Brazil's rehabilitation in the international capital markets
received a major filip last month with the launch of a hugely
successful $3bn 30 year global bond.
Issued in exchange for the country's Brady bonds, the new global
bond had a symbolic significance in signalling the end of the
embarrassing era of rescheduled debt.
But it also proved that Brazil could access the international
markets in size, at the longest maturities available and on the
strength of its pure, uncollateralised sovereign credit.
Until then, Brazil's return to the capital markets had been
chequered - with the country falling victim to a mixture of bad
luck and over-ambition.
But the strategy is now back on track and the Brazilian government
is well placed to start concentrating on liability management in
its widest sense.
Accessing new markets, extending tenors and reducing borrowing
costs will be the three priorities as Brazil sets about broadening
its international investor base and selling the attractions of the
new Brazil as a sovereign credit.
THE YEARS of debt crisis and exile from international financial
markets have left an unwelcome legacy for Brazil in the form of a
universe of restructured bonds.
Like their peers elsewhere in Latin America, government officials
are keen to put that embarrassment behind them as quickly as
"There was a time when the most traded bond for Brazil was the IDU.
Do you know what that means?" asks Gustavo Franco, the central
bank's director of international affairs. "It means interest due
and unpaid. It is terrible to have a bond like this."
While the IDU still has a few more years before it matures, Franco
and the economic team went a long way to alleviating their apparent
embarrassment when in June they launched the republic's $3bn 30
year global bond issue, exchangeable for $2.8bn worth of Brady par,
discount and 'C' bonds.
The deal, led by JP Morgan and Goldman Sachs, was a resounding
success - not simply for the fact that it was triple the intended
size and tightened more than 30bp after launch - but also because
it begins Brazil's long term dream of becoming like any other
ordinary debtor in the international markets.
"This deal weakens the memory of the problems of the past decade,"
says Franco. "Today the only reminder of those (1980s debt crisis)
problems are the Bradys. Some people don't even remember the
problems that caused the Bradys, but we do. All along we have been
telling people that we want to move the liability structure of the
republic towards more conventional instruments."
As importantly, the success of the global bond offering has
rejuvenated Brazil's slightly chequered performance in the
international markets in the past year and proved that the country
is as capable as Argentina and Mexico of executing a blowout long
dated jumbo bond.
"If you look at the run of deals they have done in the past 18
months, the global bond has probably been the best and most
successful deal since the Deutschmark offering back in 1995," says
the head of emerging markets operations at one leading bank in
The Republic of Brazil has raised about $7.4bn internationally
since May 1995, when it broke a 15 year absence in the markets with
a ¥80bn two year Euroyen offering launched at around 425bp over
Unlike Mexico and Argentina, Brazil has been blessed with a
substantial level of reserves since it launched its Real plan and
so has had the luxury of picking and choosing its timing and
Sometimes the country has done so with a flash of brilliance: the
republic's five year DM1bn three year deal in June 1995, for
instance, was among the best deals that year, being priced at less
than 400bp over Bunds and swapping into about 375bp over dollar
Libor - much cheaper than a May 1995 yen deal.
Originally set to raise DM750m, the issue was sold out the
afternoon that it was launched, leading to the increase to DM1bn,
which was quickly sold out again.
Since that promising start, however, some of Brazil's sovereign
bond issues have been complicated by bad market conditions and
over-ambition on the part of the central bank, through which
international bond issuance is executed.
Typical of an emerging market issuer not in need of funds, Brazil
has followed a strategy of diversifying its investor base with a
series of debut transactions in as many currencies as possible and
extending tenors and reducing launch spreads wherever
In three years it has issued a wide range of other currency issues,
including escudos, sterling, Deutschmark, yen, French francs, Dutch
guilders and Austrian schillings.
Most recently the republic launched its first long dated European
bond with its debut transaction in the Italian lira market,
launching a highly successful 20 year bond via Deutsche Morgan
Grenfell that was increased to Lit750bn.
And, in mid-July, the country also revisited the Eurosterling
market with a 10 year deal, raising £150m via BZW and Credit Suisse
First Boston at a spread of 275bp over UK Gilts in a deal whose
reception was marred by the uncertainty sweeping emerging markets
in the wake of the Asian currency turmoil.
The overseas debt issuance programme began with a Esc12bn three
year deal in April last year, followed by a £100m three year
offering in May 1996.
The escudo deal was targeted at the local Portuguese bond investor
and went reasonably well. The sterling deal was considered fairly
priced at the time at 250bp, but the sterling investor base's
tentative approach to emerging market issuers left the deal
vulnerable to widening just after launch on the back of weakness in
Brazil's worst luck was to come a few months later when it finally
decided to go ahead with its debut in the dollar global bond
market. This was something Brazil had wanted to do since 1994 when
it mandated Goldman Sachs to launch a five year global bond, only
to have to shelve the idea for another two years because of the
Mexican peso devaluation.
The idea was to start with a five year global of $750m that it
could increase to a round $1bn+ figure and then follow that up
early in 1997 with a 10 year global bond.
Before launching the deal, however, state-owned oil company
Petrobras was sent out in October to prime the market with a $375m
five and 10 year offering - achieving then unheard of respective
launch spreads of 250bp and 350bp.
The deal was a huge success, prompting the republic to quickly
begin marketing its own $750m five year global bond, mandated to JP
Morgan and SBC Warburg at spreads inside Petrobras.
By the time the bond came to market later that month, however,
investors had abandoned Latin issuers again on fears that the Latin
debt markets had overheated, that spreads were far too tight and
that a severe correction was just around the corner.
"At the end of the day they launched the transaction at 265bp over
Treasuries, which was quite a bit wider than the initially
mentioned spread talk of around 225bp," says Richard Luddington,
head of emerging markets debt syndicate at JP Morgan in
"The decision was whether to wait and see if they could launch in a
more favourable underlying market, or to launch something which was
a message to the international markets that Brazil could access the
global bond market at spreads significantly inside of where
Argentina was trading at the time. At the time of launch it was
about 75bp inside of Mexico's 2001s and 120bp inside of Argentina's
2001s," adds Luddington.
Also, having gone on a global roadshow and having already postponed
its dollar debut once before in 1994 because of bad market
conditions, Brazil was loath to call the deal off - especially
since it considered the 265bp launch spread enough of a concession
to the market.
The deal was savaged by traders going short on the issue and long
on Brazilian Brady bonds as a way of profiting on the market's
The deal widened out to more than 300bp after launch and bankers
warned Brazil that it would have to put off any other dollar bond
ideas until the memory of its five year deal had faded.
While Argentina and Mexico were making the headlines in the first
quarter of 1997 with blowout dollar global bonds, Brazil tactfully
stuck to debuts in other currencies. It started with a successful
DM1bn 10 year deal in February, at the time the longest dated issue
by Brazil in recent memory and done at a tight 230bp over
The issue, led by Credit Suisse First Boston, was well timed and
very strongly received by German retail investors keen to take up
the rare offer of Brazilian bonds.
Brazil then became the first emerging market issuer to launch a
parallel bond in Europe with a $500m+ deal in French francs, Dutch
guilders and Austrian schillings in late April.
For Brazil the parallel bond concept made a lot of sense. Here was
a way to carve another notch in its belt for innovation, but also
to diversify into three new markets in one go.
The five year deal was certainly not a flop, but it was not the
huge success Brazil was hoping for either. It appeared that while
top European issuers could get away with parallel bonds, having a
Latin borrower use the structure did not quite strike quite the
The deal, arranged by ING Barings, consisted of Dfl 400m, Ffr1bn
and Asch2bn of five year 6.625% bonds that redenominate into euros
if and when the single European currency is introduced.
ING Barings was bookrunner on the guilder tranche, Paribas on the
French franc and Creditanstalt on the schilling portion.
Brazil offered an attractive spread relative to government paper in
each market. With spread talk for all three tranches in the 170bp
to 190bp range, Brazil priced the schilling and guilder portions at
173bp over respective government benchmarks and the French franc
tranche at 185bp - the latter requiring a wider spread because it
was a more institutional than retail investor base.
The schilling tranche achieved the greatest success, largely
because Creditanstalt had already led 12 emerging market deals in
schillings and was also able to tap an already well established
German retail base.
The guilder tranche also sold reasonably well, with ING Barings
having sold about 60% of the deal in the first few days after
ING Barings, which has been working hard this year - and with some
success - to make its name as an underwriter for emerging market
sovereigns, did an impressive job of ferreting out a good number of
institutional investors for the offering.
Paribas however, drew the short straw. France is a largely
institutional investor base, given that retail investors can easily
obtain higher yields in neighbouring markets.
Only a handful of those institutional investors dabble in emerging
market securities and few issuers have bothered to try and nurture
Before Brazil the only other Latin American French franc issue was
a poorly received and badly timed Republic of Argentina offering in
December 1994 - just before the Mexican peso collapse.
To Paribas' credit, it unearthed entirely new institutional
investors for Brazil, but the French tranche remained the toughest,
and bankers question how much Brazil really achieved by doing the
"From Brazil's perspective they achieved tight pricing and access
to three new markets," says one banker. "I am just not sure that it
left the right taste in investors' mouths."
All concerns about previous deals were drowned out however, by the
unprecedented success of the 30 year global bond in early
Priced at a very attractive launch spread of 395bp, the bond soared
in the aftermarket, with its spread tightening to a low of 375bp
and its issue price of 93.234 rocketing to 95.50 as soon as it was
Days later the deal was trading even tighter at around 365bp bid
and as intended, the momentum from the deal caused a 20bp spread
tightening across the Brazilian curve.
More than 600 investors came into the 30 year deal and the cash
portion of the offering alone, amounting to 25% of the transaction,
attracted $16bn of orders.
From Brazil's perspective, the offering raised an extra $1.5bn in
international reserves in the form of the cash sales and the $670m
odd of collateral it freed. All of it would be used to pay down
The deal called for holders of the Brazilian par, 'C' and discount
bonds to exchange their paper for the 30 year global bonds. Brady
bondholders could also sell their bonds for cash for up to 25% of
the total amount of Bradys tendered.
A quarter of the deal was also set aside for sale to investors who
did not own Brazilian Bradys. All buyers of the bonds were asked to
put in a bid for a clearing spread for the 30 year global. JP
Morgan and Goldman whittled the $16bn of cash orders down to $750m,
or 25% of the deal.
Around $542m of global bonds were exchanged for the Par bonds,
$1.622bn for discount bonds and $86m for 'C' bonds.
Brazil received bids in the 350bp to 415bp region and at 375bp the
deal was widely considered to offer fair value.
At 375bp the Brazilian 30 year bond would trade about 40bp wider
"It was widely held in the market that our transaction should be
about 20bp to 30bp wider than Mexico's 2026s," explains Franco.
"The pricing also had to add something like an extra 15bp to 20bp
to compensate for the fact that we were accepting Brady bonds at a
price that was slightly below the market price at the time of
By late June the deal had settled to trade around the 375bp level,
compared with a 325bp trading spread on the United Mexican States'
As for the five year global bond, Brazil's argument all along that
it would tighten in considerably from its highs has been more than
In late June the Brazilian 2001s were trading at 152bp, a far cry
from its 265bp launch spread comparing well with 149bp on the
Argentine and the UMS 2001s.
Although the 30 year bond's 395bp launch spread seemed generous,
bankers argue that Brazil did the right thing in leaving something
on the table for investors.
"Of course they probably could have done it tighter," says one
banker. "By looking at it they could determine what clearing spread
they could get for $2bn what at $2.5bn and what at $3bn. Could they
have come at 380bp or 375bp? Yes, but they probably would not have
got $3bn and the risk of getting this large, long dated and
complicated deal successfully at a tighter spread, just to save
10bp or so, was probably not considered worth running. They did the
Size was definitely an important factor. One of Brazil's main aims
in the deal was to take the market's focus off the Brady 'C' Bonds
as Brazil's most liquid sovereign instrument.
"I have seen some market participants thinking that perhaps this
deal would not be so big, and that the 'C' bond would remain the
benchmark at the long end of the curve," said Franco, shortly after
launching the deal. "These people went long the 'C' and short the
new issue and now they're in trouble. There is tension there and it
looks like this new 30 year bond has every condition to be the most
In mid June it was not quite there: the 'C' bond was still more
liquid, but traders said 1iquidity in the 30 year was increasing
and that trades were almost the same amount as 'C' bonds.
That should work in Brazil's faovour: having a clean global bond as
the most liquid benchmark is not just aesthetically pleasing. A far
wider investor base can participate in the global bond market than
in the Brady bond market.
Having a benchmark uncollateralised sovereign issue that is more
liquid than the 'C' bonds should tighten Brazilian spreads at a
faster pace over the long term.
Brazil is keen to continue buying back Brady bonds. Like Mexico,
however, it may decide to do so more discreetly next time - by
launching a straight global bond and using the proceeds to go
quietly into the market and buy back Bradys.
The Brazilian congress has given the green light for the government
to buy back all of its outstanding Brady bond debt if it desires;
while that is hardly likely, Franco is clearly keen to do
"This deal shows there is a fair difference between the way the
market appraises Bradys and globals," he says. "Bradys are
restructured debt and many people cannot even buy them. Globals
have a much greater audience because of their greater simplicity
and their market coupons and yields. If this is so, throughout the
yield curve there is an arbitrage to be gained by retiring Bradys
and replacing them with globals of a similar duration."
The next logical step for Brazil is to issue a 10 or 20 year dollar
global bond to fill in the curve. With the successful lira bond
acting as a 20 year benchmark, having been issued at an equivalent
dollar spread of 340bp over Treasuries, the country is now lacking
a 10 year benchmark in dollars.
Franco would not be drawn on his next step in the international
markets, except to say that a 10 year global bond later this year
was "open to consideration". EW
Republic of Brazil bond issuance
(1/1/92 - 15/7/97, by currency of issue)
|Source: Capital Data
Top bookrunners - Republic of Brazil
(January 1 1992 to July 15 1997)
|Rank||Manager||Amt $m||No||Share %|
|4||Credit Suisse First Boston||737.71||2||9.52|
|5||Dresdner Kleinwort Benson||713.93||1||9.21|
|6||Deutsche Morgan Grenfell||442.76||2||5.71|
|13=||Banco Comercial Portugues||38.83||1||0.50|
|Source: Capital Data Bondware|