When Mexican oil giant Petroleos Mexicanos (Pemex) issued the first Latin American perpetual bond in 2004, Asian investors sat up and took notice. With no fixed maturity date and what was perceived as a high-yielding coupon of 7.75%, the Pemex bond was unprecedented and oversubscribed. Asia's retail and private banking investors, experiencing a national account surplus and an appetite for high-yield instruments, bought out the largest chunk.
Today, these Asian investors are seen as a driving force behind perpetual bond issuance in Latin America. As one Latin American credit strategist describes: "The vast majority of these deals go through the large private networks into individual accounts. That was how this market originated and it is still the largest part."
Gruma, Mexico's leading tortilla maker, issued the country's second perpetual bond in May this year: a $300 million deal rated triple-B. But analysts say that Brazil is increasingly emerging as the show-stopper in this area of debt issuance. In July, Brazilian steelmaker Companhia Siderurgica Nacional (CSN) sold $500 million in 9.50% perpetual bonds. The non-call five-year bond was so oversubscribed that a week later lead manager Credit Suisse First Boston reopened its books to complete a two-part deal totalling $750 million. This marked the largest structure of its kind ever priced, providing CSN with funds at an extraordinarily low cost.
The success of these deals has carved out a number of new Brazilian perpetual issues. Among September's deals were issues from Odebrecht, Brazil's largest construction company, which sold $200 million of 9.625% bonds, and Banespa, the third Brazilian bank to sell perpetual bonds following Unibanco's $250 million issue and Banco Bradesco's $300 million deal. Banespa sold $300 million in junior subordinated perpetual securities to mostly overseas investors. Gerdau, Latin America's largest steelmaker, also sold $600 million of 8.875% perpetual bonds.
To date, more than half of the investment in these deals has come from Asia, and principally Japan. Helene Williamson, head of emerging market debt at F&C Asset Management in London, explains that Asian retail investors, as with other global investors, are seeking to diversify their holdings by investing further into high yield. In Japan, government bonds have teetered around the 1% yield-point for years while short-term interest rates are virtually zero. Long-term rates have not fared much better, remaining just below 2%. "This has pushed many investors to look oversees for high yield," Williamson says.
Diane Vazza, head of global fixed-income research at Standard & Poor's in New York, concurs with this sentiment. "You are looking at yield-starved investors that want some pick-up," she says.
Analysts say that most of the interest for perpetual bonds comes from high-net-worth Japanese investors as they are more willing to take on long-term and less liquid bonds. One emerging market strategist explains: "These investors are not looking at perpetuals as a trading instrument but as a cashflow instrument." He adds that investors are also attracted to perpetuals as a way of diversifying their portfolios. Ricardo Amorim, head of LatAm research for WestLB in New York, says: "The gains that an investor has from diversification means that their aggregate portfolio has a higher return with less risk rather than more." Analysts are also finding that Asian investors prefer these bonds to the US high-yield market as investors receive better coupon payments from Latin American industrials and financial institutions.
Arnab Das, global head of emerging market research and strategy at Dresdner Kleinwort Wasserstein, argues that this shift in interest is related to current micro- and macroeconomic developments in Asia. At present, Asia is a high savings and high growth zone, reflected in trade surpluses, rapid investment growth and capital inflows in various key countries. Despite being large energy importers, countries in Asia are seeing a "bumper balance payment surplus", says Das, with a massive accumulation of foreign exchange reserves. Asian investors are using their substantial financial surpluses to buy longer-dated bonds from Latin American firms, among other products with high return potential. "The macro backdrop in Asia is supportive of buying high-yielding assets," he says. "Like everybody else in the world willing to take more risk to earn a higher premium, the Asians are looking for somewhere to do that."
Another key factor that both Das and S&P's Vazza point out is that a majority of Latin American countries are witnessing their own strong fiscal surplus. Risk appetite has improved from a macro perspective as emerging market default rates continue to stay residually low. "We have seen default rates tumble across the globe in all regions," Vazza says. "In the near term, the credit quality outlook appears to be upbeat."
In September, the Brazilian central bank cut Brazil's base interest rate by 25 basis points to 19.5%. It was the first rate cut after more than a year of a monetary tightening cycle which saw the base rate climb from 16.0% to a peak of 19.75%. Analysts say more rate cuts are likely to come in the next few months. Although the changes are incremental, the news is expected to be encouraging to foreign bond investors, particularly as US rates are on the rise.
There may be another, non-economic explanation for Latin America's appeal to Asian investors: the human element. Sao Paulo has more than 1 million individuals that are either Japanese or of Japanese origin. "This is a major pull," says WestLB's Amorim. Over the past few decades, the close cultural relationship between Brazil and Japan has allowed Asian investors to become more familiar with Brazil's credits compared with other nations in the region.
Latin American strategists also anticipate that due to Asian special interests in the region, greater activity in the perpetual bond market may also come from investors in China, Hong Kong and Singapore. Among the reasons for this are Asia's growing demand for minerals and agricultural commodities from Latin America's resource-rich countries. Also, China continues to experience a demographic migration of its population from rural areas into the cities, bringing with it a decline in agricultural production which will eventually fail to meet consumer demand. As a result, Latin America, an agriculturally rich region could be set to become a key exporter of foodstuffs to Asia.
Closer ties between the regions have led to certain corporates expanding their operations across the Pacific. Last summer, for example, the growing popularity of Mexican food in Asia prompted Gruma to build a $15 million tortilla-making plant in Shanghai. Due to open later this year, the company's first factory in Asia will supply an anticipated $30 million worth of tortillas and chips to restaurants and stores each year.
As sophisticated Asian retail investors aim to diversify their returns through high-yielding perpetual bonds, Latin American corporates and financial institutions are equally reaping the benefits that these funding vehicles can offer. One source familiar with a number of recent Latin American transactions says: "Since so many local companies are dominated and controlled by families, issuing perpetual bonds is a way for the family to get quasi-equity and not dilute themselves or their ownership."
Secondly, the company has the option of paying back the debt at its own discretion. Call options on the debt permit the company to repay the debt at five- or 10-year maturities, but also allow for the company to never call the bond at all. However, at present only well-known Latin American companies have issued perpetual bonds, providing investors with an element of security knowing that the companies will not just default on payment at any time, says WestLB's Amorim.
It may be too early to tell whether the trend for Latin American perpetual bonds is just a fad or here to stay. But Amorim and other emerging market experts are confident that issuance will continue strongly for the moment at least. "I don't expect to see a change in condition in the global financial markets in the coming months," says Amorim.
Another source says that the worst-case scenario is that "there could be an increase in risk aversion based on lower world growth and the higher possibility of a slowdown in the profitability of those companies." But as the bond between Latin American and Asian investors strengthens, the market's future looks rosy.
The week on Risk.net, July 7-13, 2018Receive this by email