Deals in Focus: South Africa 10-year bond

We take a look at the 10-year issue from the National Treasury of South Africa which saw strong secondary market performance due to attractive spreads over other triple-B sovereigns.

For bond investors as well as football fans, South Africa may be a country to watch in 2010. As anticipation builds ahead of this summer’s World Cup, Africa’s richest nation has issued its largest international bond to date, attracting interest from across the globe.

Standard Bank and Deutsche Bank acted as joint leads on the $2 billion 10-year issue from the National Treasury of South Africa, which was allocated to institutional investors in the US (60%), the UK (23%), Europe (10%) and Asia (4%).

The sale will help support government stimulus packages that have been implemented in response to the global recession. This has led to the country’s fiscal position moving from a surplus of 1% of GDP in the 2007/08 fiscal year to a 7.3% deficit in 2009/10. The country’s overall public debt, meanwhile, is expected to rise from 23% of GDP in 2008/09 to 44% in 2015/16.

However, South Africa’s debt burden is modest in comparison with struggling economies elsewhere. According to OECD figures, Greece’s debt-to-GDP ratio was 114.9% at the end of last year and its fiscal deficit was 12.7%; the comparative figures for Ireland were 65.8% and 12.2%.

More critically, South Africa seems to have a credible plan to reduce its deficit in the medium term. “Higher government borrowing is only a temporary solution to our economic challenges,” said finance minister Pravin Gordhan during his budget speech on February 17. “As the world recovers from the recession, countries with low levels of debt will be better placed to take advantage of growth opportunities. Our medium-term fiscal framework allows for a gradual reduction in the budget deficit.”

While resisting the temptation to hike taxes this year, which might have destabilised the recovery, Gordhan says the government needs to raise tax revenues in future to fund its spending commitments. Even without higher tax revenues for the next fiscal year, Gordhan has targeted a fall in the deficit to 6.2% for 2010/2011 and 4.1% by the end of the 2012/2013 fiscal year.

Investors clearly bought into the idea of South African fiscal prudence. The 10-year bond was issued on March 2 and carried a nominal coupon of 5.5%. It was priced at a discount of 99.250 to give an issue yield of 5.594%, or 197 basis points over 10-year US Treasury bonds. That represented a new issue premium of around 13bp over where the nearest available South African tenors (due in 2019 and 2022) were trading.

Secondary market performance has been strong: in the first 24 hours, the price of the bond traded up to 100.569 to yield 5.426%. On March 24, the price had risen further to 102.45 for a yield of 5.181%, or 133.4bp over US Treasuries.

Secondary showing

According to Florian von Hartig, head of global debt capital markets at Standard Bank, the bond’s strong secondary showing proves it was issued at the right price. “The spread was tight but right,” he says. “I think that is expressed pretty well in the after-market performance; the bond never dropped below par, and that’s exactly what you want. The performance was perfect from everyone’s point of view – the issuer’s as well as the investors’.”

The strong demand for the deal – it attracted $7 billion of orders – reflects the confidence in the South African sovereign, von Hartig adds. After a conference call with investors on Monday, March 1, during which the Treasury gave a presentation and answered investor questions, the transaction was wrapped up the following afternoon.

“South Africa is a highly regarded name in the international market. The Treasury spends a lot of time with investors to keep them informed and in the loop on what’s going on, and that naturally makes investors feel comfortable about their credit. All that hard work is starting to pay off,” he says.

Despite the fact coupons have tightened since South Africa issued its last 10-year bonds (a $2 billion deal last May with a nominal coupon of 6.875%), investors such as David Bessey, managing director of emerging market bonds at Newark, New Jersey-based Prudential Fixed Income Management, believe the latest deal still offered good value. He says the yield compared favourably with existing South African paper and emerging market credit.

“Of course, spreads for all fixed income products have come in over the last six to nine months, so the prospect wasn’t as attractive as it would have been, say, a few quarters ago. But in the current context we thought it was good.”

Kevin Daly, portfolio manager of emerging markets debt at Aberdeen Asset Management, says the South African bond represented considerably better value than debt from comparable emerging market countries.

“A good index for pricing would be the likes of Brazil or Mexico. With the South Africa deal we were looking at 40–45bp above Brazil, and probably 45bp above Mexico, so in that sense it was attractively priced. We got a good allocation, and we’ve been pleased with the secondary market performance.”

On a relative value basis, South Africa currently offers a decent pick-up over comparable issues by those two Latin American countries. South Africa is rated BBB+ by Fitch Ratings and Standard & Poor’s – higher than both Brazil (BBB-) and Mexico (BBB). But on March 22, a bond from the Brazilian government due to mature in January 2020 yielded 4.879%, while a December 2019 bond from Mexico was yielding 4.777%.

Not all investors were convinced of the value of the South African offering, however. Vivienne Taberer, fixed income portfolio manager at Investec Asset Management, says there is better value to be found in rand-denominated issues. “The pricing was fair, but though the secondary market performance was good, it wasn’t particularly great given that the whole market has rallied,” she says. “We feel there is better value in domestic currency issues in the emerging markets, particularly in South Africa and Brazil.”

Arthur Hovsepian, emerging market strategist at investment manager Payden & Rygel in Los Angeles, also looked at the deal, and declined to bid. “While we like the South African Treasury as a credit, the bond doesn’t represent huge value,” he argues. “We weren’t bullish at those levels.”

Hovsepian says sovereign bonds from other sub-Saharan African countries are more appealing to investors seeking higher returns. Payden & Rygel has exposure to both sovereign and domestic currency debt in Ghana, which was the first country from sub-Saharan Africa after South Africa to sell bonds in the international market, raising $750 million with a debut 10-year Eurobond in 2007.

All eyes on Africa

However, higher returns on sub-investment grade debt in other African nations reflect the greater risk of investing in those markets. Concerns over governance in sub-Saharan African countries persist. “You always have to make a call as to whether you’re being compensated for being burdened with the extra risk,” Hovsepian says. He cites “governability, fiscal prudence and the outlook for the export sector” as the key factors investors should take into account.

Nevertheless, sub-Saharan sovereign debt may not be as risky a prospect as it once was. On March 8, International Monetary Fund head Dominique Strauss-Khan declared “Africa is back” during a live TV debate in Nairobi. He praised improvements in governance and fiscal policy across the continent in a statement that may boost investor confidence ahead of future sovereign issues. Each of the investors Credit spoke to thought further issuance this year from African sovereigns is probable, particularly while interest rates are low.

“There’s so much infrastructure in these countries that could be improved with money from the international capital markets: roads, construction programmes, power plants,” says von Hartig. “It is surely in these sovereigns’ minds to take advantage. What stopped them 18 months ago were interest rates, or credit spreads in particular, that were way too high. But now, with spreads having come down to levels that are historically attractive again, I’m not surprised that some countries are getting prepared to issue bonds.”

The continent’s two largest oil producers, Angola and Nigeria, look the most likely to offer debut international bonds in 2010. Officials in Angola met with delegations from Fitch, S&P and Moody’s in March to secure the country’s first credit rating ahead of a possible $4 billion issue. Hovsepian thinks such a bond may offer good value. “We may be interested, especially if it comes with a large issue. Angola has good commodities exposure and would be attractive at the right price,” he says.

Nigeria, which is rated BB- by S&P, announced on March 17 it is planning a $500 million issue by the end of October, subject to parliamentary approval. A deal from Nigeria would attract interest too; Daly says if the mooted bond offers yields of around 7% he may consider participating.

The increasing interest in African sovereign debt reflects investor confidence in the emerging markets more broadly, at a time when the risk of sovereign default in developed economies is becoming a serious concern.

Taberer believes confidence in the emerging markets is likely to continue. “As investors, we’ve been impressed with how well emerging markets have handled the peripheral Europe story,” she says. “There’s good growth, and we’re positive on the emerging markets as an asset class going into the future.”

Deal terms

Issuer: National Treasury of South Africa
Date of issue: March 2, 2010
Size of deal: $2 billion
Maturity: March 9, 2020
Ratings: A3 (Moody’s), BBB+ (S&P, Fitch)
Bookrunners: Deutsche Bank, Standard Bank
Nominal coupon: 5.5%
Issue price: 99.295
Issue yield: 5.594%
Issue spread: 197bp over 10yr UST