Sri Lanka defies sceptics with benchmark bond

A total of 136 investors buy into the debut bond despite political opposition to the deal in Sri Lanka.
Late Wednesday last week Sri Lanka finally issued its maiden sovereign bond (B+, BB-), succeeding in raising $500 million through a five-year 144A, Reg-S bond at a yield of 8.25%, or the equivalent of 397.5bp over five-year Treasuries. The deal was arranged by Barclays, HSBC and JPMorgan and co-managed by the Bank of Ceylon.

Executing the bond was no easy task. The main political opposition party in Sri Lanka, the United National Party (UNP), held a number of press conferences and public demonstrations objecting to the offering, and argued that the bond was improperly authorised. The UNP also threatened not to honour payments on the bond, should the party come into power. Legal experts have since certified the bond complies with Sri LankaÆs foreign loan regulations.

Investors have also had to contend with the ongoing civil war between government forces and the Tamil Tigers, which led Fitch Ratings to place the sovereign on a negative outlook in 2006. The agency has maintained its stance yet again this year.

At 8.25%, one investor believed the deal was expensive compared to Pakistan (B+,B1), which at the time of pricing was trading at 8.04% for its 2016s, and 8.22% for its 2017s. Others say the price reflects the risks in Pakistan. ôBenazir BhuttoÆs arrival from exile in Pakistan triggered two massive bombs attacks, killing 130 people and causing the sovereign's credit default swap to widen by up to 10bp. In my opinion, the risks of a violent regime change are much higher there than they are in Sri Lanka.ö

When questioned about the threat of default by Sri Lanka's opposition party, he said: ôOpposition parties always make life difficult for the ruling party. It wouldnÆt make sense for them to actually carry out that threat since this would be harmful to Sri Lanka, its prospects for growth and attracting foreign investment. Anyway, even if they do, I have time to work my position out if I donÆt like it. Elections are in 2010.ö

He adds: ôItÆs a credit were there will be continued negative headlines and tension, but I take comfort from the countryÆs excellent sovereign debt service record.ö

Economically, the country suffers from weak public finances, high public debt ratios, and a weak financial system. Inflation has risen sharply (averaging 17.3% in 2007), while the fiscal deficit and public debt have remained high in 2006 at 7.3% and 93% of GDP respectively, according to a Fitch report.

But Sri Lanka also has some strong cards to play. The country enjoys high levels of human capital development, good governance, reasonably strong institutions and a liberal economic climate, continues the report. Moreover, in 2006, the economy expanded at its fastest rate in 20 years (7.4%) thanks to rising domestic and foreign investments and record inflows of remittances.

The bonds are now trading at 99.5 to 99.875, having initially reached a high of 100.75 after issuance.

Some sources argue the bonds werenÆt placed in safe enough hands, and that the leads may have overstated the levels of subscription. This reportedly gave the fast money accounts that participated in the deal an excellent excuse to sell. ôWe have seen $33 million of Sri Lanka bonds being sold to this institution, mainly by prop desks and hedge funds,ö says one syndicate banker.

This statement is supported by a source on the buy-side who states: ôI agree the allocations could have been a bit more selective, but if people want a free call by the market, they are in the deal for the wrong reasons. Maybe the leads were economical with the truth, but we all have to decide whether the pricing, the tenor and most importantly the current market sentiment is appealing enough to want to subscribe. I think the bonds will perform fine given time. They came in a pretty weak market sentiment, so they will take a little longer to settle down.ö

Other accounts that participated in the deal had no complaints regarding the execution of the transaction: ôI think if there was that much fast money in this deal, its performance would be worse than it is. ItÆs the overall market that is weaker. As far as I am concerned, the leads did very well in educating the public, pricing at the right levels, and keeping investors informed about the subscription levels at every step of the way û it was $250 million initially, then moved to $400 million at the announcement. Overnight, it swelled to $1.25 billion, ending up at $1.6 billion at the time of pricing.ö

ôIÆd like to see the bonds perform, of course, but there are buyers coming in. This is the countryÆs first global deal, with representation in the Emerging Market Bond Index and the JPMorgan index. Some of the US investors benchmarked against these indices will be interested in these funds for diversity purposes. Also, given its tenor and yield, some private banks will get involved as well, while some real money accounts that initially stayed out of the trade because of market weakness, are now coming in on the secondary market. So there is a good two-way flow.ö

In the meantime, the deal has now set Sri Lanka on the international capital map, achieving an impressive US participation, with 40% of the bonds selling to that country alone. A further 30% sold to EMEA, and 30% to Asia. In terms of investor-type, 53% of the bonds sold to asset managers, 25% to banks, 10% to funds, 7% to insurance companies and pension funds, 5% to retail and private banks. As many as 136 investors participated in the deal.
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