Mexico scraps 21 year tranche as investors shun long dated risk
The United Mexican States scrapped the 21 year tranche of its bond issue this week and opted instead to only issue a five year, disheartening Latin American markets by highlighting the divide between prolific US high-grade borrowers and emerging sovereigns deprived of market access for new long-dated paper.
Mexico, rated Baa1/BBB+/BBB+, on Wednesday morning with leads Credit Suisse, Deutsche Bank and HSBC, sought to issue around $1.5bn to $2bn through a five year tranche and a new 21 year benchmark. But when the deal was announced there was a sell-off in Mexican paper as the market re-adjusted to the prospect of new supply.
The adjustment was deeper than expected and disproportionately concentrated at the long-end of the curve. Bankers say on average the short-dated paper widened by around 20bp compared with 30bp for the long-end.
It demonstrated how the market would not be receptive to new supply with longer maturities. But the leads persisted and sent out official pricing guidance of 437.5bp- 450bp over US Treasuries on the 21 year, expected to be around $500m to $750m, and in the 425bp area for the five year notes.
This represents around 65bp concession compared with the 2034s, say rival bankers. But the longer paper only received around $600m of interest with many seeking wider levels. The 21 year was cancelled, though the five year SEC-registered global went ahead.
The $1.5bn 2014 bonds were priced at 99.424 with a 5.875% coupon to yield 6.010%, or 425bp over US Treasuries in line with official pricing guidance. According to bankers on the transaction, the new issue concession represents around 35bp compared with the 2014 benchmark. But some rival bankers say the concession could be in between 50bp to 60bp depending on Wednesday’s trading levels. This compares with the 40bp pickup for Mexico 5.959% 2019 in December that reopened international markets for emerging sovereign issuers. That debt sale had a spread of around 390bp and was widely praised for its canny execution as well as competitive pricing.
In any case, the 2014 deal traded up in the aftermarket up from 99.424 to 99.50 at around 5.93% to 5.99%, comfortably inside the original 6.010% yield. The deal attracted a modest $3.25bn of orders from 200 accounts. Around 55% come from the US, 20% in Europe and 25% to Mexico and Latin America with an overwhelming real money take-up.
One rival banker has described this week’s scraped 21 year tranche as a "significant negative market development", highlighting the lack of demand for long-dated paper and the difficulty in determining market-clearing levels for less straight-forward deals.
A lead on this week’s transaction said: "Obviously we did not like to scrap a deal and in hindsight, the market was not ready to take more Mexican risk being an emerging market issuer."
Another banker on the deal said: "There is a misconception that this 21 year tranche was marketed on a yield or coupon basis but instead it was on a spread basis and in the end given the secondary levels, the concession offer was too small."
But one banker away from the issue said: "Emerging market issues are always seen from a spread basis."
The issuer’s strategy aimed to appeal to investors seeking both short and long-dated paper. A re-tap of its new 2019s was not possible since it was trading below its threshold price so a new issue would have not been fungible. This was also the case for its 2040s. In addition, the $1.5bn bond 2019 was issued only in December and is still being digested by the markets. A 21-year off-the-run bond was chosen since the 2030 maturity date was an easy round number for the issuer and a possible discount of around 95 was mooted to boost the trading prospects of the lower dollar-priced bond.
Rival bankers say demand for the proposed off-the-run benchmark should have been investigated further before the issuer was advised that market access for such a deal was forthcoming. To secure tight pricing, reverse enquiry offers would have been necessary, said one banker, citing investor wariness for new long-dated paper from emerging market names.
Execution and pricing levels are less relevant when "the primary culprit was supply indigestion," said Siobhan Morden, Latin American debt strategist at RBS Greenwich Capital in Connecticut. She said that oversupply of Mexican risk was becoming a problem following the $2bn deal in December and Pemex, the quasi-sovereign oil company, raising $2bn at end-January.
This is a rare misstep in global capital markets for Mexico since it has earned the reputation of being one of the most innovative and investor-savvy sovereign issuers in emerging markets in recent years. The government of president Felipe de Jesús Calderón has embarked on an array of debt buy-backs and yield-curve clean ups to establish a liquid benchmark with a strategic extension in the long-end of the curve.
Mexico last launched a five year bond in April 2003 with a $1.5bn. In any case, the government has successfully fulfilled its 2009 funding requirements and opted to issue now instead of waiting until conditions potentially deteriorate or US Treasuries widen. The country has around $3.2bn of upcoming debt maturities this year and a $1bn to $2bn global bond was expected from the issuer but not so soon.
Mexican credit default swaps have been trading in line and below Brazil this week — a historic first — demonstrating concerns about the country’s strong economic links with the US. In addition, sovereign spreads have widened in recent weeks amid rumours of a possible credit downgrade and the central bank’s recent costly attempts to support the peso.
The issuer paid 30bp in fees — the same for December’s debt sale. This is still relatively low and has disappointed bankers hoping for higher compensation in the choppy environment. Though the scrapped deal has sent shockwaves through Latin markets this week, the fallout for Mexico should be minimal. One banker in New York concluded: "Ultimately, the market will forgive Mexico and forget this unusual episode while investors are still in love with the credit."