Navigating the new normal
August 2, 2018 |
Just seven trades crossed the tape in the corporate dollar market between May and mid-July. And as bankers navigate the August lull, sources hope their origination work will bear fruit in September
Seven. That is the number of cross-border corporate dollar bond issues between the first week of May through mid-July. Despite a deep pipeline of clients, according to debt capital markets bankers, volatility has dampened issuer appetite to float new debt.
In the first half of the year, 82 international bond issuances from Latin American and Caribbean credits had crossed the tape, raising roughly $67.4 billion, according to Dealogic. At the same point in 2017, 105 deals worth a collective $77.2 billion had priced.
Investment grade corporates such as Pemex and Codelco tapped overseas markets in recent months, as well as Enel Chile, Hunt Oil Peru, Consolidated Energy and Panama’s Tocumen Airport. Frontera Energy, Cemig and Brazilian company Unigel are the only sub-investment grade corporates to tap the primary cross-border dollar bond market since the first week of May.
“We have seen all sorts of signals. But in my view, it is a correction,” says Lisandro Miguens, the head of Latin American debt capital markets at J.P. Morgan. “This year, new issue volumes started strong then faded away with volatility.”
Last year, more than $150 billion worth of bonds were printed in the region, the highest new issue volume seen at least over the last decade. Issuers took advantage of low interest rates to refinance their liabilities, while investors jumped at the chance to increase exposure to emerging markets.
As the markets digest a higher interest rate environment, a new Mexican president and soon, a new leader in Brazil, bond buyers and sellers alike are catching their breath while adjusting to a new normal. Days of lower interest rates and small new issue concessions are fading.
“Institutional investors and dealers were very overweight on Latin America when global market conditions suddenly changed,” adds Miguens. “The fundamentals in Latin American economies are OK and corporate balance sheets are much improved. We need for the technicals to be restored.”
One such technical is bondholder flows. From April through September, Miguens says roughly $50 billion in cash is due back to investors through coupon payments, amortizations and tender offers, while new issuance could be in the $20 billion range.
“Negative new issue volume will restore technicals, and this should ease up some of the market anxiety” he says. “Hopefully, better technicals will restore prices because Latin America still provides good value.”
Some of the recent issues were floated to address the payment schedule. Frontera Energy, a Canadian oil and gas company with Colombian assets, used its $350 million bond sale in June to exchange 2021 papers with newly issued 2023 bonds. The old 2021 bonds, however, came with a 10% coupon, and the new sale in June priced to yield at 10%.
Frontera did not immediately hit the market after completing its roadshow, but when it did, the company did not rope in yield from initial price talk. It also decreased the new issuance from the $500 million it sought during investor meetings.
“Until a few months ago, the primary [new issue] market was attractive and you could put money to work in size,” says Roger Horn, an executive director for emerging markets fixed income sales and trading at SMBC Nikko.
It is important to note that Frontera, formerly Pacific Rubiales, went through a hefty debt restructuring in 2016, and investors are certainly not quick to forget this. The refinancing also covers 2021 debt the company picked up through a debtor-in-possession loan as part of the restructuring, and investors were sure to flag this during meetings with the company over new debt.
In contrast, Empresas CMPC provided an example of one that has opted to wait out the wishy-washy marketplace. In May, the Chilean pulp and paper company completed investor meetings, only to hold off on new issuance because of market volatility. A New York-based banker said at the time a company like CMPC would not be willing to take a 20 basis point or 25 basis point new issue concession.
A little over a year earlier, in March 2017, CMPC sold $500 million in 2027 bonds and only paid 4.375%. “This deal traded through the roof,” the banker, who was not involved in the trade, says about CMPC’s transaction from 2017.
Comparing CMPC (rated Baa3/BBB-/BBB) and Frontera (BB-/B+) may not be fair from a credit ratings standpoint. But their approaches to the market do epitomize the new normal. Companies in today’s marketplace, unless they really need money, are in no rush to print new securities.
“It looks like Frontera was happy to pay a bit more, move on and gain a fresh start [post-restructuring],” Horn says. “Getting free of those constraints allows Frontera a chance to grow.”
The dollar’s ripple effect
Since mid-April’s strengthening of the dollar, investors have flocked to the haven of US Treasury bonds. At one point, the 10-year Treasury bond topped 3% yield, the first time the US benchmark hit this level in roughly four years. The ripple effect of a stronger dollar caused sharp currency depreciations, particularly in Argentina and Brazil, and significant declines in foreign exchange reserves.
“Countries with large current account deficits, high external debt and substantial foreign currency government debt are exposed to the stronger dollar,” says Alastair Wilson, managing director of Moody’s sovereign ratings group.
In addition to CMPC, Peruvian agribusiness Camposol and Paraguay’s Banco Regional also canceled liability management exercises. Potential sales from Telecom Argentina and Usina Coruripe never materialized, and since then, market makers have clustered their efforts into higher-rated credits that are more likely to find favor in a tough new issue space.
“Investors are not going to take a new issue discount,” adds Horn of SMBC Nikko. “And issuers do not want to be perceived as desperate for new money.”
Higher treasury spreads and short-term volatility, or headline risk, is all that is needed to sow doubt into the sell-side. “Management teams are human beings and there is a human element of questioning the rates right now,” says Horn, who points to headlines over a global trade war and uncertainty following elections in the region. “And remember we cannot predict where interest rates are going to go.”
Conversely, fund managers already long on Latin America are balancing opportunities for greater exposure with the options of de-risking from the region’s fixed income securities. Ray Zucaro, CIO at RVX Asset Management, says there is something of a “black cloud” over emerging markets, and believes the region faces deeper uncertainty if the 10-year Treasury bond offers more than 3.5% yield. “Rates of between 2.8% and 3.2%, generally, are priced into EM bond issues,” he says of Treasury levels. “But costs are going up and investors are skittish to add more risk.”
The available buyside liquidity in the market is also constrained. “I do not believe there is a retreat from the asset class, but buyers cannot put too much money to work right now,” says Horn.
J.P. Morgan’s Miguens agrees, saying several accounts buying new issuances are putting in significantly smaller ticket sizes. Fund managers are willing to walk away from deals if the price is not right.
“Investors require a larger new issue premium,” adds Miguens. “The market is afraid to put too much money to work and investors need to reduce how long they are on Latin America,” meaning those investors structurally long in the region can afford to sit on the sidelines throughout some new bond issuances.
Concerns, generally, are based on matters largely out of the control of those in the capital markets, much to the chagrin of several syndicate bankers who spoke to LatinFinance.
“The market correction comes as quantitative easing [still] takes place. Rising yields and a distortion in FX rates pushes the dollar stronger,” adds RVX’s Zucaro. “It is sort of an evolution with monetary cycles unwinding.”
After years of quantitative easing, the European Central Bank is preparing to stop its bond buying program later this year, while a third rate hike from the Fed is expected in 2018.
Generally, when volatility hits, investors are pressured to ensure they make sound decisions on lending to borrowers. While high- grade credits still have market access, the possibility of higher US interest rates can spook investors from committing to lesser-known credits with rare structures or longer maturities, according to Andrew Stanners, a senior portfolio manager at Aberdeen Standard Investments. “Longer maturities are going to have a question mark next to them,” he says.
Miguens describes the marketplace as “unpredictable and sensitive.” But he is confident that Latin American issuers are well-positioned to absorb external macroeconomic shocks. “Fundamentals are going to come around and people will realize that Latin America is more resilient than people think,” he says.
Stanners says volatile moments will pass and potential windows of issuance will open again in the coming months, and he reckons pricing will be favorable enough to warrant investors putting their money to work in Latin America once again.
To highlight the region’s relative value, J.P. Morgan’s Corporate Emerging Markets Bond Index (CEMBI) LatAm high yield corporate index is typically 15 basis points wide of par, but since the onset of volatility, the index is roughly 75bp back, offering a little more for yield-hungry investors.
“Valuations are definitely more attractive, however with the passing of QE and the arrival of quantitative tightening, issuers need to work harder to sustain market access,” adds Stanners.
While new issues have been few and far between, liability management exercises will inject impetus into the docile primary bond issuance market.
Approximately $45 billion in bond debt is maturing next year in Latin America and the Caribbean, followed by some $100 billion in 2022, according to Miguens.
Solid debt management therefore, will become increasingly important. Stanners says issuers would be wise to complete refinancing “sooner rather than later” because the rising size of maturing debt will provide more of a test to the capital markets than in previous years.
“At this stage in the US interest rate cycle, the adage of ‘the early bird catching the worm’ looks like a pretty prudent policy to take,” he adds.
As rates head north, those issuers looking to refinance or exchange existing bond debt may have little choice but to pay a bit more.
And investors willing to tack on the risk of volatility may reap the rewards in extra yield. Whether it is companies with bridge loans or those credits with maturing bond debt, several issuers will have very few options but to tackle the new issue market and give into investor demand for a new issue concession.
“If you have been waiting to invest or need capital, this is the time for higher yields,” RVX’s Zucaro says. LF