Bloomberg News

BRICs’ Most Dangerous Bonds Enticing Investors: Brazil Credit

October 17, 2012

BRICs' Most Dangerous Bonds Enticing Investors

Petrobras, as the state-controlled oil company Petroleo Brasileiro SA is known, sold $7 billion of notes in the largest-ever Brazilian debt sale on Feb. 1 to help finance $236.5 billion of investments in the five years through 2016. Photographer: Dado Galdieri/Bloomberg

Corporate bonds in Brazil are becoming more vulnerable to losses than any major developing nation as companies exploit record-low borrowing costs to sell the longest-dated overseas debt in three years.

The duration of Brazilian company bonds, a measure of how much prices change as yields rise or fall, which increases with longer maturities, climbed to a 13-month high of 6.12 years on Oct. 12, according to Bank of America Corp. That exceeds the average of 5.18 years for company debt in China and is about 40 percent higher than in Russia and India.

While bond investors turn to Brazil in search of higher returns as the Federal Reserve pledges to keep interest rates near zero into 2015 to bolster growth, a rise in U.S. government bond yields would result in the biggest corporate debt losses of any so-called BRIC nation. Investors have snapped up 30-year securities from companies as varied as Vale SA (VALE3) and Odebrecht SA, helping push the average maturity for Brazilian issues this year to 11.03 years, even as the country is forecast to grow at one- third the pace of the other BRICs.

“There’s so much money coming into the asset class beyond what should be based on fundamentals,” Ray Zucaro, who helps manage about $230 million of emerging market debt at SW Asset Management LLC in Newport Beach, California, said in a telephone interview. “At some point rates will rise again, and there’s so much duration that you’re going to see a lot of price volatility on the longer-dated assets.”

Duration Losses

The prices of longer-maturity bonds are more sensitive to changes in global interest rates than shorter-dated debt, so an equal rise in yields cuts more value from longer-dated notes that pay a larger number of coupons. An investor holding $10 million of Rio de Janeiro-based Vale’s 5.625 percent securities due 2042 would incur a loss of $525,000 if yields climbed to 5.5 percent from 5.16 percent now, data compiled by Bloomberg show.

With the Fed announcing its third round of asset purchases, known as quantitative easing, and the European Central Bank pledging to buy unlimited amounts of government bonds, investors in debt securities have been searching farther afield for returns and taking on more risk.

Money managers have piled $3.2 billion into Brazilian foreign and local currency bonds in 2012, nearly double 2011, according to Cambridge, Massachusetts-based EPFR Global.

That’s pushed down yields on the country’s overseas corporate securities by an average of 83 basis points, or 0.83 percentage points, in the second half of 2012 to 5.16 percent, data compiled by JPMorgan Chase & Co. show.

‘Limitless Demand’

Corporate borrowers have responded by selling a record $31.5 billion of overseas bonds due in 10 years or more in 2012, triple the $9.9 billion of shorter-dated notes that have been issued, data compiled by Bloomberg show.

Company finance chiefs “are taking advantage of low financing costs today that could be temporary,” Alfredo Viegas, the managing director for emerging markets at Knight Capital Group Inc., said in a telephone interview from Greenwich, Connecticut. “This is the first time emerging-market corporate issuers have been welcomed to the long end of the market with almost limitless demand.”

Votorantim Cimentos SA, the cement unit of Brazil’s Grupo Votorantim, sold $500 million more of its 7.25 percent notes due 2041 in February.

“Following its strategy of constant improvement of its capital structure and diversification of funding sources, Votorantim is permanently studying funding alternatives both in the Brazilian market as in the international market,” Votorantim’s press office said in an e-mail statement.

Relative Value

Vale, the world’s largest iron-ore producer, issued $1.5 billion of 30-year notes on Sept. 4 with a 5.625 percent coupon, the lowest ever among similar-maturity Brazilian company bonds.

Odebrecht, Brazil’s largest construction group, raised $1 billion in June by selling debt due in 10 and 30 years. Its $400 million of bonds due 2042 now trade at 115.05 cents on the dollar to yield 6.03 percent.

Petrobras, as the state-controlled oil company Petroleo Brasileiro SA (PETR4) is also known, sold $7 billion of notes in the largest-ever Brazilian debt sale on Feb. 1 to help finance $236.5 billion of investments in the five years through 2016. The $1.25 billion portion of bonds due 2041 traded at 128.17 cents on the dollar to yield 4.9 percent yesterday.

Press officials at Vale, Odebrecht and Petrobras didn’t respond to e-mail requests seeking comment.

Still Protected

“If you’re a treasurer getting 30-year money at these rates, that’s great,” Zucaro said. For investors, “rates are so low that your duration risk is becoming higher and higher.”

The Federal Reserve could raise interest rates if a rebound in U.S. economic growth pushes inflation toward levels higher than what policy makers found acceptable.

Economists surveyed by Bloomberg forecast U.S. growth of 2.1 percent this year will quicken to 2.7 percent in 2014, as inflation accelerates from 2 percent to 2.2 percent in the same period. Policy makers will next raise rates in about mid-2015, trading in overnight index swaps show, in line with the Fed’s pledge.

Corporate bond investors still have some protection against an increase in yields because Brazil’s longer-dated notes are concentrated among the highest quality issuers, according to Shamaila Khan, an emerging-market money manager at Alliance Bernstein LP, which oversees about $418 billion of assets.

Default Swaps

Petrobras is rated BBB by Standard & Poor’s, the second- lowest investment grade and in line with the Brazilian government, while Odebrecht’s bonds are one level lower at BBB-. Vale is two steps higher than the sovereign at A-.

Modified duration for Brazilian overseas government debt is 8.8 years now, almost 45 percent higher than dollar-denominated company bonds, according to Bank of America.

“There’s been more issuance in the longer part of the curve, but these are basically names that have business models that make long-term sense,” Khan said in a telephone interview from New York. “This is probably a better place to be than the sovereigns because there’s shorter dated issuance and on aggregate, maturities aren’t as long.”

The extra yield investors demand to own Brazilian government dollar bonds instead of U.S. Treasuries fell seven basis points to 134 basis points at 2:42 p.m. in Sao Paulo, according to JPMorgan.

The cost of protecting Brazilian bonds against default for five years fell two basis points to 109 basis points. Credit- default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to comply with debt agreements.

‘Underweight Brazil’

The real rose 0.1 percent to 2.0308 per dollar. The yield on the overnight interest-rate futures contract due in January 2014 rose five basis points to 7.44 percent.

Even as the money-printing stimulus measures of central banks around the world pushes bond investors toward riskier assets, the combination of slowing economic growth and a pick-up in inflation makes Brazil, the largest developing economy after China, less attractive, according to SW Asset’s Zucaro.

Brazil’s economy is forecast to grow 1.54 percent this year, slower than China, Russia or India, according to economists estimates compiled by Bloomberg. Annual inflation accelerated to a seven-month high of 5.28 percent in September, more than the nation’s 4.5 percent target.

“If I look at fundamentals in Brazil, I don’t really love them,” Zucaro said. “I’m very underweight Brazil compared to other markets as I don’t think I’m being compensated for the risk.”

To contact the reporters on this story: Boris Korby in New York at bkorby1@bloomberg.net; Drew Benson in New York at abenson9@bloomberg.net

To contact the editors responsible for this story: David Papadopoulos at papadopoulos@bloomberg.net; Michael Tsang at mtsang1@bloomberg.net


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