The premium is worthwhile

Sri Lanka’s US$500 million 8.25% fixed rate notes due 2012 wins Best Sovereign Bond award

The Democratic Socialist Republic of Sri Lanka defied political noise and investor concern about the decades-long civil war with the Tamil rebels as it successfully launched its debut offshore offering amounting to US$500 million in October.

The B+/BB- rated sovereign priced the five-year issue at par to offer a yield of 8.25%, or a spread of 397.2bp over the US treasuries. The Reg S/144A deal was 3.2x oversubscribed with an order book of US$1.6 billion – an impressive result for the first US dollar bond from an Asian sovereign since the credit crunch unraveled due to the US subprime crisis. Joint Bookrunners were Barclays Capital, HSBC, JP Morgan.

The government has been toying with the idea of a sovereign bond issue since 2005, but as Central Bank Governor Ajith Nivard Cabraal points out, it has always been interrupted by the intermittent violence breaking out in the country. But in mid-2007, it took a firm decision that although there may be challenges ahead, it will proceed with the bond issue.

“We made preparation and took a commitment that we will be not be taken back by the various extraneous circumstances that may arise,” Cabraal told The Asset in an interview.

But as they move toward the launch, they were confronted with another problem that they did not foresee the unraveling of the subprime crisis during the summer that completely changed the market conditions. “That was a much greater challenge than we originally envisaged,” notes Cabraal.

But that did not stop Sri Lanka on its track especially as a window of opportunity was opening towards the end of September. “Overall, we were able to pitch a good message,” says Cabraal. “We were very frank with the investors and we responded openly to all their questions. I believe that brought confidence to the investors so much so that the deal was oversubscribed. We were happy with the ultimate outcome.”

He adds: “We want the international community to see Sri Lanka in the light of what our country should be seen. We believe we have achieved that and had we fallen short, I would have still thought that it was a great consolation to have conveyed this message across the world.”

Cabraal highlights the importance of having a sovereign issue in the market. “We are conscious that as Sri Lanka moves towards the new stage of development, it is time also for the Sri Lankan corporates to be looking at outside financing for themselves. And unless the sovereign has a benchmark issue out there, it will be difficult for corporates to go out and tap the market. So for all those reasons, we felt that it was important to go ahead with the transaction, even during one of the most difficult times in the bond market. We thought that as a first time issuer and a new kid in the block, we would be attractive enough for investors to come and invest with us.”

Cabraal describes the pricing as good enough given the prevailing market conditions and the political noise the issue had created. “Had it been an ideal market condition and without all the noise created by the opposition, the pricing may have been a few notches lower than that what we’ve finally achieved,” he says. “We believe that the slightly higher premium that we may have paid is still worthwhile in the overall context of the issue. It was good enough deal for us.”

Cabraal says he is not overly concern about the subsequent widening of bonds in the secondary market. “I do not think it is something peculiar to Sri Lanka bonds. “It is something of a worldwide phenomenon that we have to suffer from the overall sentiments in the market. But I am sure that in the medium to longer term, investors would gain more confidence in our issue with the way our economy is moving.”

As Cabraal points out, various steps are being taken to put the Sri Lankan economy in the right shape. “We are conscious that we are now being watch by the international community and so we have to put a lot of discipline into our system,” he says. “We believe having that sense of discipline and being accountable to investors will definitely be a good thing for our economy and our rating will be better as times goes on.”

At present, Sri Lanka is in a major investment drive to finance its infrastructure development. “Some of the projects that we are undertaking today are by far the largest ever in the country’s history, including ports, airports, highways and power plants,” says Cabraal. “The overall pipeline of projects right now is in the region of US$4.5 billion and we see a further pipeline of another US$4.5 billion to US$5 billion unfolding in the next couple of years.

The offering attracted 136 investors across Asia, Europe and the US. Cabraal commended the three joint bookrunners – Barclays Capital, HSBC and JP Morgan – for preparing them very well for their maiden bond offering. “They appraised us of the various frameworks on how the international bond market works as it was something we have never done before,” he says.

“It was an excellent team effort and I am pleased that we were able to work together in a very harmonious manner. We selected them based on the strength that they were bringing into the deal. JP Morgan is very strong in the US, HSBC in Asia and Barclays in Europe.”