Friday, 14 December 2018

Perfect timing

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Banco Espirito Santo was already a familiar name for equity-linked investors when it approached the market in early 2009, as were the two underlyings for the exchangeables. What marked BES out was its impeccable timing – just weeks after the second issue, the market had closed up. Robert Venes and Owen Wild report.

Banco Espirito Santo visited the equity-linked market twice in the space of a month in early 2009 when the company issued exchangeable bonds into Bradesco and Energias de Portugal. The Portuguese bank had previously attempted similar bonds to maximise value to be gained from its stakes in the other companies, and in 2008 the Bradesco bonds priced while the EDP issue had failed.

In neither of the 2009 deals was disposal intended: both are cash-settled, and the bank simply wished to reduce its cost of funding by using the equity value of the exchangeables.

But the bank could not have known how just well timed the end-March Bradesco issue would turn out to be. The bank was then seen as a strong credit, before the eurozone sovereign crisis took hold and the equity-linked market closed to new issues.

When BES came to market with the US$950m exchangeable bond into Brazilian bank Bradesco it was an opportunistic move. The structure was familiar to many investors as BES had issued the same three-year paper in 2008. The logical plan might have been to wait for those bonds to mature before issuing with the same underlying at maturity, but the strength of demand in the market dragged BES back sooner.

BES/Bradesco combined a prized robust credit with an exotic emerging market underlying, while offering hedge funds further excitement thanks to an embedded play on the spread between Bradesco’s ordinary shares and its ADRs.

BES was at that stage rated Single A by S&P (it became A– on June 1) and for investors that was crucial. At launch the bonds were not expected to be rated, but by pricing the term sheet confirmed a rating would be sought. BES also has liquid three-year CDS that was indicated at 150bp.

Using the same structure as on the 2008 issue, the exchange property is common stock listed in Brazil, but the reference price for the bonds came from the more liquid ADRs. The spread between the ADRs and ordinary shares was reflected in how the reference price was calculated.

The reference price saw the VWAP of the ADRs adjusted to reflect the spread between the closing prices of the ADRs and ordinary stock on March 22, the day before launch. Many funds were particularly attracted to the bonds this time because of the spread trade.

In 2008 the ADRs traded at a premium of 9% over the ordinary shares, but that rose massively to an all-time high of 24% when the bonds were issued, which some investors believed could not last.

The bonds were launched with a fixed premium of 35% and a coupon of 1.25%–1.75%, before pricing at 1.625%.

Comparing the final terms with those achieved in 2008 showed why BES had returned to market. The credit spread had more than doubled from 65bp–70bp to 150bp and volatility assumptions had fallen from the mid-30s to the mid-20s, yet the premium of 35% was only a little below the 37.5% seen in 2008 and the 1.625% coupon was also attractive against 1.25% in 2008.

Credit Agricole, Espirito Santo Investment and Morgan Stanley were joint bookrunners.

Later, BES returned with a €500m five-year exchangeable bond into Portuguese electricity operator EDP on April 21, against a backdrop of widening credit spreads for Greece and Portugal. The deal got away, but only just.

Guidance for the coupon of 2.25%–3% and a fixed premium of 30% ended with pricing at 3%. Bank of America Merrill Lynch, Citigroup,Credit Suisse and Espirito Santo Investment were joint bookrunners on the deal.

Ongoing concerns surrounding sovereign risk led five-year Greek CDS to widen by more than 26bp on the day to close at 484.8bp. The Portuguese sovereign moved 29bp wider in sympathy and five-year protection on BES was 22bp wider on the day, starting off at 245bp and ending the session at 267.49bp.

The next day credit markets blew out and BES pushed 70bp wider to close at 337bp. Investors felt the pain as the new issue dropped to 96 in the aftermarket.

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