LatAm DCM: Frequent issuers eye euro arbitrage

By:
Rob Dwyer
Published on:

Petrobras deal shows swap advantage over dollars; Room for more quality issuers but a limited window

Brazil’s Petrobras shrugged off market concerns about its deteriorating financial leverage and a potential threat of downgrades to attract hefty demand early in January for its $5.1 billion-equivalent international debt capital markets transaction.

Three euro-denominated tranches sold for a combined value of €3.05 billion and a £600 million sterling tranche made the total deal a record for an emerging markets issuer in European currencies, according to data provider Dealogic. The size of demand – orders of around €11 billion were attracted – and the pricing arbitrage that the issuer achieved compared with the all-in-cost of currency conversion highlighted the attractiveness of the European bond market for Latin American issuers.

Brazilian state development bank BNDES followed the oil company to the euro market in the following week and bankers report strong interest from other potential issuers keen to take advantage of the lower benchmark rates in Europe and the improving basis swap.

Petrobras’s record deal consisted of three euro-denominated tranches: €1.5 billion of 2018s priced to yield 2.829%, a €750 million eight-year priced to yield 3.849% and €800 million of 2025s that yielded 4.845%. The deal was rated Baa1/BBB/BBB and was led by Banco do Brasil, BNP Paribas, Bradesco BBI, Crédit Agricole, HSBC, JPMorgan and Mizuho. The pricing demonstrated the credit arbitrage between euros and dollars available to issuers, which, depending on the tenor, can constitute a funding efficiency when compared with the respective dollar curves.

Leandro Miranda, managing director and head of fixed income for Bradesco BBI
Leandro Miranda, managing director and head of fixed income for Bradesco BBI
"When you swap the 2018s’ 2.829 yield it gave you 3.422% in dollars, but when you look at Petrobras’s theoretical dollar curve you are comparing with 4.35%, so there is 93 basis points of arbitrage [at that point in the curve]," says Leandro Miranda, managing director and head of fixed income for Bradesco BBI.

"When you consider the 2021s, the yield of 3.849% was equivalent to 4.91% [after swaps] and the comparison with Petrobras’s theoretical dollar curve was 84 basis points – it’s huge. As you go longer the arbitrage lessens and the 11-year notes’ yield of 4.845% in dollars is equivalent to 6.11% against a theoretical rate of 6.25%, which is just 14 basis points. It still makes sense [at that tenor] but is not as compelling as at the shorter end of the curve."

The credit arbitrage doesn’t exist in the sterling market but the market is liquid between 15 and 25 years and as such offered Petrobras diversity in tenor, as well as further diversifying its investor base.

The following week BNDES sold a €650 million, five-year note to yield 3.783. The Baa2/BBB/BBB transaction was led by Deutsche Bank, JPMorgan and Santander and reportedly raised a book of €1.8 billion. However, according to bankers the size of the books raised by Petrobras and BNDES belies the more restricted size of the euro market.

"The euro-denominated market is less liquid and has less depth than the US dollar market," says Miranda. It is also more conservative, according to Rodrigo Fittipaldi, director of debt capital markets at BNP Paribas in São Paulo. "The euro market is a restricted market – you have to be a quality issuer," he says. "It is going to be very hard [to issue in euros] if you are not rated investment grade by all three agencies."

Despite the stress on credit quality among euro investors, the concerns affecting Petrobras (negative cashflows compounded by subsidizing oil imports, growing debt and a deteriorating leverage position) and the sovereign didn’t materially hurt demand.

"The investors came in despite all the negative news around Brazil, such as the potential downgrade of the country, which would automatically imply a downgrade of a number of companies in Brazil – maybe including Petrobras," says Fittipaldi. "But we have been working with Petrobras for some time and what I can tell you is that the new investors – especially those that made the key orders that make the difference in a book – have a long-term view. And Petrobras and we underwriters were smart enough to announce the trade on a calm day when all the recent negative news had already been digested in the market.

"You should notice that Petrobras’s spreads in euros and dollars had been widening over time and European investors view this spread as already pricing in everything that they should. Everyone understands that Petrobras remains a solid credit."

Market tap

Miranda says Bradesco BBI is in conversation with the top-10 Brazilian issuers – which account for about 70% of international debt capital market issuance – about tapping the market. "We have been talking to them all and they are making their calculations to see if there is an arbitrage for them," he says. "However, most Brazilian issuers do not need international money – they are cash rich – and they have availability locally but they are always looking at the most cost-effective transactions."