Title: The Determinants of Corporate Bond Yield Spreads
1- The Determinants of Corporate Bond Yield Spreads
- in South Africa Firm-Specific or Driven by
Sovereign Risk?
Martin Grandes (DELTA and OECD Development
Centre, Paris) Marcel Peter (HEI Geneva and IMF)
2This presentation
- Motivation and policy relevance
- What do we know about it?
- The determinants of corporate default risk premia
in theory - Firm-specific variables
- Sovereign default risk
- Empirical evidence for South African corporates
- Data sources and sample period
- Econometric framework
- Results
- Concluding remarks and policy recommendations
3Motivation and Policy Relevance
- Global
- Feeds into the Post-Monterrey agenda
- Cheaper finance for development, debt
sustainability - Higher rates of investment required in LDCs to
achieve MDG - Regional
- Contributes to NEPAD Capital Flows Initiative
(CFI) and the NEPAD-OECD Africa Investment
Initiative - Aim increasing private capital flows to Africa,
filling the resource gap - Two priorities
- i) address investors perception of Africa as a
"high-risk" continent - ii) promote the deepening of financial markets
within countries, as well as cross-border
harmonisation and integration. Positive spillover
effects. - (see OECD DEV WP 231 or session I tomorrow!)
4Motivation and Policy Relevance
- Domestic
- Researches a unique case in Africa,
- A liquid bond market in local currency. Yet,
small truly corporate bond market but - Good prospects for further development (see RMB
and BESA) - Big firms tapping this market. Could help inform
decisions made by other potential issuers gt
alternative, cheaper source of finance - Scope for lowering corporate debt costs when
public solvency improves - Source of concern
- The cost of capital (of which debt cost is a
component) is a critical driver of long-term
growth. - Relatively high real cost of capital blamed for
sluggish long-term growth (see also Michael
Powers presentation)
5What do we know about it?
- Main questions this study aims to answer
- 1) Can we observe something like a sovereign
ceiling in local-currency-denominated corporate
bond yield spreads? - In other words, Is a given increase in sovereign
risk associated with a more or less than
proportionate increase in South African corporate
bond yield spreads? - 2) Do idiosyncratic (i.e. company-specific)
factors help explain corporate default risk
premia? - Very scant literature on developing countries.
- Virtual inexistence of long-term, fixed rates,
local-currency denominated issues (Original
Sin) - Many corporate bond markets still poorly
developed - Only Durbin and Ng (2001) foreign-currency
denominated issues no firm-specific controls.
Main finding the sovereign ceiling doesnt
hold, esp. in low-risk countries
6The determinants of corporate default risk
premia. Theory
The Cost of debt for an emerging market borrower
This morning
This presentation
7The determinants of corporate default risk
premia. Theory
- Firm-specific variables (Black and Scholes, 1973
Merton, 1974 Shimko et al (1993), others)
8The determinants of corporate default risk
premia. Theory
- Sovereign default risk and the sovereign ceiling
if
gt the ceiling in spreads applies
if
gt the ceiling in spreads does not apply In
this latter case, corporate spreads higher than
sovereign spreads due to higher firm stand-alone
risk
9Empirical evidence for South African corporates
- Data sources and sample
- BESA and DATASTREAM.
- Excludes parastatals
- Excludes non-listed (at JSE) corporates
- Excludes illiquid issues
- gt We found 12 bonds October 1997-May 2003.
Monthly observations - Half banks, half industrials
- Benchmark bonds EBRD, EIB and IBRD (World Bank)
ZAR denominated issues - Econometric framework
- Panel data estimations. Modern techniques. Two
equations - Corporate spread levels
- Corporate spread differences
Therefore, task is to test the significance and
value of
10How do we compute corporate spreads?
Example I ABSA 05
In points
11How do we compute corporate spreads?
Example II ISCOR 03
In points
12Empirical evidence for South African corporates
Type of Risk Variable Variable Impact on Corporate Default Spreads Impact on Corporate Default Spreads
Type of Risk Variable Variable Expected Estimated
Systematic Sovereign default risk Sovereign default risk
Firm-specific Leverage (quasi-debt to firm value ratio) Leverage (quasi-debt to firm value ratio)
Firm-specific Firm value volatility Firm value volatility
Firm-specific Time to maturity Time to maturity /- -
Firm-specific Risk-free interest rate volatility Risk-free interest rate volatility /-
Firm-specific Liquidity Liquidity -
Firm-specific Interaction Terms Leverage ? Time to Maturity /-
Firm-specific Interaction Terms Leverage ? Risk-free interest rate volatility /-
Note and means the variable is
statistically significant at the 1 and 5 level,
respectively.
13Main results policy recommendations
- Indirect sovereign risk is less than 100
- Hence, the sovereign ceiling as defined does
not apply for local-currency bond issues - Corporate default risk is also explained by
relatively higher firm stand-alone risk. This is
due, according to our findings, to - An increase in the firms leverage
- A rise in the volatility of returns on the firm
value - Shorter remaining time to maturity
- Higher risk-free interest rate volatility, when
firms are highly leveraged - However, sovereign risk is still an important
determinant of corporate debt cost! - Scope for policies targeting public sector
solvency
14Annex
South African Corporate spreads I
Basis points
15Annex
South African Corporate spreads II
Basis points