The capital markets have not been friendly to Brazilian issuers over the past year, least of all to the sovereign, which at one point was trading at a spread of more than 2,400 basis points over US treasury bonds. Traders had decided that a victory by leftist presidential candidate Luis Inacio Lula da Silva (Lula) would be tantamount to default. After Lula won and appointed a solid economic team, however, spreads started tightening dramatically, and soon it became clear that the market was, in fact, open for the right issuer at the right price.
Although a couple of banks did issue small, short-dated bonds, it was state-owned oil company Petrobrás that really reopened the international capital markets for Brazilian issuers.
Petrobrás is an innovative borrower: it won an award last year for introducing political risk insurance (PRI) to the Brazilian bond market, which subsequently issued dozens of bonds with PRI attached. And because it is a dollar-generating commercially run company with sizeable revenues outside Brazil, Petrobrás was trading at up to 1,000bp through the sovereign during the height of 2002’s political turmoil. Even so, it was clear when Petrobrás decided to return to the markets at the end of March that the success of the bond would, in large part, reflect the market’s view of the new Workers Party administration, which was now in ultimate charge of the company.
Petrobrás made it easy to see how popular the new government was: in an attempt to develop its own yield curve, it decided to shun offers of doing another PRI bond. Indeed, it had a very ambitious goal: to prove that PRI was completely unnecessary, by pricing unenhanced paper right on top of its PRI curve.
It was Bear Stearns that finally showed Petrobrás what it was looking for: a five-year bond with a three-year put, appealing to both institutional and retail investors within Brazil. The institutions could lock in high yields for five years – in fact, the coupon rises from 9% to 12.375% for the last two years if the paper is not put back to the company. But individual buyers could be assured that they could get their money back after only three years if they so desired.
The reason for the step-up coupon was Brazil’s incredibly steep yield curve. The yield to the put was 9.5%, 190bp inside the Brazilian sovereign, but even after taking into account the step-up coupon, the yield to maturity was 10.5%, fully 380bp through where Brazil was trading.
The deal was a blow-out. The original size of $200 million was doubled after the leads received more than $700 million in orders, mainly from Brazil, although a good 25% of the book came out of Europe. The issue attracted so much demand that not only did the new bond rise sharply in the secondary market, it even helped to reprice the sovereign curve as well.
Petrobrás achieved its aim of pricing on top of its PRI curve, which is a very impressive achievement considering that its PRI-enhanced bonds carry an investment-grade rating and appeal to a totally different investor base to the mainly domestic and retail investors to whom this bond was targeted.
The company also gained sufficient momentum to enable it less than a month later to sign a one-year $335 million revolving credit facility, arranged by HSBC, Barclays and HypoVereinsbank.
Shortly thereafter, Brazil itself came to market, with probably its best-received bond issue in living memory: the order book was closed at more than $7 billion. Despite dozens of pitches for a new benchmark 10-year bond, Brazil decided to follow in Petrobrás’s footsteps, and came with a 2007 issue instead. Once again, Petrobrás had set an impressive precedent.
