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Friday, 31 October 2014

Exceeding expectations

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The spike in LatAm new issuance post summer, which saw September become the busiest this year, surprised even the optimists. A recycling of flows into riskier assets after a dearth of supply this year helped buoy LatAm DCM, luring a broader range of investors and borrowers, as well as tightening spreads. But has the market come to far too fast, or will year-end volumes near those seen in 2007? Paul Kilby reports.

It is shaping up to be a great second half for Latin America. In September and early October alone, the region saw close to US$13bn in new DCM supply, not including a US$3bn plus local Reg S issue from Venezuela. That is almost half of the approximately US$28bn in international issuance seen between January and August.

The healthy US$41.6bn sold by October 2 is also more than double the US$20.29bn seen during a lacklustre 2008, when markets began to feel the full brunt of the global financial crisis and liquidity dried up. If momentum triumphs over fatigue, volumes near to the US$55bn seen in 2007 are conceivable.

"We were expecting the market to come back, but not that fast....the credit markets have been positive but I don't see a scenario where we will have a major shutdown, though there will be volatility," said Katia Bouazza, head of global DCM, Latin America at HSBC.

Where few dared to tread

Until recently the composition of LatAm bond borrowers was mostly confined to sovereign, quasi sovereign and blue chip names, as investors sought safety and liquidity in new issues. Just US$6.55bn of the US$20.29bn generated last year came from pure corporate names, the rest coming from governments or state controlled entities such as Pemex and BNDES.

It was the same story earlier on this year: between January and August, US$21bn of the US$28.67bn issued was generated from sovereigns, quasi sovereigns or development banks such as CAF. That has started to change during the summer. Mexican homebuilder Javer (Ba3/BB-) stepped forward in late July with what some considered a rather ambitious five-year international debut, given how investors were naturally wary of anything that smelt of real estate, although Mexico's housing story is very different from the US’.

Javer proved such credits could be sold, but also illustrated some of the pitfalls for names lower down the credit scale, especially for smaller issues. Its status as a privately held company also gave pause to investors worried about transparency. The paper priced at par with a juicy 13% coupon, but slipped on the break and hit as low as 95, though it did bounce back on the back of market rallies post summer.

The deal paved the way for others in August with Brazilian sugar and ethanol concern Cosan (BB-/BB-), Mexican telecom Alestra (B2/B+/BB-) and Mexican petrochemical company Petrotemex (BB/BB+) all coming with five-year issues.

September will probably prove the busiest month this year. Double B corporates continued their march to the capital markets, with Homebuilder Geo (Ba3/BB-/BB-), telecom Axtel (Ba2/BB-/BB-) steel concern CSN (Ba1/BB+/BB+) and Latin American McDonald's franchise operator Arcos Dorados (Ba2/BBB-) all enticing leads, often bringing in guidance as demand grew.

Brazilian bank Bradesco also successfully tested investor appetite for different structures. Its US$750m Tier 2 bond achieved a tight 6.75% yield for what was, after all, subordinated deferrable debt – at least compared with global comps. Its success is likely to encourage other banks to follow suit.

Both corporates and sovereigns were pushing tenors out further, with final maturities moving out to the 10-year mark: Uruguay and Mexico, raised 16 and 31-year money in September, while Brazil created a new 2041 benchmark with record tight pricing. Colombia and others are expected to follow suit.

The post summer rallies were driven by growing faith in a global economic recovery and what had really been a relatively light supply this year, especially from corporates. In the primary market borrowers saw healthy book sizes as crossover investors, including an increasingly large retail component, return to EM after sticking to their home markets for most of the year.

Reviving interest

This year LatAm borrowers have seen a marked broadening in the investor base. Previously the preserve of dedicated EM buyers, it is now seeing interest from local, retail, US institutional crossover and European investors.

With the exception of perhaps Brazil's Odebrecht – which has its own blue chip status despite its BB/BB+ rating – most sub-investment grade issues earlier this year, like Kansas City Southern, JBS USA and Digicel, had to rely on an US component or support from US high-yield investors. But increasing interest from a diverse investor base has seen borrowers make extensive and successful roadshows in Europe – and even Asia. Demand there is re-emerging, though still subdued. Asian investors "don't have a good feeling about the strength of the US dollar as a currency," said Mato. With credit spreads already tight locally, some accounts are looking to pick up yield on some of the better-known household names out of countries like Brazil.

"We are seeing a lot more real-money investors and private banking rather than speculators and fast money, so it is a very solid investor base," said Gerardo Mato, co head of global banking and head of global capital markets, Americas at HSBC. "We are not seeing a lot of padding in orders either as investors look to rebuild portfolios. We are seeing many more accounts participate in deals."

This allowed borrowers to ride pricing tighter earlier September, amid strong rallies in the secondaries. CSN, Axtel, Geo and other borrowers squeezed guidance far beyond initial expectations, and saw strong secondary performance despite tight pricing.

In some cases, new issue premiums have all but vanished, particularly on blue chip credits. Brazilian mining giant Vale (Baa2/BBB+/BBB+) priced a US$1bn 10-year with a 5.625% coupon to yield 5.625%, coming anywhere between 15bp to flat to underlying curve and inside the 6.346% yield on its previous 10-year trade in 2006. Brazil itself priced an upsized US$12.5bn long 30-year bond with a 5.625% coupon to yield 5.8%, marking the sovereign's tightest ever coupon.

"In many cases we have seen spreads improve on pre-Lehman levels. Many top names are tapping to take advantage of low US Treasury yields combined with tight spreads and yields," said Bouazza. She said a blue-chip name like Chilean copper giant Codelco can probably come close to again achieving levels like those seen in 2004 when it issued a US$500m 4.75% 2014 – one of the lowest corporate coupons seen out of the region.

Technicals have worked in the market's favour. Speaking at recent Emerging Markets Traders Association event in New York, David Rolley, a portfolio manager at Loomis Sayles, said investors are switching out of large G4 markets into smaller and less crowded markets. As recessionary worries fade, investors are taking cash off the sidelines and putting it to work in emerging markets. According to fund data company EPFR, US$47bn was pulled out of money market funds during the second week of September alone. EM bond funds recently saw year-to-date flows move into positive territory for the first time since January.

Of course, flows can reverse very quickly. The market was showing signs of fatigue in early October, as some recently issued deals failed to rise above re-offer. This concern is obviously playing on the minds of investors.

But as David Spegel, global head of EM strategy at ING recently pointed out at an EMTA panel, amortisation and coupon payments are still high in emerging markets - some US$164bn in 2010. The recycling of such flows should provide a supportive base for the asset class.

If market sentiment remains positive, the next stage may be a return to Latin American local currency issues. That could appeal to Asian accounts, given their reluctance to take on US dollars, and their interest in currencies that can still provide some upside, said Mato.

Mexican state-owned oil company Pemex ventured into a variety of currencies this year to diversify its funding base and ease pressures on its core dollar market amid high capex needs. It most recently made a rare €1bn 2017 issue, marking its sixth foray this year and reopening a market that has been shut to LatAm corporates for at least two years. With the quasi sovereign pricing at least flat, if not inside, it dollar curve, bankers have been pitching such trades to other potential candidates. It remains to be seen whether the diversification argument or pricing will make sense for all borrowers.

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