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Asia's passion for perps intensifies

15 Sep 2005

Selling Latin American credit in perpetual format to the Asian investor base has been one of the big surprise success stories of the past year. Almost $4bn has been raised by Latin credits from Asia's wealthiest individuals since Pemex's trailblazer. However, some fear for the market's future if interest rates rise quickly, while others worry about whether the investors really know what they are buying. Danielle Robinson reports.

When Pemex placed $1.75bn of perpetual non-call five year bonds with Asian retail investors this time last year, one banker involved in the deal hailed it having "brought a whole new investor spectrum to the emerging markets".

No one really believed him, of course, until now.

Including Pemex's ground-breaker and up until the beginning of September Asia's wealthiest individuals have poured $3.7bn of their savings into six Latin American deals and bombarded lead managers with almost $12bn of orders.

As the summer came to a close three more large perpetuals out of Brazil were in the pipeline for September issuance: a deal from Santander Banespa; another from steel company Gerdau; and one from Odebrecht, a construction company.

"Everyone is being hit up for a mandate," says one head of Latin American origination in New York. "Even if they are barely known, it seems they are getting pitched."

Even sovereigns like Brazil are being urged to tap into the Asian perp market, although some believe the structure too undignified for a government.

Issuers and underwriters have been shocked not only by the amount of money out there, but also by the speed at which Asian retail investors will slap down tens of millions of dollars each on deals. "The perpetual market is being driven by the tremendous savings pool in Asia," says Chris Gilfond, managing director and co-head of Latin debt capital markets at Citigroup. "That's a big nut and it will not disappear over night."

CSN, the Brazilian cement maker, astonished emerging market bankers in July by issuing a blowout $500m perpetual non-call five year, increased from an initial $150m after attracting $2.3bn of orders.

The offering, led by Credit Suisse First Boston and Deutsche Bank, was priced at 9.5%, inside the 9.625% region at which a 30 year CSN bond would theoretically trade, and was ultimately re-opened and taken up to $750m in size.

A desperate search for yield has also driven the buying frenzy, so much so that Asian retail investors are virtually giving the call options away and not asking for the sort of pick-up they should be getting for the maturity extension.

 "There are not a lot of opportunities for retail investors in Asia to buy a piece of paper yielding 9.5%, so it seems as if they are willing to underprice the value of the option and the maturity extension," said a head of Latin American debt capital markets.

Although underwriters claim to have sold some of the bonds to institutional accounts, it is largely a retail game, where investors are less likely to compare the cost of a corporate perpetual to the sovereign curve.

Merrill dominates
Merrill Lynch has dominated the business so far this year. It led the Pemex deal with Citigroup and HSBC; brought Mexican tortilla maker Gruma to market in November last year with a $300m deal priced at 7.75%; and underwrote the $300m tier one perpetual for Brazil's Bradesco in May and Brazilian petrochemical company Braskem's $150m perp in June. With UBS it led a $500m perp for Unibanco in July and has the mandate for the Santander Banespa deal.

Jack Gunn, Merrill's head of Pacific Rim debt new issues based in Tokyo, put two and two together early last year, following discussions with colleagues managing high net worth clients in Asia.

"There has been an enormous accumulation of wealth and liquidity over the last number of years in Asia, driven by strong economic growth in the region and the highest savings rates in the world," he explains.

"There is no indigenous high yield market to speak of in Asia and these investors have been gravitating towards fixed income assets over the last few years because equity performance has been relatively lacklustre in the region."

"We recognised these investors might be willing to extend way out the curve and buy perpetuals in addition to granting aggressive call flexibility to Latin American issuers in exchange for incremental yield," he adds.

The flow of deals has been steady all year.

In May Bradesco became the first speculative grade bank to offer international investors a tier one capital security deal when it priced $300m of a perpetual non-call five year at par to yield 8.875%, almost entirely sold to Asian retail investors. The deal was increased from $200m and priced at 8.875%, inside initial talk of 9%-9.5%.

Braskem, the Brazilian petrochemical company, became the first non-investment grade corporate to place a perpetual non-call five year with Asian retail investors in June, when it priced a $150m deal, increased from $100m and yielding 9.75%, inside its initial talk of 10%-10.25%.

It attracted $750m of demand and came about 9bp-12bp wider than the Brazilian sovereign 2034 global bonds. It soared in the after-market to 102.375 bid and continues to trade well above par.

After Braskem's performance, CSN priced its $500m of perpetual non-call fives in July, increased from $150m and at 9.5%. A week later it sold another $250m at the same yield to soak up some of the excess demand from the original transaction's $2.3bn order book. CSN has also received further reverse inquiry from investors who had been slow to pick up on the original deal, and from those who wanted to fill their initial orders.

Then Unibanco, another Brazilian bank, priced $500m of perpetual non-call fives at 8.7%, in from an 8.75%-9% talk after attracting $2bn of orders.

Scepticism remains
In spite of the strength of demand for the deals, some underwriters which have not participated in the market are still sceptical of its sustainability.

"I think they're crazy," said a managing director at a bank in New York not involved in the Asian retail perpetual market. "It is something that is supported by the view that interest rates are not going to increase so much — the so-called 'Goldilocks global economy'. These are great deals for the issuers, but I'm not sure if the end investors know what they are buying."

Critics point to the 200bp fees on the deals, making the job of selling them simply a matter of offering smaller retail banks in the region fees of up to 1% to take large chunks of the bonds.

"I get the impression that private banks in Asia will sell their mother for a 1% fee, and that is what they're getting by taking these Latin perpetual bonds," says one emerging market banker in New York. "These Asian tickets are huge. Some orders are $120m each and in a lot of cases Asian private banks are putting in orders on spec, figuring that, with a 100bp cushion in fees, they can load up with these bonds and then stuff their retail accounts with it later."

Retail investor is a definition that conjures up memories of the 400,000-odd European individuals who were convinced of the benefits of buying high yielding Argentine bonds in the 1990s.

Asian retail accounts are not your typical Belgian dentist, however. "We're talking about billionaires in some cases," argues one banker familiar with the product. "Some of these investors are the size of US hedge funds, and they are knowledgeable on the perpetual product."

Their knowledge is based on a spate of tier one perpetual capital securities issued by Japanese and European banks in the past few years, deals that banks almost always call.

"I think a lot of these investors have been sold these [Latin perp] deals believing that they too will be called," said one banker not involved in the market.

Yet it is difficult to imagine seasoned issuers in the international capital markets like CSN, Braskem, Bradesco and Unibanco would look at it the same way.

"From an issuer's standpoint, calling in five years would make it a completely stupid deal," said one syndicate head in New York. "It would mean they've really paid up for five year money."

For the issuers, the deals are a great way to lock in long dated debt at prices they would never be able to achieve in the dollar market.

"It is an investor base that is providing them with some features the traditional dollar market would not have," says Carlos Mauleon, managing director in charge of Latin American debt capital markets at Barclays.

"It may be fickle and dry up down the road, but it's something you have to take advantage of now."

Here to stay?
Merrill's Jack Gunn argues Asian demand for high yielding products from Latin America will remain, even if rates rise.

"The dynamics driving this opportunity will remain in place for the foreseeable future: the continued accumulation of wealth and liquidity, and a lack of attractive assets in the fixed income arena," he argues.

With crude oil prices hitting $70 a barrel and commodity prices still strong, investors feel comfortable with arguments that at worst, the Federal Reserve will continue a measured pace of rate hikes.

"Another factor driving the perpetual market in Asia is the search for yield," says Gilfond. "Brazilian perpetuals are trading in the 8.5%-9.0% range in the secondary market, and that is a long way away from a 4% 10 year Treasury yield. We would have to see a very dramatic move in US rates to significantly change risk appetite for this product, and it is hard to anticipate that occurring."

Even if rates do rise and liquidity falls away from the perpetuals, few think there would be any reputation risk on the part of issuers in doing the deals.

"If issuers do not exercise the call [in the fifth year] I don't think there will be a backlash," says Gilfond. "These deals have attractive coupons by historical terms and I think investors will be happy to get these coupons for some time."

While the bid is there, Latin American issuers will be urged to take advantage of it.

"The perpetual market in Asia continues to show a very strong bid for Latin paper," says Gilfond. "I think those investors will be picky in terms of names they will sponsor, but there are a lot of great corporates in Latin America that haven't come to this market, so there is tremendous growth potential." 

15 Sep 2005