Capital raising via traditional bond markets particularly expensive for African countries, as risk appetite among typical bond investors has declined, pushing pricing up to prohibitive levels, writes Miranda Abraham.
The perfect storm of inflationary pressures, aggressive monetary tightening from central banks, combined with a deepening of the Russia/Ukraine crisis, has made capital raising via traditional bond markets particularly expensive for African countries whose governments have been forced to find innovative ways to raise capital.
While the quality of African sovereigns hasn’t declined, risk appetite amongst typical bond investors certainly has and this has pushed pricing up to prohibitively high levels.
African government bonds have historically offered fairly priced, long-term debt for issuers and attractive returns for investors.
But now sentiment has turned; in a risk-off environment investors generally prefer to buy investment grade credits, and inflationary pressures mean that for investors, there are many opportunities which are perceived as lower risk and which now offer higher yields.
As the international bond market becomes less appealing, African governments have begun to explore alternative options such as syndicated loans – typically offered by a group of bank lenders who work together to provide credit to large borrowers like governments, state owned entities or large corporates.
Bridge financing is also providing an alternative solution.
It is a form of flexible, interim financing used to cover short-term costs until a long-term financing option can be put in place. It is typically priced relatively cheaply, at least initially. Borrowers benefit from a significantly lower cost of funding, as long as the bridge is refinanced within expected timeframes.
We have noticed that banks active in Africa have reported an uptick in interest from sovereigns on these loan products as a workaround to traditional bond market funding. And as a number of loan market deals have not been refinanced, banks have excess capital and are actively looking for ways to deploy these funds.
This decoupling of bond and loan markets has paved the way for alternative, attractively priced funding sources. Liquidity in the loan markets is very strong.
And as a result, credit insurance, which has been a popular credit risk mitigation tool in the banking market for many years, has now come to the fore as lending banks also adapt to a more challenging credit environment.
Credit insurance is typically organised on a separate and private basis by individual banks when they join a syndicated loan to protect themselves from borrowers which may default.
Most recently, we have seen a growing trend for deals with some form of credit risk mitigation embedded into the loan upfront. This can be in the form of embedded credit risk insurance, or Export Credit Agency (ECA) and Development Finance Institution guarantees.
The embedding of the risk mitigation upfront transforms the profile of the syndicated loan. An enhanced credit profile means the deal holds appeal for a much wider audience of investors.
This enhanced credit profile also has the benefit of reducing the cost of funding for the borrower.
Looking ahead, we expect that while the inflationary pressures continue, the bond markets are likely to remain subdued.
It is important to note, however, that many African sovereigns have already successfully issued bonds in the post Covid environment: Kenya, Nigeria, Angola, Gabon and South Africa, to name a few.
There is also very little pressure for most African sovereigns, as there are very few impending bond maturities looming. Technically sovereigns could still issue, but pricing is now very unattractive for any potential sub-Saharan issuers.
We therefore expect more sovereigns to turn to short term bridge or syndicated loan financing in the coming months.
Miranda Abraham, Co-Head of Loan Syndication at RMB in London. Views are her own.