The Daily Update - Maldive's junk bond

With all the wet ‘summer’ weather we have been having in the UK it seems as good a time as any to discuss the sunnier shores of the Maldives. The archipelago's economy is largely based around a competitive travel and tourism industry, which directly and indirectly contributed just under 80% to the country's GDP in 2016; nominal GDP stands at roughly USD 3.8bn. Although the country has maintained robust growth in recent years, around 5%, with such an undiversified economy, growth is susceptible to shocks. On the other hand GDP per capita (PPP) is estimated at $15,000: equivalent to ~60% of the world's average. We estimate the Maldives has a 4 star NFA rating, with net foreign liabilities less than 25% of GDP. The country however has only recently been assigned ratings; Fitch allocated the B+ rating for the first time in mid-May, a notch above Moody’s B2 rating, which was announced in February 2016.

The nation launched its debut 5-year, USD 200m sovereign bond last week with a 7% coupon; the deal was through one of China’s largest banks, Bocom International Holdings Co.. The fairly liquid high yield bond currently trades at an attractive spread around 505bps over US Treasuries, compared with other single B rated credits which are currently around 355bps over. We therefore calculate that the bond offers an expected return plus yield of just 13% with less than 2 notches of credit cushion. Even if this was a bond we could hold across our investment grade portfolios, we wouldn’t as it does not offer sufficient protection against unforeseen events and does not compensate for the potential political and undiversified economic risks.

To add some perspective we could use, Aa3 rated, quasi-sovereign bond Sinopec 3.125% 2023, as an example of what we find interesting. This bond trades at a much tighter spread of 120bps, but it is rated 10 credit notches higher than the Maldives’ new issue and offers a ~6.5% return and yield, and trades almost 4 notches cheap.

It seems the search for yield has witnessed some investors fill their boots with high yielding junk bonds, which has seen the likes of USD single B rated bonds trade at their tightest spreads to sovereigns in recent years. However, we don’t think the current economic environment is conducive to that sort of approach. Sub-investment grade bonds usually perform best when the global economy is strong, which is not the case today. In today’s environment, the best investments are investment grade credits. We believe that buying undervalued investment grade bonds, which have strong fundamentals can significantly outperform high yield bonds, whilst at the same time taking less risk.

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