Investors hail the second coming of Latin debt
Latin borrowers are back riding the global liquidity wave and pricing ever-aggressive deals. In the near term, the fate of the region’s borrowers lies in the hands of G7 policy-makers. But in the long term, the crisis may have set off a bull market.
Between the summer of 2008 and spring 2009, the global turmoil pushed Latin external debt into a new territory in credit markets. After years of ever-tighter pricing in absolute terms and relative to developed peers, Latin borrowers were saddled with sky-high risk premiums and vanishing liquidity while primary markets were hostile to lower-rated private firms. Fast forward to the second half of 2009: investors were dancing to the emerging markets beat as the global credit party drummed up new Latin issuance and hammered down credit spreads to pre-crisis levels.
This thaw in the primary market followed a pattern. In the beginning of 2009, sovereigns kicked open the primary market for top-quality Latin issuers by uncorking bottled-up liquidity for the asset class. And then came state-backed firms and blue-chip borrowers.
But only those issuers with well developed yield curves, which provided clear and liquid pricing points for investors, braved primary markets. And wide credit spreads combined with large new issue premiums in the first half of 2009 capped new external bond supply from Latin America’s cash-rich, high quality borrowers.
However, the sea of global liquidity and spirited resurgence of the region’s economic growth prospects boosted pricing levels while borrowers’ ambitions shot up. For example in the fourth quarter of 2009 alone, Latin issuers prised open the doors to long-dated, euro, perpetual and junk issuance with ever-tighter yields.
Brazilian borrowers led the charge, says Chris Gilfond, head of Latin America debt at Citigroup in New York. "Latin credit markets are marching to the Brazilian beat like never before." Brazilian financial issuance came back with a vengeance. Bradesco demonstrated investor appetite for subordinated debt with a $750m tier two bond with a tight 6.75% yield in November. In October, Banco do Brasil attracted a $13bn order book for a perpetual bond to price at a competitive 8.5%. In the same month, Banco BMG joined the subordinated debt party with a $300m tier two bond despite volatile market conditions that week.
As the global economy picked itself up, Latin credit markets broke new records. In October, Brazilian oil firm Petrobras launched the largest ever corporate deal in Latin America with a $4bn issue across 10 and 30 year tranches. Brazil also priced a long 30 year bond with a 5.625% coupon to yield 5.8%, marking the sovereign’s tightest ever coupon. Colombia, Mexico and Brazilian mining firm Vale also followed the liquidity trail for long-dated paper by launching new bonds.
But it was not only high quality borrowers that hit the primary markets in recent months. For example in mid-November, Caribbean telecom provider Columbus International, rated B/B2, priced a $450m 2040 bond to yield 11.5%. The deal attracted $900m from a roughly 50:50 mix of emerging market and dedicated US high yield investors desperate for some yield.
This hunt was exacerbated by the fact Latin spreads were generally trading at tight levels relative to EMEA and many Asian credits. So for many investors, yield dethroned cash to become the new king. The enthusiasm for Columbus, which had little room for manoeuvre with tight liquidity conditions, sharply contrasts the market hostility, in the grip of the downturn, for companies with large near-term debt maturities.
As fiscal and monetary firepower from G7 nations triggers deep global liquidity, Latin sovereign and corporate borrowers are diving into external bond markets. In 2009, around $90bn of Latin bonds were launched — an all-time record — with 40% of the total from sovereigns and 60% corporate, according to Dealogic.
The Latin cross-border debt landscape went back to the future as sovereign bond supply shot up. "It was primarily a sovereign-driven market five years ago, which then became a corporate-driven market two years later," says Andrew Schwendiman, head of Latin American fixed income capital markets at Morgan Stanley in New York. "We now have a healthy balance in supply between the two types of issuers."
Despite strong supply in 2009, the market technicals for the Latin sovereign debt market suggest secondary levels and new issue premiums will be stable if global credit markets remain benign. That’s because cash from redemptions and coupon payments from Latin government paper will total $17.1bn in 2010 while $19.6bn of new issuance is on the cards, say Bank of America Merrill Lynch analysts.
In this forecast, just $2.5bn of fresh cash into the asset class is needed to soak up new supply. This benign supply and demand dynamic will cap all-in funding costs and trigger more sovereigns to come to the markets even if they have ostensibly prefinanced their 2010 fiscal needs, say bankers.
Pent-up financing needs and opportunistic timing by issuers also set off an avalanche of new Latin corporate debt in the last few months of 2009. A record $37bn of emerging market bonds was priced in October. Latin American firms, representing 46% of the volume, printed some $17bn of this total.
Bankers expect a frenzy of front-loaded issuance this year as issuers clinch historically low rates and ample liquidity. "Issuers are looking to lock in lower rates as it continues to be a benign rate environment," says Gilfond. "This dynamic will continue until at least the first half of 2010 and issuance will be substantial."
Despite the record supply in 2009, Latin borrowers may still have been slow to join the global bond party, says Michael Schoen, head of Latin American and CEEMEA debt at Credit Suisse. This may be down to the typically longer registration and compliance process for new bond issuance from emerging markets borrowers — or just inertia.
"It is fair to say issuers have been somewhat slow to take advantage of the current market by prefunding upcoming maturities in 2009 so we will see more issuers doing so in 2010," he says.
The relative value of external bond markets has also jumped as liquidity in regional banking systems and local capital markets has generally not reached pre-crisis levels, says Katia Bouazza, head of debt capital markets for Latin America at HSBC. "I don’t think we will get back to the scenario two years year where the Mexican peso market was significantly competing with the dollar market in terms of size and volume."
As credit markets thawed, Latin issuers were buoyed by the return of the global investor base. Sub-investment grade borrowers such as Digicel relied primarily upon US high yield investors to price new deals. However, the return of a diverse investor base saw borrowers blitz the globe with roadshows in Europe and Asia while offshore private banking investors snapped up Brazilian deals towards the end of the year.
Schwendiman at Morgan Stanley says a captive global investor base will trigger lower quality Latin firms to enter the external bond market in 2010. "There is investor demand for some yield pick-up as US treasuries will remain relatively low while Latin sovereigns will continue to trade tight," he says.
But the 800lb gorilla for Latin debt markets is Mexico’s soaring risk premium. The country’s investment grade rating is in jeopardy as investors raise the alarm over its 2010 budget gap, estimated at 2.8% of GDP. On November 23, Fitch lowered Mexico’s BBB+ rating to BBB, two notches above junk status, due to falling oil production. Markets have priced in a revision of Mexico’s creditworthiness to a weak BBB rating on a stable outlook and expect flat to +2% growth in 2010, say bankers. However, a more malign outcome could trigger a repricing of Mexican corporate credit spreads.
As a general rule, investors demand higher yields from emerging market companies when their home government’s credit rating is cut. However, a large glut of Mexican corporate credit is from companies rated above the sovereign or that generate the majority of their revenues outside the country. This applies to Mexican telecom companies America Movil and Telemex as well as Cemex, the world’s number three cement maker.
State oil monopoly Pemex will be the biggest casualty as the government’s creditworthiness plummets. The company’s rating is chained to the government, reflecting its status as the country’s cashcow. But analysts say the higher borrowing costs will not put the brakes on further global bond issuance from the firm since its high tax burden forces it to fund most capital expenditures with debt.
Instead, it is the corporate borrowers lower down the credit spectrum that will be most affected if Mexico’s rating is further undermined. For example, Moody’s downgraded 17 Mexican financial institutions in October on the back of its reassessments of the government’s ability to provide financial support in the event of a systemic crisis. The downgrades are in line with the government’s own local currency bond rating of Baa1.
In any case, bankers says the resurgence of EM risk appetite and hunt for yield will trigger a divergence between pricing levels and credit ratings for Mexican corporate issuers in the short term at least.