Immune to Asian contagion?

  • 01 Mar 1998
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Latin American bond issuers have made a speedy recovery from the Asian meltdown last October, which looked for a while as though it would take all emerging market regions down with it.

Bankers and investors, impressed by the dramatic improvement in the economic fundamentals of many Latin countries over the past three years, are much more prepared to give the region the benefit of the doubt.

In addition, the prudent liability management strategies pursued by the major Latin sovereign borrowers in recent years -- through retiring expensive Brady debt with longer dated Eurobonds, extending their debt maturity profiles, developing full yield curves, accessing new currency markets and debt instruments, and widening the range of investors to which they can sell bonds -- have paid off.

In Europe, as well as in the US and Asia, Latin borrowers have developed a wide pool of capital sources to tap and they have successfully diversified the range of markets they can access -- in bad times as well as good.

The result: the major Latin issuers have been able to return to international financing much more quickly than seemed possible at the height of the Asian-inspired emerging market turmoil at the end of last year.

Argentina has already completed its first quarter funding needs, despite having a daunting borrowing programme for the foreseeable future. Brazil and Colombia have accessed new markets in Europe. And Mexico, the new darling of the emerging market world, has proved that the all-important US institutional investor base is still there for the right name -- without requiring the substantial premium that some bankers feared.

But there is still a way to go. Investors, although more comfortable with handling the volatility that is endemic in emerging market securities markets, are still nervous. Many are still sitting on huge losses and fear further bad news from Asia.

And all issuers are faced with market conditions that are very different from those in 1996 and 1997. Instead of relying on a bullish environment, successful issuers will have to concentrate on promoting their investment stories and ensuring that their debt issuance strategies are responsive to the changing needs and views of investors around the world.

Danielle Robinson reports.

WHAT A DIFFERENCE THREE YEARS CAN make in the international financial markets. At the end of 1994, Latin America sparked a global crash across the emerging market sector as a result of the Mexican currency and liquidity crisis.

Then, Asian nations were quick to claim that they had been unfairly penalised for the problems of a region whose economic fundamentals (they claimed) were far removed from the Asian miracle.

Three years later, the roles were reversed. Asia's currency and stockmarket turmoil caught Latin America in its wake, casting a dark cloud across the emerging market universe as investors ran for cover.

But, just as Asia managed to decouple itself quickly in the minds of bankers and investors from the so-called 'Tequila Crisis' in 1994/95, so Latin America appears to have made a rapid recovery from Asian 'flu -- demonstrating an immunity to the threat of contagion which seemed to pose a major risk just a few months ago.

The change in perception over those three years has been remarkable. Not only were Latin American countries not responsible for the latest crisis to hit the emerging market world; they have also emerged from the meltdown as the favoured investment region in the emerging market universe, returning to the international debt markets in record time.

It has taken just over four months since the Asian crisis struck in late October to wean the crucial US institutional investor base back onto buying emerging market dollar bonds.

But, by the first week of March, Mexico -- whose transformation over those four years from international pariah to the darling of the emerging market world is symbolic of the region's impressive progress during that time -- proved that it could be done.

With its $1bn 10 year global dollar bond issue via Morgan Stanley Dean Witter, Mexico showed that Latin sovereigns could still access the global dollar market -- and without paying a huge premium to secondary market spreads

Other sovereigns have also been able to finance themselves in non-dollar markets, demonstrating the borrowing skill and investor following that they have built up over the past few years.

Argentina demonstrated its mastery of the art of international borrowing by completing its entire first quarter funding needs before the end of February in a variety of currencies, structures and maturities -- even though it is no secret that there are tens of billions of dollars still to come from Argentina.

Brazil -- the worst hit of all Latin countries by the Asian collapse on account of a currency that is widely perceived as being overvalued -- proved it still has access to the international markets by launching a debut Eu500m five year deal in the fast-growing Ecu/euro market.

And Latin American corporates and banks have started to drift back into the markets, with the result that by the first week of March, some $6.6bn had already been raised by Latin American borrowers in international markets through some 23 issues.

Granted, maturities have been significantly shorter than before, with corporates largely sticking to five years and under and sovereigns generally restricted to 10 years and less -- with the exception of a $500m reverse enquiry addition by Argentina to its 30 year global bond in early February.

Overall new debt issuance is well down on the same period last year -- when 36 deals had been executed raising $11bn -- and average spreads for the benchmark Latin sovereign bonds are still anywhere from 30bp to 100bp wider than their pre-October lows.

JP Morgan's LEI index of dollar denominated Latin bonds, for instance, which has an average duration of six years, was trading at 360bp over US Treasuries in early March compared with 240bp at the end of May 1997.

But what has pleased bankers and borrowers most this time around is that Latin American issuers seem able to rebound more quickly every time a crisis strikes the emerging market world.

"It seems like the recovery phase gets shorter and shorter," says Paul Dickson, senior Latin sovereign strategist at Lehman Brothers. "After the Mexico peso crisis of 1994, we saw some spreads widen as much as 2,000bp; after Asia, they moved out by about 800bp in the worst case; and my guess is that the next time the reaction will be less again."

Strong conditions in global fixed income markets and the continued high level of liquidity among institutional investors are two of the main contributing factors for the speedier recovery.

"The reason issuers have been able to come back so quickly was because global conditions are so different from 1994/95," says Joyce Chang, managing director and emerging market debt strategist for Merrill Lynch. "This year we have seen US fixed income markets at all-time tight spreads and the 30 year Treasury bond yield dropping to below 6%."

As in 1995, when the US Treasury came to Mexico's aid, the possibility of sovereign debt defaults as a result of the Asian turmoil has been substantially reduced by the backing provided by the IMF.

Also, Latin America's economic fundamentals stand out as among the best among all emerging market regions -- even though there are some concerns that the Asian crisis will cause the region's average GDP growth to drop from about 5% in 1997 to around 3%-3.5% this year and current account deficits to widen in virtually every major Latin country beyond 3%, except for Brazil.

The prudent liability management strategies pursued by the major Latin sovereign borrowers during the buoyant market conditions of 1996 and 1997 have also played a part in enabling them to return more quickly to the debt markets.

Being veterans in crisis survival, Latin borrowers used much of the record $60bn they raised in 1997 to retire more expensive debt through heavy programmes of Brady bond buy-backs.

At the same time, they used international financing markets to lengthen their debt amortisation profiles, develop solid yield curves in the core dollar sector and establish a stronger presence in other currency markets, particularly in Europe ahead of the introduction of the euro currency.

The reward for pursuing that strategy was seen in the first two months of this year. With the US dollar and Japanese yen markets essentially shut to emerging market names, Latin sovereigns have made the most of their growing reputations among investors in Europe.

Between them they have issued new debt in Deutschmarks, lire, French francs, Dutch guilders, sterling and escudos -- as well as, in the case of Argentina and Brazil, debut deals in Ecu that redenominate into euros.

To the delight of the borrowers, European retail and institutional investors were happy to buy Latin paper priced in line with outstanding spreads in the dollar market -- rather than requiring the 50bp or more premium to secondary market paper that was being demanded by US investors.

But another major factor in Latin America's swift rejuvenation is that, with every crisis, international investors become smarter in the way they trade emerging market debt instruments.

Last year, the record flow of funds into Latin bonds from the widest type and geographical spread of investors possible led some market enthusiasts to claim that the Latin fixed income market was on the verge of becoming a 'developed' market.

The Asian fall-out quickly put paid to that idea. The Latin fixed income market remains as volatile as ever, but investors are -- as result -- becoming more accustomed to its boom/bust cyclical behaviour.

Dickson at Lehman argues that, together with the factors of low bond yields in developed markets and Latin America's improved economic fundamentals, this predictability is giving US and global bond investors the resolve to participate in the roller-coaster ride.

"Each time a crisis hits, people will say: 'I know this. This is temporary and if I keep my head I will make money'," he argues. "Cross-over investors who were burned now understand that. It's a cyclical market. You get in when it's a mess and ride it to tighter spreads and then get out again."

Investors are doubling their efforts in research to be able to predict economic and market trends -- and generally favour Latin America because of the greater transparency and reliability of the region's economic data compared with Asia.

Indeed, the savvier global bond investors and dedicated emerging market players who were burned by the Mexican crisis in 1994 knew exactly when to get in and out in 1997. They were seen selling last summer when spreads were at their tightest -- and buying back in November and December when spreads had ballooned.

As a result the market's behaviour has confounded the predictions of several strategists. While bond analysts were projecting continued strong buying in January, investors like Steve Huber -- who manages about $15.5bn of funds at Aetna's Aeltus Investments -- were predicting slower inflows in January.

"I don't expect a whole lot more spread tightening at the beginning of the year and we won't be buying any more until we see spreads widen a bit more," he said at the end of last year. And so it proved.

In January spreads widened out again to their worst levels in the fourth quarter, mostly because of continued Asian shocks but also because investors like Aeltus -- who had been buying in November and December -- has already positioned themselves in the market and had taken to the sidelines again.

The pattern continued: spreads tightened again dramatically once investors saw IMF rescue packages being put together for certain Asian countries -- and once they were convinced that the spread widening had peaked.

By the end of February, spreads were only about 50bp wider than their pre-crisis lows for the better Latin sovereign credits -- a major factor in encouraging Mexico to launch its global dollar bond.

The increasingly shrewd behaviour being shown by the institutional US investor base is likely to have ramifications for the Latin American new issue market.

While the Mexican deal was praised for proving that there were deep pockets of investor demand for bonds -- and the deal traded steadily around its re-offer price after breaking syndicate -- it did not see the sort of spread tightening and marketing hype that has surrounded Mexican issues in the past.

The general consensus was that only Mexico, the pre-eminent emerging market borrower, could get away with a relatively aggressive deal under the present market conditions.

"You can draw the conclusion that the market is rapidly improving, but it is still far from clear that the new issue market is ready to sustain a deluge of new issuance," says the head of origination at one of the Wall Street firms.

Adds Keith Horn, managing director of debt capital markets at Merrill Lynch: "I don't think at this stage that it is safe to say that this deal has thrown the door right open for a host of sovereigns and corporates to come to the dollar market.

"It gives further credibility to the idea that the markets are seen as having more firmness and stability and that there are significant pockets of investor interest out there willing to participate in the new issue market. I hope this is the precursor to a series of transactions, but I think it is too early to say."

Investors are not frightened about taking a bet on new issues, say bankers; they are simply going to be more demanding at a time when there are still many bargains to be had in the secondary market.

In the case of Mexico, part of the issue's success was down to the perception of scarcity value. Mexico has only $1.5bn to raise this year and the dollar global -- which will almost certainly be its only dollar issue this year -- offered investors the only chance to buy a current coupon bond and take a play on the likely upgrading of the country's sovereign credit later this year.

In that respect, Mexico is an exception. For other borrowers, particularly those with heavy funding needs, investors are likely to strike a harder bargain until the wide spreads available in the secondary market -- for Asian, eastern European and Latin borrowers -- have come down.

"The EMBI [emerging market bond index] is at 490bp. That's almost double what Mexico's new bond at 288bp is offering," says one banker. "A lot of bonds are still trading at very wide spreads and investors are not going to get excited about a new issue unless they think it has value. They're not dumb."

Volatility has dropped significantly from its highs. Volatility on the LEI, for instance, was around 4.23% at the end of February, down from 8.35% in the previous three months and from 12.77% for the previous 12 months -- but still higher than its September 1997 low of 2.97%.

Expectations are for the Latin bond markets to remain volatile while Asian bonds continue to trade wider than Latin instruments -- and until fears of a continued supply of bad news out of Asia subside.

Also weighing on the market is the fact that the potential new issue pipeline is bulging, with about $20bn of issuance to come from Latin America this year and still more from Asian countries, whose sovereign borrowers will -- for the first time -- be competing with Latin sovereigns for the same investor base.

Expectations of continued volatility will only encourage the shorter term trading strategy of some of the biggest US dollar-based investors.

With that in mind, bankers say that many Latin sovereigns and corporates could be asked to pay significant premiums over their secondary market dollar trading spreads in the near term.

"The new issue premium for Argentina, for instance, could still be significantly wider than for Mexico if it came to market right now," says one investment banker in New York. "I would say it is still much more than 25bp, because they have a lot of funding to do and people know that. Investors believe that they can hold issuers hostage."

Adds Paul Tregidgo, managing director of debt capital markets at Credit Suisse First Boston: "The major requirement of a new issue is still the ability to convince the market that it will be a successful one. It is still too early to make a blanket statement that a particular issuer does or does not have to come at a premium."

Despite the important move made by Mexico in reopening the dollar new issue market, the next big sovereign dollar deal will have to be priced to perform -- or risk damaging the hard work done so far.

"What we need now is another bond in the dollar market that performs as well as the Mexican deal," says one Wall Street banker. "This deal opens the door, but whoever comes next has to make sure it does a successful deal. You cannot afford to have a sloppy deal out in the market right now." EW

Latin American bond issuance by currency (March 1, 1997 to date)

CurrencyAmount ($m)Issues
US dollar36,159.426142
Italian lira5,218.07622
Argentine peso825.3303
Dutch guilder449.9432
French franc417.3822
Canadian dollar360.6981
Portuguese escudo305.9915
Austrian schilling249.6632
Spanish peseta138.2651
Swiss franc102.7051
Source: Capital Data Bondware

  • 01 Mar 1998

All International Bonds

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • 24 Oct 2016
1 JPMorgan 317,793.98 1355 8.72%
2 Citi 301,114.13 1092 8.26%
3 Barclays 259,580.63 846 7.12%
4 Bank of America Merrill Lynch 258,842.43 934 7.10%
5 HSBC 224,273.23 905 6.15%

Bookrunners of All Syndicated Loans EMEA

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • 25 Oct 2016
1 JPMorgan 32,854.00 58 6.73%
2 BNP Paribas 31,678.29 142 6.49%
3 UniCredit 31,604.22 138 6.47%
4 HSBC 25,798.87 114 5.29%
5 ING 21,769.65 121 4.46%

Bookrunners of all EMEA ECM Issuance

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • 25 Oct 2016
1 JPMorgan 14,633.71 80 10.23%
2 Goldman Sachs 11,731.14 63 8.20%
3 Morgan Stanley 9,435.23 48 6.60%
4 Bank of America Merrill Lynch 9,229.95 42 6.45%
5 UBS 8,781.68 42 6.14%