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AmericasMarch 3 2010

Bond boom fires up Latin America

Gerdau steel plant in Brazil: issued a $1.25bn investment grade bond in NovemberWith bank lending drying up last year, many Latin American corporates turned to the bond market to strengthen their cash positions. The resulting boom has instilled a sense of confidence in the region, with firms in Brazil, Mexico and Colombia leading the way. Writer Jason Mitchell
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Bond boom fires up Latin America

Latin America saw a record level of corporate bond issuance in 2009 and the boom is expected to last well into the first half of this year.

Last year, total corporate and financial bond issuance in the Latin America and Caribbean region was about $54bn to $55bn, against $9.6bn in 2008, according to Deutsche Bank. Meanwhile, 2007 was the last record year, with a total of $36.5bn. Deutsche Bank expects overall issuance to drop this year but to remain buoyant, with a total ranging from $40bn to $45bn.

Anne Milne, emerging markets analyst at Deutsche Bank, says issuance picked up significantly in the second half of last year. Two factors in particular have helped to drive this market: first, historically low international interest rates and second, a great deal of liquidity in global markets.

"Corporate bank lending has not really been available and many companies saw the opportunity to issue paper," says Ms Milne. "Many did not necessarily require the capital but saw it as a good opportunity to improve their cash positions. January got the year off to a strong start with total corporate issuance of $6.8bn. During February, corporates have put their issuance on hold in the light of events in some European countries. They do not really need to issue and are seeing what happens next."

Syndicated lending by international banks dried up following the subprime crisis; domestic banks were in a position to lend in some countries - for example, in Brazil and Chile - but could only fill the gap partially.

Brazil

Ms Milne adds that Brazilian corporates were the most important issuers, followed by Mexican and Colombian companies. Good performance in the region in the first half of 2009 and reasonably high returns encouraged North American pension funds and other foreign investors to allocate more and more money to Latin America. She predicts that trend will continue this year.

Juan Cruz, head of Latin America corporate credit research at Barclays Capital, says: "Investors' appetite for Brazilian credit remains strong. It was the first Latin America country to put measures in place to counteract the international financial crisis, to shore up the banking system, and to ensure that its credit markets were not affected.

"Investors have been keen to participate in deals in Brazil: they believe the country has tremendous momentum, a stable, conservative government, and a solid banking system. The spreads are now very tight and it is cheap for corporates to issue paper: they know they can get cheap deals outside Brazil and it is a good opportunity for the companies to work on their yield curves."

He adds that companies realise investors' appetite is there and that they are likely to take advantage of this. The positive outlook for commodities - all-important to a country so rich in natural resources - creates an excellent backdrop for corporates to issue debt.

According to Bloomberg's Bond Radar, Brazilian corporate and financial issuance was significantly up last year at about $21.5bn, against $5.99bn in 2008 and $7.8bn in 2007.

Important deals in Brazil included: a $1bn, high-yield bond by Fibria, one of the world's leading pulp and paper producers, in October (with a coupon of 9.25% and a 10-year tenor); and a $1.25bn investment grade bond by Gerdau, the steelmaker, in November (with a coupon of 7% and a tenor of 10 years).

The Brazilian domestic capital markets picked up towards the end of the year. Traditionally in Brazil, it has been common for banks to fully underwrite debentures on behalf of companies. The banks have held some of the risk and then gradually sold the debentures to local investors over time (unlike the case in other countries where the banks quickly sell the debentures to asset managers and other investors). However, Ms Milne says that last year the banks were more reluctant to add additional risk and have therefore underwritten far fewer corporate debentures. That situation could improve this year.

Mexico

In Mexico, corporate issuance picked up in the fourth quarter. During the first three quarters, investors were concerned about the country's fiscal situation and the likelihood that the country would be downgraded by the credit ratings agencies (in fact, Fitch downgraded the sovereign in November and Standard & Poor's in December). There was no clear yield curve and this was an obstacle to corporate issuance.

Augusto Urmeneta, head of Latin America capital markets at Bank of America Merrill Lynch, says: "The second half of last year was very busy by Mexican standards. During 2009, there were 14 issuances from the country. The local capital markets were challenging, as domestic pension funds were reluctant to take on more risk. However, the international markets were wide open and foreign investors had an appetite for Mexican paper."

Cemex, the giant Mexican cement producer, was able to pull off one of the most important deals to come out of that country last year. It was facing serious financial concerns at the beginning of the year but was able to refinance $15bn in loans, which was essential for the company's future. In December, it was successful in issuing bonds with a total value of $1.25bn, which were oversubscribed. These had a coupon of 9.5% and a tenor of seven years.

Mr Cruz adds: "The recent bond deal should open the door for more capital market issuances, as the company seeks to refinance its remaining loans."

Another important deal from Mexico was a $500m, investment grade bond by Telmex, the Mexican telecommunications company, in November (with a coupon of 5.5% and a tenor of 10 years).

In Mexico, many corporates have been able to hedge the interest and in some cases the principal by putting the US dollar risk back into Mexican pesos. This is particularly true for high-yield companies that have primarily domestic revenues. It involves swapping the US dollar coupon back into a fixed peso rate of interest, which provides more certainty on the future payment amounts. Companies that have recently issued bonds and may have hedged some of the foreign exchange risk include Homex, the home-builder; Sigma, the frozen food producer; Televisa, the TV operator; Telmex, the telecoms group; and NII Capital, the mobile telecoms company.

Colombia

Last year, Colombian corporates entered the international bond market for the first time. In July, Empresas Públicas de Medellín, the water and gas company, issued a $500m crossover bond (with a coupon of 7.625% and a 10-year tenor). And in November, Pacific Rubiales, the Canadian group with oil and gas interests in Colombia, placed a $450m, high-yield final amortising bond (with a coupon of 8.75% and a seven-year tenor).

Analysts expect that there will be more issuance out of Colombia this year, especially in the energy and utilities sectors.

Peru

In the case of Peru, the domestic capital markets have been very liquid and corporates have not had to issue in the international markets. In Colombia and Chile, the domestic markets have also been very active, and corporates from those countries have issued internationally as well.

In November, Banco de Crédito del Perú (BCP), the Peruvian banking giant, issued about $107m in five-year bonds on the Chilean market. It registered to issue up to $300m on the local market and could place the remaining amount this year. The bullet bonds were issued with an interest rate of 3.97%, equivalent to a spread of 143 basis points over the five-year central bank bond.

This type of bond - in which a foreign company issues bonds on the Chilean market - has been dubbed a 'huaso' bond and the BCP deal was the second one of this kind. In April, America Movil, the Mexican telecoms group, became the first foreign company to issue a huaso bond, with a $144.5m deal.

Argentina

In Argentina, two oil companies, YPF and PanAmerican Energy, could be the first to issue international bonds but a lot depends on foreign investors' sentiment towards the country. Currently, Argentina is in talks with the Paris Club of creditor nations about the restructuring of $6.7bn in payment arrears and, furthermore, it has indicated that it would like to reach an agreement with the hold-outs on the $141bn, sovereign debt restructuring of 2005, in March or April this year.

One of the most interesting pan-regional deals took place in September when Arcos Dorados, which runs the McDonald's franchise throughout Latin America, issued a $450m senior benchmark bond (this matures in 2019 at a rate of 7.5%). The company is headquartered in Argentina and this was first Argentine corporate bond sale overseas since Empresa Distribuidora y Comercializadora Norte, the electricity distributor, tapped markets in October 2007. Investors were encouraged by the fact that the company's revenue comes from many countries in the region. Mr Urmeneta says that the Arcos Dorados deal was very well received by investors and that the company could have raised up to $2bn.

cp/76/Booth, Jerome.jpg

Jerome Booth, head of research at Ashmore Investment Management

Market trends

An important feature this year has been the strong level of issuance by quasi- sovereigns - about 35% of all issuance in all emerging markets, according to Deutsche Bank.

Peter Shaw, managing director for financial institutions in Latin America at Fitch Ratings, says: "It is quite common for sovereigns or quasi-sovereigns to come back into the markets first. We have seen that following other financial crises. They set a base line for corporates to be able to enter the markets next."

Overall, bank issuance in Latin America has been pretty low at about 12% of the total, according to Deutsche Bank. That is in line with the proportion in previous years. Brazilian banks tend to issue a higher amount than their counterparts in other countries - top tier banks in the country have been keen to issue perpetual bonds.

For regulatory reasons, a mortgage-backed securities market has not yet developed in a big way in Brazil (overall, mortgage lending in the country remains low, at only 2% as a proportion of gross domestic product [GDP]). Analysts believe there would be a huge opportunity for this market to grow dramatically if the regulatory issues could be resolved.

Last year, one of the most important trends was for crossover funds to invest in the region: traditionally, they invest in high-grade assets in North America and Europe. However, they have been attracted by the higher yields in Latin America and, moreover, some of the Latin America corporates enjoy higher spreads for the same credit ratings of companies in North America and Europe.

Currently, North American pension funds allocate a small proportion (2%) of their overall funds to emerging markets, while the emerging markets now make up some 35% of global GDP and are expected to constitute 50% in 15 years' time.

Jerome Booth, head of research at Ashmore Investment Management, the emerging markets private equity and bond investor, says: "Already on a purchasing-power-parity basis, emerging markets make up 50% of the global economy. That means that US pension funds are about 48% underweight in emerging markets. In the longer term, they must invest much more in emerging markets, including Latin America."

Mr Shaw adds: "North American pension funds only have to increase their allocation to 5% or 6% and we will see huge flows into the emerging markets. Over time, I believe that will happen."

Analysts say that two factors will be key to the level of corporate bond issuance this year: interest rates and exchange rates. They expect international rates to rise gradually during the year, which could slow down corporate issuance. A number of currencies, including the Brazilian real and the Chilean peso, are expected to appreciate even more next year, which will affect a company's decision to issue in local or international markets.

Most of the non-investment grade bonds issued in Latin America have a covenant structure, but they are usually unsecured notes with tenors typically of 10 years, although they could be shorter, for seven or five years.

Mr Cruz says: "All of Latin America will be on fire this year. Spreads are now pretty tight in Brazil and Colombia; Mexico remains attractive. In Peru, there has been virtually no corporate issuance, but that could change next year. Overall, the fundamentals are in place for more corporate issuance next year, unless there is a double-dip global recession."

Mr Urmeneta adds: "We saw a number of first-time issuers in Latin America last year. I would expect them to be more active this year. I also think we will see a number of large corporates in Brazil issue paper this year."

The subprime crisis had one beneficial side-effect in Latin America last year: it led to much lower international interest rates that enabled many firms to issue bonds for the first time and to build up their cash positions. Levels are likely to remain healthy this year, as Latin America becomes one of the world's first regions to recover from the crisis.

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