SRI LANKA

The Democratic Socialist Republic of Sri Lanka has issued its fourth dollar benchmark in the global bond markets since 2007, reflecting renewed appetite for the country in the wake of the conclusion of its long civil war. On July 20 it raised US$1 billion in a 10-year global bond, paying a fixed rate yield of 6.25%.

That price is equivalent to 332.2 basis points over 10-year Treasuries, and represented a tightening from initial guidance of 6.5%. The pricing was a more than 40 basis point improvement over Sri Lanka’s previous 10-year bond offering, in September 2010, which launched at 373.1 basis points over treasuries. Moreover, the conditions within which this deal came are arguably more volatile than those that existed in September 2010.

“I was pleased and, I have to say, pleasantly surprised by the market,” says someone close to the deal. “We thought we had a window to issue before some big event risk, and results were better than we expected. Sri Lanka has paid no new issue premium and is marginally through where fair value is, even on the most aggressive stance. It’s a great result for the central bank.”

It’s not a bad result for existing investors, either, since earlier bond deals improved in its wake. The 2020 bond was trading at around 101 before the terms of the new deal were announced, and at the time of writing was at 102 and seven eighths. The new bonded traded well in the aftermarket too, and was at 101 and three eights yesterday afternoon.

The deal, led by joint bookrunners Bank of America Merrill Lynch, Barclays Capital, HSBC and the Royal Bank of Scotland with Bank of Ceylon as co-manager, was helped considerably by a credit rating upgrade by Fitch to BB- that came in the middle of a roadshow. Moody’s and Standard & Poor’s have also moved Sri Lanka to a positive outlook. Correspondingly, $7.5 billion of orders came in from 315 accounts. The roadshow had taken in Singapore, Hong Kong, several US cities and London.

Partly, the deal’s success reflects appetite towards emerging market sovereigns in general, which have obviously become more appealing compared to several developed country peers. Funds are continuing to flow into emerging market bond funds, and the idea of getting paper in a newly-upgraded sovereign with some scarcity value – on average, it has issued once a year since rejoining international markets in 2007 – was attractive.

The deal’s distribution was well diversified geographically. The USA was the largest component, at 43%, followed by Europe at 30% and Asia at 27%. Fund managers accounted for 86% of distribution, with banks and private banks 8%, corporates 3% and insurance companies 3%. Those close to the deal say the fund managers were largely real money. “The quality of the book was among the highest I have seen for quite a long time,” says one.

SMBC

Sumitomo Mitsui Banking Corporation has raised US$2 billion in a three tranche fixed and floating rate bond issue.

The deal, which priced on July 18, was made up of US$1.1 billion of 2.9% senior bonds, due 2016; US$400 million in three-year senior bonds, paying 1.9%; and US$500 million of senior floating rate bonds, due 2014. The floating rate bonds will pay three-month dollar Libor plus 0.95%, payable quarterly.

Although SMBC has launched a number of fixed rate yankee bonds in recent years, with similar three- and five-year fixed rate bonds last July and then again in January, this latest issue marks the first time the issuer has added a floating rate instrument. This broadened the investor base. “With a five year bond you’re talking about asset managers, banks, insurance companies and so on, but with floating rate bonds there is a different investor base,” says someone close to the deal. “Specifically, money market funds and bank treasuries. Those are the core buyers for three-year floating rate. There is minimal contamination between the investor bases.”

Despite volatile conditions, the deal attracted $5.8 billion in total demand, according to someone close to the deal. The deal featured six joint bookrunners: Goldman Sachs, Citigroup, Barclays, Deutsche, SMBC Nikko Capital Markets, and Credit Suisse. On Friday New York time, with the European debt situation worsening, they opted to monitor headlines over the weekend to assess whether further volatility was likely, then decided on Monday morning Tokyo time to launch. Pricing appears impressive compared to established international financial credits active in the yankee markets; while JP Morgan increased a five-year senior deal by $500 million and paid 160 basis points over treasuries, Sumitomo paid 150 over for the same tenor.

CHINA SHANSHUI

China Shanshui Cement completed a RMB1.5 billion CNH bond issue last Friday in a rare example of good news from the Chinese credit space. The deal was completed in a week during which three other dim sum deals were pulled.

The cement group, rated BB/BB- by Standard & Poor’s and Fitch, raised its funds in three-year bonds and paid 6.5% to do so, at the wide end of a 6.25-6.5% marketing range. Bank of China International, Credit Suisse, Deutsche Bank and UBS were joint bookrunners on the deal.

Shanshui Cement may have been helped by the fact that it is a very recent borrower in dollars, having raised $400 million in a five-year deal in May. While some raised eyebrows at it returning to the markets so swiftly, it does appear to have helped the issuer. “The fact that it issued the dollar bond was positive for the credit,” says someone close to the deal. “That bond, vis a vis the rest of the Chinese industrial space, was trading well, and above par; that was a good indicator for credit investors.” During a roadshow in Hong Kong and Singapore, which saw 35 accounts in one-on-ones or groups, few issues were raised about the credit, but rather concerns about market volatility.

Bookrunners said that although the deal could have been completed at a lower size at the 6.25% end of the range, in these markets it made more sense to take funds while they were available.”It was obviously a deal that could have happened at a tighter spread, but in this market the issuer was encouraged to get as much funding done as possible,” says someone close to the deal. “In my view, if you look at the next few weeks, the macro noise doesn’t die down. If there’s a market window, all issuers should go with it.”

The deal went almost entirely to Asia – 99%. Funds accounted for 50% of the deal, private banks 24% and banks 16%. It was approximately twice covered with a book around the RMB3 billion level.

Shanshui Cement was a rare example of braving the markets last week. China Eastern Airlines, China ITS Holdings and Hangzhou ZhongCe Rubber (through its Hai Chao Trading subsidiary) had all planned dim sum bonds, only to postpone or outright axe them. Hangzhou ZhongCe did so despite having a guarantee from China Eximbank, the first such credit enhancement for a dim sum bond.

The dim sum pipeline is modest, with Qingdao Haier Holdings a rare exception, with an expected RMB2 billion bond through HSBC and UBS. For others, there is little appeal in such choppy markets. “The better borrowers are still looking to the dollar market,” says one banker. “If you’re BB or BB-, that market makes more sense; you’re not going to get pricing like in January, but it will be executable. Issuers who don’t have ratings may migrate to the CNH market. But as there are more CNH deals to choose from, investors are going to become more discerning.”

THAILAND

Thai Union Frozen Products Public Co completed a Bt6.75 billion multi-tranche local currency bond in Thai baht this week. The deal, led by HSBC, Siam Commercial Bank and Kasikornbank as joint bookrunners,

The deal reflected continuing enthusiasm for Thai baht bonds, and was notable for including a Bt1.5 billion 10-year tranche alongside a Bt1.95 billion five-year and a Bt3.3 billion three-year. This was the longest tenor the issuer has so far achieved.

The deal priced at a coupon of 5.02%, 4.7% and 4.51% respectively across the three tranches, and was well covered by institutional investors, according to someone close to the deal.

HDB

Singapore’s Housing Development Board upsized a 10-year deal to S$600 million this week, reflecting a taste for emerging market debt provided the credit and territory is strong enough.

The deal, originally planned as a S$400 million print, priced at just 2.815% for 10-year paper, which is 32.5 basis points cheaper than a S$500 million 10-year deal from the same issuer in March. ANZ, CIMB, Citigroup, HSBC, OCBC, Standard Chartered and UOB were lead managers on the deal – a seven-bank lead group for a single-tranche deal equivalent to just under US$500 million.

The bonds went to around 40 accounts and were understood to have included some big orders from foreign accounts based in Singapore. The success appears to reflect growing optimism about local Asian currencies in the face of continuing concern about dollars and euros.

http://www.euromoney.com/Article/2331913/Sri-Lanka-looks-beyond-euphoria.html

If you think a rebound in world stock markets improves your mood, try the end of a 25-year civil war. Interviews in the Sri Lankan capital of Colombo reveal a sense of unbridled optimism and opportunity.

“It’s a pivotal moment,” says Nick Nicolaou, HSBC’s CEO for Sri Lanka and the Maldives. “When a conflict like this is over – and you can look at analogies like Northern Ireland or Kosovo – the post-conflict scenario is one of great hope and an increase in economic activity and foreign direct investment. That’s the background that everyone is looking towards.”

The country’s major industrialists see the end of the war as one of the most significant developments in their recent history, in a business as well as a social context. “For us, it is going to be a complete change in the way we do business,” says Ajit Gunewardene, deputy chairman of John Keells Holdings, Sri Lanka’s biggest conglomerate and listed company with interests from plantations to food and beverage, transport, leisure, property, financial services and BPO. “The way we have done business for the last 25 or 30 years is no longer relevant.”

A few years ago, John Keells had become so big it had outgrown the country, partly because of the constraints imposed by the war, and so had begun a regional strategy. “We have now put all that on the back burner. We are focusing on the opportunities in Sri Lanka, and we believe those opportunities are going to give us better returns than what is available elsewhere. We expect the economy to grow at a minimum of 8% a year for the next few years: it’s not a complicated decision for us to decide where we should be.”

And it couldn’t have come at a better time – for as little as nine months ago, Sri Lanka was in a perilous situation. In recent years despite the war Sri Lanka has managed to keep its head above water and record annual GDP growth rates of 4.5 to 6 per cent. But by early 2009, with the global financial crisis and continued expenditure on the war having an increasingly damaging effect on the economy, full-year growth of around 2% looked more likely. Conflict was draining everything: the necessity for a vast armed force, fully equipped, in a nation that had once had only a symbolic force and could spend their money on welfare instead; lost potential from agriculture and tourism, which ordinarily would have been mainstays of the economy in the north and east where the war was taking place; use of the complex irrigation set-ups linking the dry and wet parts of the country, which ought to have benefited the east; the ability to exploit fishing stocks off the north and east coasts. “The war naturally brought a straight burden on the finances of the country,” explains deputy finance minister Sarath Amunugama, who is also the minister of public administration and home affairs (the formal finance minister title is held by the president). “But it also was a burden in terms of the potential we missed in the one third of the country that was inactive.”

And then the country went straight into the teeth of a foreign exchange crisis. Sri Lanka had permitted foreign investors to take up to 10% of government securities, but they almost universally pulled their money out early this year, as they did from most emerging markets during the worst of the crisis. “There was an outflow, not because of anything problematic in our economy as such, but because of what was happening elsewhere,” says Uthum Herat, deputy governor of the Central Bank of Sri Lanka. On top of that, movements in commodity prices had also depleted reserves. By March foreign exchange reserves had plunged to around US$1.2 billion – barely a month’s import cover – with almost all of the foreign holdings in the government securities market withdrawn.

Almost everything that has happened since then economically has been good news. History will probably judge May 18 2009 as the formal end of the war, as that is the day Velupillai Prabhakaran, the leader of the Liberation Tigers of Tamil Eelam (LTTE, or the Tamil Tigers), was killed, but it had been clear for some months that it was nearing a conclusion and it is really this realization that marks the turning point for Sri Lanka on a number of economic levels.

In July, after some months of negotiation and delay, the IMF approved a 20-month US$2.6 billion stand-by arrangement to support economic reform, US$322.2 million of it upfront with the remainder to come in quarterly instalments subject to reviews. “Without doubt, that has put a backstop on the foreign exchange reserves, and with that has come more investor confidence,” says Nicolaou. The same month, the sovereign took off around the world on a non-deal roadshow organised by HSBC and JP Morgan, and within weeks it had a clear illustration of how sentiment had shifted: a US$875 million investment in four- and six-year treasury bonds by a single US fund manager, believed to be a hedge fund. Total reserves now stand at US$4 billion, and the coffers will be further improved by a US$500 million global bond issue (see Euromoney, October 2009) which is in large part about putting a flag in the ground and setting a benchmark for pricing for the new, peaceful Sri Lanka.

So, with the fiscal position redeemed, what now? Where to start? Because, though the mood of optimism is tangible in Sri Lanka, there is much to do and none of it easy. Most obviously, there is a pressing need for basic infrastructure development, particularly in the country’s north. Donor funding will accommodate much of it, but obviously not the whole lot – and the government is committed under the IMF program to reducing expenditure, not increasing it. That means attracting FDI, which could require some level of reform in regulation and possibly tax, and in the meantime non-performing loans are creeping up worryingly – today 9% – in the banking system. Human rights groups have raised concerns both about the circumstances of the war’s conclusion and the displacement of hundreds of thousands of people into camps, which may have an impact on the willingness of multilaterals or donors to engage. And there are presidential and parliamentary elections to come early next year, although the president’s popularity is extremely high post-war. “On the one hand you have the euphoria: the huge possibility this country offers for transformational change in the next 10 years,” says Clive Haswell, CEO of Standard Chartered Bank for Sri Lanka. “On the other hand there’s some significant challenges that in the short term need to be managed, and the politics of the election process in the next six months as well.”

Infrastructure is the natural starting point. “That has lagged behind, because the war as consumed a lot of brainpower as well as investment dollars,” says Haswell. “There’s been a steady flow of soft loans and investments by a number of donor countries through this period but it’s still pretty slow in terms of building up the infrastructure of this country, and that’s going to be the main change in the short term.”

Herat at the central bank accepts that the costs of reconstruction will be immense, but makes two points. “Firstly we envisage much of the reconstruction will be funded by donor funds, or by funds at very concessional rates from multilaterals or on a bilateral basis,” he says. “To that extent the burden will be greatly reduced. But even it if it is a burden, it is something that has to be done. This is an opportunity we have not had in three decades and it must be seized.”

Minister Amunugama notes that the situation in attracting donor assistance is different to the reconstruction effort that accompanied the tsunami in 2004. “There was an outpouring of sympathy then, and donor countries were more than happy to contribute. Now it is not so clear, donors are not so unambiguous. But the humanitarian part of it is there.”

The second issue is the restriction on government spending. The IMF facility comes with several conditions. It seeks to reduce the central government budget deficit from 7% of GDP this year to 5% by 2011, by broadening the tax base, reducing tax exemptions and improving enforcement. At the same time it seeks to protect expenditures on social protection, improve bank supervision and restore the reserve position (which is surely already done). It doesn’t seem to leave a lot left over for roads or power.

Nevertheless, bureaucrats seem happy with the terms of the IMF deal. Herat at the central bank says he is “absolutely comfortable” with the conditions because “none of the conditions deviate in any way from Sri Lanka’s own policies. We have no qualms in agreeing to them.”

Herat says FDI has typically been US$600 to $800 million a year in recent years even during the war, and one can see it in the vast expansion of Colombo harbour, as well as a port and a power plant elsewhere in the country also being backed by foreign funds, particularly the Chinese. “I don’t want to put a number to things, but clearly if we can have $800 million FDI when the war was at its worst, it’s bound to increase.”

That’s going to be an important step. “In the immediate aftermath of the war we’ve seen a growth in appetite for investment in government securities. That’s really positive, but it’s not FDI in terms of building productive capacity on the ground, we’ve yet to see that,” says Haswell. It’s naturally going to take time to convince foreign money that this really is the end of conflict. “There’s a number of questions people will have from a risk point of view before we see a big step up in international appetite,” Haswell says.

That apart, there’s the broader environment for FDI. Amunugama points to widespread investment in areas like telcos – where Telekom Malaysia, India’s Airtel and Singapore Telecommunications (through Airtel) are all heavily involved in Sri Lanka – as evidence that the environment for foreign involvement, particularly through partnership, is attractive. 

But others think more could be done. Sri Lanka ranks 105^th out of 183 in the World Bank’s ease of doing business rankings, and is among the very worst ranked in terms of getting construction permits, registering property, paying taxes, and enforcing contracts. (On this point, each of Standard Chartered, Citibank and Deutsche are in disputes with various Sri Lankan entities about derivative contracts; these disputes are in arbitration and all parties declined to comment.) One institution highlights “the processes around legal recourse, around governance, issues of corruption, the huge taxes that get paid”, although the Board of Investments does offer mechanisms to give foreign investors relief from that.

Foreign banks are cautiously positive but aware of the challenges. “Next year you’ll see people dip their toe in the water but you do need to see evidence of change and the government is making the right noises about that,” says Haswell. At HSBC, Nicolaou says “the building blocks are there” and the board of investments is investor friendly, but highlights tax, which in the banking sector can hit 60% once income tax and VAT are considered.

So those are the challenges: what of the opportunity? HSBC is looking closely at project and export finance as infrastructure development gets rolling; even during the war it has facilitated over US$1 billion in finance in Sri Lanka in this area. “With ECA [export credit agency] cover becoming available we are expecting a flurry of activity in that space,” Nicolaou says.

The John Keells group says it is already seeing a difference, with agricultural production climbing and so prices of crops and seafood coming down. “The north and east was the rice bowl for the country,” says Krishnan Balendra, president of corporate finance and group strategy. “Prior to the conflict it produced 850,000 metric tons of various crops. Last year production was only 150,000 tons. Now there’s no reason we can’t get back to those numbers.”

Ajit Gunewardene says “tourism is obviously the quick win” post-war. Sri Lanka’s capacity is about 700,000 tourists a year, he says, and is likely to hit that very quickly, probably next year: in addition to the traditional markets of western tourists, the emergence of India’s middle class has made that the biggest provider of tourism. “It’s going to require a lot of investment to build new capacity. We should be getting to a target of 2.5 million tourists a year in four or five years time and that’s going to require up to 20,000 rooms.” Already the group is planning ahead, and is looking at three new projects next year: a brand new hotel on the west coast and two upgrades, one of them in east coast Trincomalee, which has been effectively out of bounds to tourists for years. The following year he expects to develop two more, including another in Trincomalee. Elsewhere, he expects property to be a boom area as falling interest rates prompt people to seek mortgages again.

For Rajendra Theagarajah, managing director of Hatton National Bank, one of the country’s leading banks, “we believe the bread and butter is to scale up fisheries and agriculture.” For that to succeed, he says, money is not enough: there needs to be access to markets, and storage facilities. Hatton’s approach has been to set itself up as a linkage between the buying power of its corporate customer base and the newfound sales capability of producers, “to make sure this is a win win for all of us.”

Hatton, like many others, is also looking with interest at the new funding opportunities that may arise from Sri Lanka’s improved visibility on the radar screen of international capital – something the sovereign bond issue will be very important for. “For the likes of us who have been clenching our fists and managing with internally generated funds for the last three to four years, we could look more optimistically at raising a different style of finance for growth,” he says. “A number of us have been showcasing ourselves beyond Sri Lanka. Now it is time to say there is a specific plan: come and back us.”

There is one caveat to the optimism, though. When Euromoney asked interviewees about whether they thought war really was over, almost all spoke about the obliteration of LTTE as a military force and the discovery of arms caches. Very few spoke about the integration of the different segments of Sri Lankan society, particularly Tamils from the north of the country, into everyday life, or redressing the issues that prompted people to fight or sympathise in the first place. That, surely, will be a challenge as important as any of the others this newly optimistic state faces today.

BOX: the stock market

Stock markets are always a useful barometer of a national mood, and the Colombo Stock Exchange is no exception: its All Share Price Index has doubled so far in 2009. On top of that, it’s also attracting IPOs.

The first post-war IPO was Hemas Power, with an almost Rp2 billion raising that was 3.7 times oversubscribed in September; another, Seylan Bank, was in the markets at the time of writing. More will follow. “We have some in our deal pipeline,” says Darshan Perera, chief operating officer of NDB Investment Bank, which led the Hemas Power deal. “The market is booming.” He says price earnings ratios are now around 13 times.

There is certainly room for more activity. “Only 200 companies are listed on the Colombo Stock Exchange out of 30,000 registered companies in the country,” says Krishnan Balendra at John Keells Holdings. “We think many more will list as valuations are becoming more attractive.”

What’s peace worth – in basis points? Sri Lanka will provide something of an answer in the coming weeks as it tests the global investment community’s appetite for a $500 million bond.

Sri Lanka is back in the debt markets with a new story to tell. This year its 25-year civil war came to an end and the mood today on Colombo is peerlessly enthusiastic, as the country looks forward to economic growth unfettered by violence, a divided country, impeded supply (the war-hit regions of the north and east are where much of the country’s farming and fishing takes place) and military spending. The bond, which will be lead managed by JP Morgan, HSBC and RBS alongside local house Bank of Ceylon as a co-manager, aims to create a new, peacetime benchmark for the country, and to improve the cost of its funding.

There is nowhere so unemotional as the global capital markets, and it is an intriguing question to work out just how far inside existing paper, if at all, a new bond might price as a dividend for an end to conflict. There have been rumours of exuberant expectations from the government and the Central Bank of Sri Lanka, which will issue the bond on behalf of the sovereign, with talk in August that it was hoping to raise five-year funds at a yield of 7% – which would be dramatically inside the 8.9% yield at that time of its existing five-year paper, a US$500 million Reg S/Rule 144a issue launched in October 2007 (and which at the height of the financial crisis had gone as far out as 17%).  But those close to the central bank describe its leadership as pragmatic and willing to listen to the market, though clearly hopeful of a positive reception.

Neither the Central Bank nor the three leads were able to discuss the bond due to legal and regulatory restrictions, but Euromoney understands it will launch at an appropriate window before the end of the year and will be five or 10 years in duration depending on investor appetite at the time. Sri Lanka does have some sense of what reception it should expect, for it was taken on a non-deal roadshow across Europe, the US and Asia by HSBC and JP Morgan in July.

Uthum Herat, deputy governor of the central bank, says the reception on that roadshow was “very good. In the last 15 to 20 years, we have had one major underlying fundamental problem,” he says. “Whenever we spoke to investors, they would acknowledge that there was a great deal of potential in Sri Lanka, but they would say: there is one debilitating factor, and that is the war.

“Today we are in the happy position of being able to say: these are the underlying economic fundamentals of the country, and there is no war. That makes a huge difference.”

The message appears to have been getting through. Just weeks after the roadshow, in August, the central bank announced that an unnamed US fund manager purchased US$875 million of four- and six-year treasury bonds, which almost trebled foreign reserves in a single hit. This comes alongside an IMF standby facility that committed US$2.6 billion to Sri Lanka in instalments over the next two years, with about $325 million. Today, total reserves stand at around $4 billion.

That’s a far cry from earlier this year, when an outflow of foreign funds by managers hit by the financial crisis brought reserves to eight-year lows of around $1.2 billion – barely enough to cover a month’s imports. A closer look at the contribution of foreign money to government securities (foreigners can hold up to 10% of these securities) is starker still: Herath says that it went from US$750 million in July 2008 to just $19 million by February. “Pretty much everything had gone.”

Sri Lanka’s subsequent revival, underpinned by peace but supported by the IMF facility and more recently an outlook upgrade by Standard & Poor’s, has been impressive. It’s expecting to log 3-3.5% GDP growth for 2009 and Deputy Minister of Finance and Planning Sarath Amunugama tells Euromoney that “8% is quite doable” in the medium term. That’s the story the central bank will be putting to world investors who appear to be rediscovering appetite for high yield securities. The next edition of Euromoney, containing the full central bank and finance ministry interviews, will include a feature looking at Sri Lanka’s new proposition – and whether it stacks up.