Bond Issues From Russia and Ecuador Serve as Cautionary Tales for Junk-Rated Debt
If David Letterman did a top 10 list for dubious bond investments, a case might be made for including two fast imploding issues from Ecuador and Russia.
The euphoria for junk bonds from emerging market economies, fueled by rock-bottom interest rates in the United States, Japan and Europe, has offered up any number of fallen angels, from OGX, the bankrupt Brazilian energy firm, to a spate of Mexican home builders.
But, in many ways, a $600 million bond issue by a Russian train company in 2012 and, two years later, a $2 billion offering by the government of Ecuador, serve as cautionary bookends for high-yield bond segment, even though it shows no sign of ending anytime soon.
When Brunswick Rail, Russia’s largest private-sector train company, offered $600 million worth of bonds to global investors in 2012, the deal was a blowout. More than $3 billion in demand came from yield-starved global investors.
Oil prices were high and Russian railroads were seen as a good growth play, notwithstanding the competition the company faced from state owned firms and the fact that Brunswick was borrowing in dollars and getting a good chunk of its revenues in rubles.
According to Bloomberg, big buyers included fund giants such as Pimco, Capital Research and Fidelity.
To say that Brunswick Rail has suffered from the ruble’s 50 percent collapse relative to the dollar would be an understatement. Bond yields have jumped to 29 percent, from 6.5 percent, and the securities are now on offer at a deeply discounted price of 60 cents on the dollar.
With refreshing candor, the company has acknowledged recently that this toxic combination of ruble based revenues and a $600 million debt does not bode well for the future.
“The macroeconomic conditions in Russia, including depreciation of the RUR, appear to us to be very difficult,” the company said in a recent statement. “These conditions have begun to adversely affect our business and will likely continue to adversely impact our business volumes, lease rates, including our ability to finalize leases in dollar rates.”
Moreover, the firm said it would be talking to its “banks to explore potential changes to the financial covenants under its credit facility.”
There is no evidence, yet, that the government of Ecuador, which defaulted on its bonds in 2008, is having similar thoughts for the $2 billion worth of 7 percent bonds it sold investors last spring. But one might excuse bond investors that gobbled up the issue for feeling a bit queasy just the same.
In recent weeks yields of the bonds — which mature in 2024 — soared to a high of 13 percent and bond prices hit a low of 73 cents on the dollar (with oil prices recovering on Friday, the bond prices bounced back to 85 cents, still a significant discount.)
While Ecuador’s debt levels have come down in recent years, it still runs a 4.5 percent budget deficit, a gap that should widen significantly as oil-driven government revenues decline.
That Ecuador’s fiery president, Rafael Correa, has in the past called the holders of his country’s bonds “true monsters” must also be a bit disconcerting to this second generation of Ecuadoran creditors. They include Goldman Sachs, which recently lent $400 million to Ecuador.
And, according to Bloomberg data, Franklin Templeton which owns 27 percent of the bonds, followed. Other bondholders include BlackRock, Schroders and Massachusetts Financial Services.
According to the data provider Lipper, emerging markets and corporations have issued $2.2 trillion worth of bonds to global investors since 2009, with most of that amount coming from corporations.
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