Close to $30 billion in cross-border bond supply during the first two months of the year left some investors happy that blackout periods and a brief bout of volatility in February had slowed the issuance pace. Yet this turned out to be a brief respite.
By late February bull market trades were once again making an appearance, though one has to wonder where investors will draw the line in regards to risk, particularly the retail accounts that have arguably driven some of these deals.
The buyside still clearly has money to put to work despite investors’ warnings that they shall take a more conservative approach to portfolio construction until there is more clarity on a Volker Rule that is essentially dampening liquidity in the secondary bond market.
Certain portfolio managers say cash reserves will remain relatively high as long as it remains difficult to meet any potential redemptions in the secondary. Outflows are a very real threat as events in Europe still loom large and could trigger a sudden flight to safety.
Others, meanwhile, seem to be casting all cares aside, betting that the worst of the European crisis is behind us. Many have shown little compunction in putting in orders for new issues, at least for stronger names, and have been moving up the curve and lower down the capital structure to generate better returns.
Just look at the $7 billion book on Bradesco’s 10-year Tier II offering or how the $750 million retap of Banco do Brasil’s deeply subordinated Basel III-compliant hybrid perp generated some $4.7 billion in demand.
Technicals are clearly working in borrowers’ favor. Those who had remained sidelined waiting for Europe to sneeze have clearly miscalculated and missed recent rallies. They undoubtedly broke into a cold sweat when they saw issues like Banco do Brasil’s new hybrid perp hit a high of 110.00 after being priced at par in January, and other untouchable sectors like beef make a comeback earlier this year.
The overall strength of the market has many investors making up for lost time before potentially poor returns show up in quarterly results. With the secondary so illiquid, the primary market has become the first port of call for any investor who wants to buy in size and beef up his portfolio.
Appetite for hairier junk credits was put in doubt after Brazilian sugar and ethanol name Grupo Farias and Dominican port terminal Caucedo axed bond plans in early February ahead of key decisions on Greece. But the mood has quickly changed. The City of Buenos Aires held off as well, only to come back a week later to print a five-year bond on the back of some $1.2 billion in demand.
By late February, bull market trades were back in vogue, most notably a hybrid perp from Brazil’s General Shopping. The structure resets coupons to protect investors against interest rate changes, but overall it was thought to be designed to give equity treatment in the eyes of the ratings agencies and help the highly leveraged company avoid a downgrade.
Brazilian utility Energisa was the last Brazilian company to try a hybrid instrument, though that was a senior perp with deferrable coupons rather than a subordinated issue like General Shopping’s.
It was also structured to allow the company to earn equity treatment, but under accounting rules so that it could avoid FX losses. Ultimately, local regulators disallowed the company from using the perp this way, although Energisa has appealed the decision.
Either way, the Energisa perp, although clever in its structure, was not an overwhelming success. The Ba2/BB minus electric company’s ability to defer interest payments left some investors cold and in the end it was only able to generate $300m in demand for the $200m 9.5% bond.
In late February, some bankers were wondering whether General Shopping would also receive a frosty reception, though with whispers at 12%, this deal will clearly turn some heads.
The retail buyer base that typically absorbs the vast majority of the perps out of Latin America is certainly yield hungry, but it may not be as compliant or as fickle as some think. Brazilian airline Gol, which admittedly is working in a tough sector, failed to get its perp off the ground, illustrating that such accounts are not buying blindly. Investors need to put money to work, but the market may not be quite ready for bull market trades. LF