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Tuesday, 24 October 2017

Reaching new heights

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  • Latin America new issuance volumes

International bond issuance volumes out of Latin America are set to break records this year. Borrowers are returning in droves, tapping everything from core US dollar markets, to perps and local currency plays. Some investors have been calling a peak to the euphoria, but bankers reckon it will continue, albeit at a slower pace. Paul Kilby reports.

It has been a busy year for Latin American issuers. By late September, they placed a little over US$72bn in the international bond market in 2010. According to bankers, there is more on the way as long as the broader sentiment holds. Those volumes have already exceeded last year’s record US$71bn and are comfortably above the US$55.43bn seen during the region last high water mark in 2007.

Latin America has certainly benefited from increased flows toward EM and fixed-income markets in general, as weaker US and European economies lose favour. The continent’s strengthening fundamentals and investors’ love of all things Brazilian have helped draw a crowd in the primary markets. And with secondaries still very illiquid, new issues have been the only way accounts can buy in any size.

Even market pariah Argentina looks set to regain its footing. It successfully completed an exchange reopening that has brought over 90% of holdouts back into the fold, preparing the ground for the sovereign’s first international bond in 10-years.

With conditions so ripe, Argentine corporates and provinces are not waiting for the government to step forward. Some have decided to jump while high beta credits are still the favoured choice among yield-seeking accounts.

However, evidence of some frothiness had clearly come to the fore by late September, after volumes had reached US$15bn for that month alone. Talk of a century bond from Mexico, an overly crowded perp market, suggested the market was reaching its peak, said one investor. This was compounded by more chatter about an unusual Peruvian sol denominated issue from Morgan Stanley.

With long tradition of tapping the market at its tightest, Brazil’s deft US$500m retap of its 2041s was a clear indication that pricing could only widen from here.

Slow off the blocks

In such a low rate environment, it has been surprising how slow Latin American borrowers were to respond to the opportunities post summer. But they soon made up for lost time: they have transacted 24 issues in September alone.

Borrowers have also been starting to diversify outside core dollar markets, with LatAm companies and sovereigns also returning to the euro market. Global local currency issues have also started to make a comeback for the first time since the global financial crisis scared investors away from this relatively illiquid asset class.

The investor base has also widened. Crossover accounts are taking an increasingly larger component of LatAm bond issues, said bankers, as they seek yields away from their own ultra-tight markets.

“We are seeing more crossover participation than ever before,” said one syndicate official. “This is not only from high-grade accounts but also from traditional high-yield investors, who more than ever are taking a serious look at EM deals.”

With perhaps the exception of a name like Caribbean telecom Digicel which has its own special following in the US high-yield market, sub-investment grade LatAm names have typically remained the domain of dedicated accounts. But this is changing as US investors see yields on new issues nearing record lows. LatAm may be one of the tightest regions in the EM universe, but it is certainly benefiting from this phenomenon.

It is a similar story with US high-grade investors as they seek value outside their home turf. While it is not unusual to have US high-grade participation in LatAm deals, interest has typically been focused on sovereigns and corporates with some US exposure. Now bankers are seeing such accounts show an increased interest in names that do not have those US links.

The same is increasingly true of Asian accounts, which are also buying the region’s issues in larger numbers. This is not only true in standard US dollar issues, but in the perp market as well.

Perhaps nowhere have the recent opportunities been as enticing as in the perp market, where if a company had a first mover advantage it could achieve extra tight yields to refinance existing perps. It could also lock in extra cheap funding for perpetuity, with a virtually free call should market conditions improve.

With 24 LatAm borrowers having issued some US$11.7bn in perps during the last wave in this market, it is hardly surprising that they wanted to jump on the bandwagon. They will also have been lured by the success of CSN in September, when it refinanced its 9.5% perp with a tight new issue.

After generating some US$7bn in demand, the Brazilian steelmaker both upsized and tightened its perp to raise US$1bn with a yield and coupon of 7% after starting with guidance of 7.00%-7.25%.

However, by pushing on both price and size, CSN was thought to have threatened the other perp hopefuls in the pipeline after the bond slipped to 98.5 in the secondary.

Opportunity knocks

At 7%, CSN came almost flat, if not tighter, than a new 30-year. It essentially broke the standard rule of thumb that perps should price 75bp–100bp back to a long bond if the borrower is to pay for the privilege of perpetuity and the call option.

But Asian and European retail investors who buy these instruments do not think like the institutional accounts that make such calculations. They are more enthralled with the coupon, especially one that pays 7%, and this certainly helped CSN.

Borrowers and bankers have been quick to seize on this opportunity while it lasts, knowing that the perp market can close just as quickly as it opened. Arguably excessively quick: just before Brazilian construction and engineering firm Odebrecht made a second try in this market post summer, there was considerable scepticism that the market was ready for such instruments, considering the uncertain global backdrop.

But since then the momentum has gained, with Mexican state-owned oil company Pemex quickly following CSN despite the latter’s poor secondary performance.

While Pemex had to sacrifice on size and come at a smaller than expected US$750m, it priced its non-call five par at 6.625%, marking the tightest ever deal of this kind to emerge from the region.

The only exception to this was the step-up structure tried by Brazilian media giant Globo, which essentially kicked off the trend of perp refinancing in April. However, it tried a perp with a step up in year five, allowing it to trade like a shorter bond, hence targeting institutional accounts that don’t typically buy these instruments. Hence Globo’s perp came with an even tighter 6.25% coupon.

Still there was some evidence the perp market was losing steam after Brazilian petrochemical company Braskem tried its luck. It followed Pemex, which had come with a smaller US$450m non-call five that generated some US$2bn, but dipped in the grey after launch and closed lower in the secondaries on the day of pricing at 99.25-99.35. The 7.375% yield and coupon was thought to be just a little too tight.

Retail investors, who have so faithfully supported the perp market, have been parking their money in the fixed-income market ever since they lost faith in equities earlier this year, said one banker. But they could just as easily head for the exits should they decide to follow institutional accounts back into stocks.

The perp market is starting to get too crowded. Not only LatAm issuers, but borrowers from outside the region such as Glencore, are also taking a stab at it. By late September Votorantim Cimentos and BR Properties had joined the throng of borrowers eying the market.

This comes amid complaints in the broader LatAm market that strong technicals have warped pricing on certain credits. This is particularly true of those from the market darling Brazil, which can do no wrong as far as many are concerned these days.

“Technicals are outweighing fundamentals. So we are now seeing pockets of bubbles in different countries like Brazilian steelmakers. I am talking about prices and relative value rather than the fundamentals of the steelmakers,” said one disgruntled investor.

Yet while volumes have certainly exceeded the last pre-crisis issuance boom in the 2006 and 2007, the region has yet to see the diversity of credits and types of instruments seen during that period.

In 2007 investors were also on the hunt for yield. This was reflected in the diversity of credits as well as the frequency of lower-grade names. That year saw some US$26bn of corporate issuance, of which US$8.6bn came from issuers with single B ratings and below, US$6.8bn from BB names and another US$10.24bn from investment grade.

Up until September 2010, corporates had issued some US$49bn of debt, about US$11.5bn from single A and up, about US$25bn from triple B credits, close to US$12bn from double B names and US$5bn.

So far the proportion of Single B credits remains relatively small, though that may partly reflect the region’s improving credit story. Nor has the string of Argentine local currency deals that were commonplace just prior to the global financial crisis been seen again. Taken together, the indications are that the boom in new issuance has yet to reach the frothiness seen in 2007.

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