Copying and distributing are prohibited without permission of the publisher.


Selling the new Brazil overseas

30 Jun 1997

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 possible.
"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 London.
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 Libor.
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 markets.
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 possible.
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 US Treasuries.
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 London.
"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 general downturn.
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 Bunds.
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 right note.
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 launch.
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 their interest.
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 issue.
"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 June.
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 launched.
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 local debt.
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 than Mexico.
"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 launch."
By late June the deal had settled to trade around the 375bp level, compared with a 325bp trading spread on the United Mexican States' 2026s.
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 vindicated.
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 right thing."
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 liquid benchmark."
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 more.
"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)

CurrencyAmt $m
US dollar3,750.000
Italian lira442.759
Dutch gilder206.409
French franc171.821
Austrian schilling164.878
Source: Capital Data Bondware

Top bookrunners - Republic of Brazil bonds
(January 1 1992 to July 15 1997)

RankManagerAmt $mNoShare %
1JP Morgan1,875.00224.19
2Goldman Sachs1,500.00119.36
4Credit Suisse First Boston737.7129.52
5Dresdner Kleinwort Benson713.9319.21
6Deutsche Morgan Grenfell442.7625.71
7SBC Warburg375.0014.84
8ING Barings206.4112.66
11HSBC Markets151.2911.95
13=Banco Comercial Portugues38.8310.50
13=Banco Finantia38.8310.50
Source: Capital Data Bondware

30 Jun 1997