelming G7 statement. Australia, Canada and Malaysia have all cut rates this week. The IMF and World Bank also pitched in with offers of financial support to affected countries. Still nothing from the ECB though (although it has asked banks for emergency plans to deal with the outbreak). Besides the global monetary response, some countries have also instituted their own fiscal packages. Whether this global response is enough remains to be seen. It may just be the first wave.

The coordinated response followed the almost panicked market reaction last week. Global equities fell sharply, with S&P500 -13%, EUROSTOXX -14%, and the Nikkei -10%; the EMBIGD spread rose 65bps, while safe haven US government bonds saw 10yr yields fall 32bps to 1.15% (they have since fallen to all-time lows, below 1%). Investors’ initial concerns over the virus earlier this year centred on what the hit would be to China’s Q1 GDP and what this would mean mechanically for global growth (given China’s global economic influence is so much bigger today than it was 20 years ago, even 10 years ago). But with the spread of the virus outside China and its near neighbours, beyond the evolving human tragedy, concern over the global economic impact has been magnified. The OECD warned of a global recession on Monday. The IIF today said global growth could approach 1.0%, below the 2.6% last year and the weakest since the global financial crisis. There will surely be casualties from a more prolonged period of weaker economic growth, increased risk aversion and tighter financial conditions, which may cause some countries and corporates to fall into distress, although the most vulnerable in the near-term look to be those with pre-existing vulnerabilities (whether that’s Ecuador or the UK’s regional airline Flybe). 

For EM sovereigns specifically, the macroeconomic impact will depend, inter alia, on i) the impact of weaker Chinese and global growth, and impact on trade, ii) lower commodity prices – which can be positive or negative depending on their economic structure, iii) financing conditions (higher yields and/or weaker currencies), and iv) policy space – fiscal or monetary – in order to respond to the shock, and the quality of infrastructure and public services, especially health services, to deal with it. 

The IMF announced yesterday that it will make available US$50bn through its existing rapid-disbursing emergency facilities, with US$40bn available to emerging markets through the Rapid Financing Instrument (RFI) and US$10bn at zero interest for the poorest members through the Rapid Credit Facility (RCF). Neither of these facilities require policy conditionality. They have been used before recently, usually in the context of natural disasters, for example, Ecuador’s RFI in July 2016 after its earthquake, Mozambique’s RCF in March 2019 in the wake of Cyclone Idai, and Iraq’s RFI in July 2015 following the ISIS insurgency and fall in oil prices. Financial support under the Catastrophe Containment and Relief Trust (CCRT) is also available for eligible countries providing up-front grants for relief on IMF debt service falling due. The CCRT was used during the 2014 Ebola outbreak. 

The World Bank meanwhile announced US$12bn in aid for developing countries, with half coming from the IFC. Of the US$12bn, US$4bn is being shifted from previously available funds. For comparison, the IMF increased its lending capacity by some US$460bn during the global financial crisis through bilateral borrowing agreements with its members and expanded new arrangements to borrow (excluding the SDR allocation in 2009 and quota increase in 2010). 

But we think there is only so much traditional economic policy levers can do, while public policy will shift from containment to mitigation. Token monetary easing may help soften the blow and alleviate financing pressures for some, although targeted fiscal measures – for the vulnerable, unemployed, working poor and credit constrained – may be more useful. But none of these can ensure a V-shaped recovery rather than a U-shaped one, while the fear-factor (simple psychology) dominates and uncertainty over its duration persists. Moreover, we think simple comparisons of how quickly markets recovered after previous episodes of pandemic/epidemic (SARS, MERS, Swine flu) are flawed given they were not associated with anything like the same risk to the global economy (or have attached the same fear) that we’re seeing now with COVID-19, and don’t often control for other events that were happening at the same time. Notably, for instance, swine flu in 2009 occurred at the tail-end of the global financial crisis. Instead, perhaps investors may hope that when the rate of infection goes down, they will be able to pick up bargains, as has happened after previous sell-offs (eg 2009, 2016, 2018). What also remains to be seen is whether the impact of COVID-19 leads to more permanent changes in economic behaviour (hysteresis effects), positive or negative, and judging the winners and losers, and whether, and in what way, it might change the rise of China to superpower status. 

Yet, what this week also shows is that global policy coordination is not dead, at least not when it is really needed. That the G7 actually met may be reassuring, in an era when post-GFC and during the Trump presidency, multilateralism has been replaced by bilateralism, and the G7 – and other international fora – have been increasingly seen as irrelevant, if not redundant. 

Read more here

Recap of the week’s key credit developments 

Ukraine (UKRAIN): President Zelensky announced on Tuesday a surprise government reshuffle, notably removing Prime Minister Oleksiy Honcharuk and finance minister Oksana Markarova, among others. In all, two thirds of the cabinet were removed. In their place, Zelensky appointed as PM Denys Shmygal, a former DTEK executive with previous political experience, and Ihor Umansky as finance minister, who has previous experience as deputy finance minister, most recently under Natalie Jaresko, and before that under the prime ministership of PM Tymoshenko. Our view: We see the news as negative for Ukraine risk, although much will depend on what the new people say and do. Despite a seemingly good start and amid strong sentiment from international investors, Zelensky has suffered from declining approval ratings at home, possibly because he has encountered the same difficulties in governance as his predecessor, while oligarchic influences remain. Ostensibly to bring in fresh faces and experience, investors will be concerned that the reshuffle signals a step back from previous reformist instincts, and could delay even longer an agreement on a new IMF programme.

Nigeria (NGERIA): On Friday, S&P revised its outlook on Nigeria’s B long term foreign currency rating to negative from stable. Moody’s has a comparable B2 rating while Fitch rates the country one notch higher at B+. All three agencies now have a negative outlook on their ratings, after Moody’s and Fitch both changed their stable outlooks to negative in December. S&P cited the decline in foreign currency reserves. Data from the Central Bank of Nigeria (CBN) showed that gross foreign reserves ended February at US$36.3bn, down US$38.6bn at end-2019 and US$43.1bn at end-2018. In recent years, reserves had recovered from a low of US$23.9bn in October 2016, during the last recession. S&P said that the rating may be lowered if reserves continue to decline. Additionally, real GDP growth is below that of its peers; National Bureau of Statistics (NBS) data released last week showed real GDP growth in 2019 of 2.27%. The government has sought to diversify the economy away from oil, but oil price risk remains. Further weaknesses come from multiple exchange rates, low GDP per capita and rising public debt, expected at an average of 39% over 2020-23 once CBN bills are included. Meanwhile, S&P also changed the outlook on six Nigerian lenders to negative from stable. 

Tajikistan (TAJIKI): Tajikistan held legislative elections on Sunday (1 March) in which the People’s Democratic Party (PDPT) of President Emomali Rahmon was widely expected to win, and retain its dominant position. The Assembly of Representatives (lower house) has a total of 63 seats, of which 41 are directly elected in single seat constituencies and 22 are elected by national proportional representation. Results released by the Central Commission for Elections and Referenda showed that the PDPT won 12 of the 22 national proportional representation seats, receiving 50.4% of the vote, and won 35 constituency seats for a total of 47. That is down from a total of 51 seats in the 2015 election (16 and 35 seats respectively). Each of the Agrarian Party and Party of Economic Reform gained two seats for totals of 7 and 5 respectively, and the four remaining seats were won by three other parties. There have been accusations of electoral fraud, while the most credible opposition party, the Islamic Renaissance Party (IRPT), was banned in 2015. The National Assembly (upper house) is indirectly elected. More importantly, the focus will be on the next presidential election due in Autumn 2020. With President Rahmon having been in power since 1992, there has been speculation that his eldest son Rustam Emomali may be his anointed successor. Rustam Emomali, the current mayor of the capital of Tajikistan, has been introduced to foreign leaders and the Constitution was amended in 2018 to allow younger presidential candidates. 

South Africa (SOAF): On Tuesday, data released by Statistics South Africa (Stats SA) showed that the economy fell into a recession last quarter. Real GDP contracted by 1.4% qoq (ar) in Q4 19 after a fall of 0.8% in Q3 19 (revised figure). The median estimate in a Bloomberg survey of 12 economists was a 0.2% contraction. South Africa also experienced two consecutive quarters of negative growth in H1 18, making this the second recession in two years, and the second under President Cyril Ramaphosa. Of the ten key industries reported by Stats SA, seven contracted in Q4, with the exception of finance (2.7% qoq growth), mining (1.8%) and personal services (0.7%). Meanwhile construction, transport & communication and agriculture all contracted by over 5%. The overall 2019 GDP growth rate was therefore 0.2% yoy, the lowest since 2009, when the economy contracted by 1.5%. The economy has struggled as power outages have impeded production. State power company Eskom has needed government support after years of underinvestment; the deepest electricity cuts yet were implemented in December. The country (Baa3/BB/BB+) still has one remaining investment grade rating from Moody’s, which has a negative outlook, and is expected to be reviewed this month. 

Alternatifbank (ALNTF): Alternatifbank has announced another capital increase. Issued capital is to rise to TRY2.04bn from TRY1.73bn. The parent company, Commercial Bank (Qatar), previously stated that there would be further capital increases this year (and possibly next). Thus, the latest disclosure isn’t surprising. At end-19, Alternatifbank’s equity/assets ratio was 8.0%, c1.4ppts higher than at the end of the previous year. We estimate that the equity/assets ratio could rise to 9.1% following the latest capital increase. If ALNTF was to raise issued capital to the current maximum authorised amount, the equity/assets ratio would improve to 10.6% (based on end-19 figures). For more on the bank’s recent performance, see our report on FY 19 performance. 

Ahli United Bank (AUBBI): On 3 March, Ahli United Bank announced that the AUBBI 6.875% Perp will not be redeemed on the first call date, which is 29 April 2020. The bond is callable on subsequent coupon payment dates, and the lender states that its capital structure ‘will be re-assessed depending upon the results of the KFH (Kuwait Finance House) transaction.’ All Middle East banks called their foreign currency-denominated perpetual securities in 2019. It is difficult to draw any conclusions about the Middle East bank perpetual securities market from the AUBBI decision, given ongoing M&A discussions.

Fitch – Bank ratings criteria: Fitch is to update almost 500 bank ratings following a criteria change announced on 28 February. 230 subordinated (Tier 2) ratings may be downgraded, and 260 senior debt and Additional Tier 1 ratings may be upgraded. The rating differences between Tier 2 and AT1 instruments will therefore reduce. ‘Over half’ of these ratings are in EMEA (including developed markets). The rating agency will also cease to use Fitch Core Capital and will switch to regulatory CET1 in assessing capital strength. Fitch has already placed ratings assigned to lenders in the US and developed Europe ‘Under Criteria Observation (UCO)’. Emerging market banks’ ratings are likely to follow. Fitch plans to make any required rating changes ‘within six months’. 

Lebanese banks: The financial prosecutor has decided to freeze the assets of 20 Lebanese banks and their chairmen. This is part of an investigation into what the prosecutor has called ‘illegal’ transfers of dollars and sales of eurobonds to foreign holders. These actions are said to have impeded the government’s ability to restructure its debt. The actions require approval from Banque du Liban and follow news that Lebanese banks may still be asked to swap their holdings of maturing government bonds for longer-dated securities, with lower coupons. The concern is that this may lead to losses at banks, and for their bondholders. As we discussed in a previous report, Lebanese bank bonds are already quoted at deeply distressed levels and appear to already price in some form of loss absorption. 

Metinvest (METINV): METINV bonds have sold off more than most Ukrainian corporates in recent weeks, both on concerns about the company’s profitability and the potential negative effects of the coronavirus on the world economy. The METINV curve is 150-250bps over the sovereign and 140-150bps over MHPSA, the widest levels in 12 months. Signals from the steel market suggest that prices bottomed out in Q4 19 and Q1 20 will deliver an improvement. Despite taking a big hit on EBITDA in FY 19, net leverage remained within the covenant threshold, interest coverage raised no concerns and free cash flows were only marginally negative. In FY 20, the company’s liquidity requirement will reduce, together with capex, and if EBITDA remains at least flat yoy, in line with management guidance, net leverage would not exceed 3x and free cash flows could turn positive. The downside risk comes from coronavirus-dictated uncertainty which has kept all financial markets under pressure recently. An argument could be made to sell the bonds to minimise exposure to a cyclical industry that could be disproportionately affected in a negative scenario. However, we think that the bonds have already paid their “cyclical” premium and reiterate Hold. Read more here

Kernel: We downgrade KERPW 24s to Hold and reiterate Hold on KERPW 22s. In June-December 2019 (H1 20), Kernel reduced its trading activity, which visibly affected the top line, but the profitability of the business increased driven by high crushing margins and performance of the grain storage and export infrastructure. A significant increase in leverage is largely explained by non-cash accounting changes and seasonal accumulation of working capital, as well as higher inventory due to increased throughput, which will reverse towards the end of the financial year (June 2020). Having said that, we expect leverage to peak in FY 20 as the company is in the final stages of a large-scale investment programme. Most Ukrainian corporate bonds dropped 2-4ppts in price on the coronavirus-driven sell-off. The situation remains fragile and the Ukrainian corporate sector does not look cheap, yet with most bonds – including the long end – indicated above par. Read more here