Credit Fundamentals Play Second Fiddle to EMEA Sovereign Risk

LAGOS (Capital Markets in Africa) — Corporate credit metrics diverge across Eastern Europe, the Middle East and Africa (EMEA), as sector spreads are tightly correlated to sovereign risk. Fundamentals continue to improve for the region’s energy sector issuers, while EMEA banks remain subject to idiosyncratic, country-specific risk. 

EMEA energy sector debt valuations are driven by country rather than company fundamentals, resulting in higher yields than emerging market peers. Energy sector issuers from Central Asia and Eastern Europe offer 101 bps per annum of duration-adjusted yield, higher than both Latin America (97 bps) and the Asia Pacific (69 bps). Credit-default swap spreads for Russian issuers Gazprom and Lukoil are over 99% correlated to that of the sovereign over the past five years, the most among EM energy sector issuers.

State oil-company obligations dominate the EM energy sector, accounting for 19.9% of all benchmark-eligible EM corporate and quasi-sovereign debt. EM governments rely heavily on the revenue generated from national oil producers, such as Gazprom, and spreads reflect an implicit guarantee of state support in times of duress.

Bank-sector leverage remains elevated in Turkey, yet asset quality will be the focus for dollar creditors, as nonperforming loans are up over 40% year-over-year. Tight margins and a looming recession have made it more challenging for Turkish banks to increase capital buffers, exposing the sector to threat of a systemic shock. Turkey’s high funding costs reflect the financial sector’s deteriorating credit metrics, and bank spreads could widen relative to regional peers in Russia and the United Arab Emirates.

Currency weakness is expected to continue, with consensus calling for a 17% decline in the lira through year-end. Turkey is projected to exit recession in 2Q, yet exogenous factors could add to pressure on the banking sector, leaving dollar-pay creditors vulnerable

EMEA quasi-sovereign borrowers have a higher credit rating than fundamentals justify, limiting headroom for future upgrades. Based on the median of EMEA non-financial quasi-sovereign issuers with at least $1 billion of benchmark-eligible debt, S&P’s stand-alone credit profile (SACP) is two notches below the company’s long-term rating. By comparison, Moody’s median baseline credit assessment (BCA) for EMEA quasi-sovereigns is three notches below their long-term rating, implying less headroom for future upgrades.

Relative to regional peers, Mideast issuers Saudi Electric (A-/bb-) and Israel Electric (BBB/bb-) have less headroom for future S&P upgrades. Similarly, Taqa (A3/b2) may have less scope for a ratings upgrade at Moody’s. (01/30/19)

Bloomberg Intelligence EM Corporate Credit Scorecards may be used to gauge the position of issuers and industry groups across the credit cycle. We aggregate company scores by sector, region and country to derive both the current level and six-month forward trend for each of the 20 industry groups under coverage at BI. Our analysis reveals that over $308 billion, or 65% of the benchmark-eligible EM debt under BI coverage, has been issued by companies operating in sectors with improving credit fundamentals.

EM corporate and quasi-sovereign debt issued by companies under BI coverage totals $471.1 billion. Over 82% of BI coverage companies are operating in industry groups with solid credit metrics. 

Source: Bloomberg Business News