Soaring new issue premiums and ever-tightening liquidity will derail Latin American cross-border corporate issuers in the next six months as investors position themselves for a fundamental price correction.
This is the consensus of market participants, who foresee an end to the dizzying outperformance of the region’s borrowers, in a volatile trading week that has forced price-sensitive corporate issuers onto non-deal roadshows.
“There is less urgency to invest in something if you think prices are going to get cheaper – as many investors do,” said Claudia Calich, senior emerging markets portfolio manager at INVESCO in New York.
According to one DCM head: “Latin America from a relative value standpoint is very expensive compared to US domestic debt right now, across all sectors. Pricing for corporate debt has still not adjusted sufficiently.
“New issue premiums in the region will have to rise. Lehman Brothers’ $4bn MTN issue on Tuesday saw a spread of 275bp over US Treasuries. When compared with Mexico’s $1.5bn deal last week that spread 170bp - that just does not make any sense.”.
A US recession will hold borrowers in the region hostage, enforcing new issue premiums ranging from 10bp for the well-known high-grade names to 45bp for the low speculative grades, bankers suggested.
Some leads believe the market has already priced in a 50bp rate cut by the Federal Reserve next week, and are advising borrowers to wait 6 months once the fallout from the crisis in the US leveraged loan market has abated.
“I wouldn’t push new issuers. The next couple of months could get really ugly,” said one bond syndicate head.
Bankers had expected Western portfolio managers to increase their allocations to EM corporate and local-currency assets this year, but thin liquidity is now a real concern.
“Investors in this climate are more likely to stay focused on the sovereign portion of their local currency or global format deals,” said a market participant.
“This asset class is profoundly more liquid than a corporate such as ETB doing a Colombian peso deal. What’s more, even dollar-denominated corporate paper is already illiquid enough, so local currency denominated corporate paper is another story.”
Differentiating sectors
Investors are now actively differentiating EM asset classes and sectors as well as broadening their allocations in order to reduce their risk exposure.
“Market sentiment is very sensitive to what is happening out there in the US,” said Calich. “So we are diversifying our portfolio into different countries and industries because, even if we like a sector very much there is always the risk that if a new issue comes at a cheap concession then the whole sector will re-price.”
These adverse credit conditions could help tighten credit terms, deter highly indebted junk names and reduce market volatility in any flight-to-quality sell-off by shunning out crossover investors.
“This will be healthy in the longer-term for weaker, highly indebted borrowers. When you have poor credits, you have to factor in the possibility that default rates might increase. This has implications for EM local corporate debt as whole, so there may be less problems down the road now.”
Last Friday (11 January), Brazil’s second-largest steelmaker Usiminas sold $400mn of 2018 bonds at 99.127 with a 7.250% coupon to yield 7.375%, 355.6bp over US Treasuries.
The 144a/RegS sale contains a put option that allows investors to sell the bonds back at 101.00 if there is a change of ownership that results in a ratings downgrade as well as a make whole call provision at 50bp over US Treasuries.
JPMorgan and UBS managed the triple–B deal, which matures January 18 2018. It attracted $1bn demand from North America (75%), Europe (20%) and South America (2%). Investors comprised managed funds (45%), banks (43%), insurance companies (10%), and hedge funds (2%).
“We announced the roadshow right after the market opened on Monday (7 January) so unfortunately we were exposed to the volatile equity losses that week,” said a banker involved in the deal. “So this is a bigger new issue premium that Usiminas would have paid in other markets but it is still an all-in attractive price when compared to competing credits.”
“In this difficult climate, you have take opportunities like this from a good credit,” said Calich, who invested in the deal.
But observers say the Usiminas deal does not set a pricing benchmark or hold any clues for non-investment grade credits that hope to test market waters over the next month.
“Usiminas is not representative of the region’s average corporate issuer because they are a good, well-known industrial company with a strong credit profile and the deal size is very manageable,” said a banker involved in the sale. “If we wanted to go for a less modest $1bn, the firm would have had to pay a higher premium,” they said.
Borrowers this week have been alert for a window of opportunity amid huge bank write-downs, volatile equity trading and daily fluctuations in 10-year US Treasuries.
ETB on road in London
Colombian state-owned telephone company ETB, which plans to sell a $300mn peso-denominated global bond, will complete its roadshow in London today (Friday) after postponing the deal in September.
The triple B-/Ba1 corporate via lead mangers Deutsche Bank and Merrill Lynch will await more favourable market conditions next week, according to a market source.
Costa Rica’s largest consumer electronics retailer Grupo M is marketing a potential $150mn - $200 mn 10-year bond, originally scheduled in November. A roadshow for the double B-/Ba3 sale via Merrill Lynch is being quietly organized, market sources say.
Meanwhile, Brazilian bank BicBanco will end its roadshow in Geneva on Monday for a dollar bond (the size is as-yet unspecified) with a 3-5 year tenor, according to people familiar with the matter.
The next few weeks will test the price sensitivity of corporate borrowers in the region, and speculation is rife that only cash-strapped lower rated names will endure the high premiums.
“I am not sure what the leads for the planned Grupo M and ETB deals are thinking,” said one EM bond syndicate head in New York. “Why put them in the market when we have had such a negative two weeks? It is hard to see deals getting done unless the borrowers pay egregious new issue premiums. Maybe these issuers have few alternatives and need the money.”
- According to local news reports, Argentina will issue an unspecified amount of dollar bonds next month in order to meet the sovereign’s $5bn -$7 bn external financing requirements this year. In November, Argentina sold $604m in 8-year Bonar X bonds that yielded 10.43%. The nation’s bonds have rallied this week after Lehman Brothers recommended investors to go long on the Bonar 13, 15 and 17 since these curves are “the most invested in emerging markets.”
Bear Stearns is also overweight the nation’s GDP warrants in pesos and dollars, which by trading at $12 are “materially undervalued at current levels” – compared to their theoretical value of $15.50. Meanwhile, it is reported that the city government of Buenos Aires is preparing a ARP 1.6 bn (equivalent to $510m) bond issue in May. This follows the province of Cordoba’s announcement last week for an international bond sale of $100m - $150 m in the next three months of this year.