Two years ago in the wake of the Mexican peso crisis, Latin American issuers were unable to raise even short-term debt. Now a Chilean credit has launched the continent's first 100-year bond obtaining the tightest pricing for an emerging market issuer in this niche area. Strong demand for the bonds of electricity generator Endesa pushed up the size of last month's issue from $170 million to $200 million.
But while the Endesa century does provide proof of South America's improving fundamentals, analysts say this and other emerging market centuries were driven more by issuer concerns about image and US investor thirst for blue-chip credits offering above average yields. Only a handful of emerging market issuers have the capability to do 100-year bonds and Endesa was only the seventh company outside the US to tap the sector. Other members of this exclusive club include India's Reliance Industries, Tenega Malaysia and the People's Republic of China. All carry investment grade ratings.
"There is a clear difference between issuers of this quality and other emerging economies," says Brian O'Neill, Latin America managing director for Chase Manhattan, which led the Endesa deal. "Chile is a high-grade investment country and Endesa is a high-grade company that has issued yankee bonds before and has a large investor following with 47,000 shareholders, 9% of whom are non-Chileans."
According to Jerome Booth, head of emerging markets research at ANZ Bank, "a certain amount of fashion is involved with these types of bonds, and the fashion now seems to be for century bonds rather than 30-year bonds."
"Although the trend is definitely moving toward these longer-dated issues, they trade more like shorter-dated bonds. There is little difference in risk or technicalities. For a bond which has a reasonable coupon the longer payment almost becomes irrelevant."
The decision to issue century bonds is certainly influenced by considerations of image and prestige rather than technicalities. A successful 100-year issue is deemed an indication of investor confidence in an economy. For an emerging market eager to establish a firm investor base, this is a considerable attraction.
"The issue will have a halo effect on Endesa and other strong established companies in Chile," says O'Neill. "Investors who have not yet noticed Chile's recent accomplishments will now sit up and take note."
Indeed, some analysts go so far as to say that Endesa and Chile as a whole are both so unique that they have little to do with Latin America and its general perception among investors. But others do regard Endesa's century bonds as a signal of the region's recovery.
After the Mexican currency crisis broke in late 1994, Latin American borrowers had trouble finding anyone to lend them money, even in the short-term. Now investors are scrambling to buy Latin American century bonds. There have been fundamental improvements in these countries' economies, and Mexico's payment of the last part of it's $13.5 billion emergency loan from the US is likely to boost investor confidence further.
However, investors rarely succumb to the vagaries of market trends alone and the Endesa issue performed well on its own merit. At 127 basis points (bp) over the 6.75% US Treasury bonds of 2026, Endesa, (rated A- and Baa1 by Standard and Poor's and Moody's Investors Service) also managed the tightest spread for an emerging market issuer. This compares well alongside other recent issues, with 142 bp for Tenaga Malaysia, rated A+/A-; 299 bp for the People's Republic of China, rated BBB/A3; and 355 bps for the Reliance issue.
The demand for centuries is as much a reflection of the investment climate within the US as the economic conditions in Latin America. Many US investors are convinced the phenomenal returns in US stocks last year are unlikely to be repeated and are looking for alternatives.
On top of this is the growing amount of cash around the world that needs to be invested. This growing liquidity results from falling interest rates in Europe and the expectation of even lower interest rates in Asia.
The advantage of the century bond is that although these bonds offer higher yields than 30-year bonds, priced relative to 30-year US treasuries, the duration is not much greater. The duration of a bond is the time to maturity of all future cash flows weighted at the bond's present value. The greater that duration, the more its price will change when interest-rates shift and therefore the greater the risk of that investment. Century bonds therefore behave almost like 30-year issues when faced with changes in interest rates despite their longer maturity.
These issues are seen as a symbol of prestige and investor confidence in an economy, but the facts do not really bear this out. Investors are not hedging their bets on the fact that the Chilean electricity company will still be thriving in a hundred years time. As far as future cash flows are concerned, the more distant interest payments and the repayment of the principle are of little interest. Investors are most concerned with the earlier interest payments, which are higher than those for 30-year bonds. This means that the duration is similar to the duration for shorter issues.
Another feature of the century bond is its positive convexity. Convexity is the sensitivity of a bond's duration to changes in interest rates. While century bonds outperform 30-year bonds when yields are falling, they do not underperform so markedly in a rising yield environment. This makes them particularly attractive to those with large positions in mortgage-backed securities. Mortgage-backed bonds have negative convexity. Payment patterns mean that they perform less strongly than century bonds when rates are falling and fare worse when rates rise.
As anticipated, placement of the Endesa bonds was predominantly with US institutions, with over 90% of the 100-year tranche sold to a broad range of insurance companies, pension funds, mutual funds and investment advisors. Traditionally, century bonds are of particular interest to pension fund managers to match long-dated liabilities. Catherine Garner