It took three failed attempts spanning nearly two decades. But the Independent State of Papua New Guinea’s (PNG) successful completion of a debut international bond deal at the end of September represents a remarkable achievement for a country that is far more used to setbacks than success.
And no one has been more pleased than the country’s deputy prime minister and treasurer, Charles Abel, who led the roadshow team ahead of the pricing of a $500 million 10-year transaction on September 27.
“An inaugural bond issue is a very important milestone in any country’s financial history, but particularly for us since this has been talked about for almost 20 years but wasn’t executed for one reason or another,” he told FinanceAsia. “It’s a very important fundraising option, not only for the government, but also for PNG’s corporate sector as well.”
Prior to the bond deal, Abel believes PNG was a misunderstood credit because it had no outstanding international financial instruments and consequently few capital market investors following it.
“We hope this bond will change that,” he said. “We believe we’ve clarified the misconception that we’re a small Pacific country with limited growth potential, while highlighting the immense opportunities the country presents and how we intend to capitalise on them.
“I believe there’s a realisation about our economic strength and prudent governance framework,” he continued. “It’s reflected in the terms we achieved for the bond as well as its after-market performance.”
Abel notes how rare it is to get “10 years for an inaugural tenor” and believes that “pricing was competitive against comparable bonds and given the overall market situation".
Indeed, PNG’s 8.375% cost of funding underscores just how radically the pricing dynamic has shifted in Asia since PNG last tried to actively access the market in June 2016.
Back then bond investors were not interested in one of Asia’s lowest rated sovereigns, in part due to deteriorating economic fundamentals and the global commodities downturn. They wanted an 11% yield for its B2/B rated credit.
All the momentum lay on the other side of the Asian region where high-yield Chinese property companies were issuing debt at half that level.
Today it is the other way round.
The lowest rates Chinese property credits are being forced to accept double-digit yields to get deals done. Even crossover credits like Country Garden have seen their funding costs jump roughly 40% in the space of two years.
In September 2016, for example, the Ba1/BB+/BBB- rated property company was able to price a seven non-call four offering with a re-offer yield of 4.75%.
Fast-forward two years and in mid-September, Country Garden had to accept an 8% yield for a January 2024 deal (callable in 2021). On a like-for-like basis, that is the same pricing as PNG (taking the latter’s longer tenor into account).
The two credits' contrasting fates demonstrate how each one is reliant on a single set of investors, grappling with very different conundrums.
On the one side, China’s clampdown on the shadow-banking sector has not only removed a big chunk of its offshore demand, but also exposed just how dependent its credits are on investors from their own country.
PNG, on the other hand, is a classic frontier market credit, which relies on the shifting sentiments of international portfolio managers.
As such, its distribution stats show that 56% of the book was placed in the US, 27% in Europe and only 17% in Asia. By account type, fund managers accounted for 93%, insurance and pension funds 6% and others 1%.
The deal attracted notably strong demand, totalling $3.3 billion at final pricing, with allocations to 195 accounts. The sovereign was able to build such positive momentum for two reasons.
Firstly, investment bankers say frontier and emerging market investors welcomed the diversification PNG offered once they had done their credit work and become comfortable with it.
For some US investors, the deal also appeared to offer value relative to lower rated US high yield credits, which have benefited from the dollar’s strength and flight home. For example, Caa1/B- rated Chesapeake Energy executed an eight-year deal on a coupon of 7.5% in late September.
Secondly, global co-ordinator Credit Suisse and joint lead manager, Citi, waited for a good market window immediately after the latest FOMC meeting. The deal had initially been marketed in early September when comparable sovereign credits such as Sri Lanka and Mongolia were under pressure.
Sitting back for a couple of weeks made a lot of sense, because it enabled PNG to tap the market just as analysts were starting to question (again) whether emerging market turmoil had hit bottom and if contagion from Turkey and Argentina's woes had been contained.
They remain divided on both counts. However, the deal caught a good following tail wind, which has seen Sri Lanka’s 6.75% April 2028 bond tighten in almost 60bp from 7.84% on September 19 to 7.256% when PNG priced.
This means that PNG priced roughly 112bp above a credit with a one notch higher rating and a much longer track record in the international bond markets.
PNG was able to turn this disadvantage around by creating rarity value. It sensibly did not overwhelm the market on its first outing, raised less than the $1 billion it had initially indicated and dropped plans for a five-year tranche.
It was a win-win situation, which led to strong aftermarket performance, with the bond closing up one point on its first trading day.
The deal was a doubly important one for PNG because it wanted to show the world that it had access to the international bond markets ahead of its role hosting the Asia Pacific Economic Co-operation (Apec) summit in the capital, Port Moresby, this November.
This will be biggest event the country has ever held since it gained independence from Australia in 1975. It is also expected to showcase PNG’s growing tilt towards China.
President Xi Jinping is scheduled to arrive a few days before other Apec delegates and country specialists are expecting announcements relating to a potential free trade agreement and/or new infrastructure projects.
PNG is China’s fifth largest source of liquified natural gas (LNG), accounting for 6% of its imports, and has ambitions to become a global LNG powerhouse.
Growing Sino-US trade tensions should help to reinforce a move in that direction. Earlier in September, for example, China responded to America’s latest $200 billion tariff round by slapping 10% duties on imports of US LNG.
The PNG government is also particularly keen to make sure that future foreign-owned mining projects benefit the domestic economy more than previous ones, which have been paying less tax than expected. This has resulted in a budget deficit rather than the surplus the government had been hoping for.
BALANCING THE BOOKS
Bridging the deficit has pushed up government debt to GDP to 31.27% at the end of 2017, although it is still comfortably below the government’s own self-proscribed 35% ceiling.
The bond’s offering memorandum reveals that short-term Treasury bills accounted for 37.7% of the government’s overall debt at the end of June and inscribed stock 33.6%. The balance comprises foreign currency debt in the form of concessional loans (21.3%) and commercial loans (the remaining 7.4%).
This equates to a 71%/29% split between domestic and foreign currency debt. Abel intends to further rebalance it in favour of foreign currency debt over the near-term.
He says that proceeds from the new bond will be used to retire domestic short-term debt, fund the government’s development programme and cover expenses relating to the forthcoming Apec meetings. It will not be used to repay a Credit Suisse loan since principal amortisation only kicks in from 2020.
In November last year, PNG also announced a medium-term debt strategy (2018-2022) targeting a government debt to GDP ratio of 30% and below by 2022. Abel says he believes this is a prudent level compared to similarly rated countries and adds that the government is evaluating whether to retire part of its medium to long-term debt as well. It aims to balance the budget by 2022/3 too.
Where FX reserves are concerned, he says the government “intends to ensure market stability and maintain such reserves that help us maintain stability while continuing to help accelerate economic growth". FX reserves currently cover six months of imports.
One of the bond’s most important achievements has been to extend the sovereign’s maturity profile by a few years. Abel adds that it hopes to continue lengthening it at a lower cost than domestic 10-year government bonds.
It is currently discussing obtaining concessional funding for this from the multilateral agencies. Abel notes that PNG has already secured $600 million in direct highly concessional financing (as opposed to project financing) from the Asian Development Bank (ADB) and World Bank over the past three years as part of the government’s debt strategy to boost concessional debt, lower interest costs and reduce rollover risk.
The government’s reliance on short-term debt was one of the key issues flagged by Moody’s when it put the sovereign’s credit on negative outlook in March this year. Another was impact of worst earthquake in the country’s history this February, which shut down key mining projects for three to four months.
However, Abel believes that since then PNG has “directly answered the concerns raised in the downgrade reports through the resilience of our resource project infrastructure and the fact that production has exceeded nameplate capacity at certain facilities, especially on the PNG project".
He also reiterates the government's repayment of short-term debt as a second positive factor. The government is no doubt hoping that the completion of the bond issue will help to reverse the rating agency’s stance.
However, the earthquake’s knock-on effect has led the government to revise its 2018 GDP forecast down from 2.2% to around 1%.
The Asian Development Bank (ADB) has also slashed its own forecast to just 0.5%, citing a likely 10% fall in LNG production this year. The sector accounts for 14% of PNG’s GDP.
Abel says that while he cannot comment on why the multilaterals have come up with their forecasts, it seems “they may have expected a more severe and lasting impact from the February earthquake versus what the country actually experienced”. In fact, he notes that the World Bank initially forecast negative growth for 2018 immediately after the quake struck.
He also does not want to be drawn on when the sovereign may come back to the international bond market again.
“I think it’s premature to say how often we’ll issue international bonds,” he concluded. “What’s more important is that proceeds from this issue are utilised judiciously and in the best interests of the country.”