Offshore markets dominate Peruvian corporate bond issuances

The market for dollar-denominated Peruvian corporate bonds has grown by a factor of 80 since 2010, swelling from $200m to $16bn by 2014, according to Bloomberg. Demand among foreign investors has surged, propelled by economic growth and the upgrade of the country’s sovereign credit rating over the period. In the local market, after a slow first quarter, the amount of Peruvian corporate bonds issued in the second quarter of 2014 rose by 47% year-on-year, according to BBVA, Peru’s second-largest bank.

In a sign of the market’s growing maturity, JP Morgan noted average yields on offshore Peruvian corporate bonds have fallen 1.87 percentage points since 2009, to 5.31%, making them slightly less attractive to asset managers looking for higher yields. The greater challenge going forward lies in how to address the disparity in the size of the booming foreign Peruvian bond market and that of the still-small local one.

Offshore Appetite

The allure of Peru’s corporate bonds to foreign investors remains clear, with Peruvian securities producing the highest returns among emerging market peers in 2014 – 12% in the first nine months of the year, compared with a global average of 6.5% for emerging markets’ corporate bonds, according to JP Morgan. Seeking to capitalise on low rates and the enthusiasm for Peruvian corporate debt, Transportadora de Gas del Perú sold $850m of notes in 2013 in what was the largest offshore debt issuance ever by a Peruvian company.

This momentum carried through into 2014, with the value of Peruvian corporate bonds issued offshore during the first half of 2014 already equivalent to 64% of the total value for 2013, at $4.08bn. The year saw another significant deal in the $600m bond issuance by Cofide, a state-owned development bank, in July, which Melvin Escudero, CEO of El Dorado Investments, said was offered at very competitive rates. “The problem we face is not a lack of demand for Peruvian corporate bonds, but a lack of product – too few companies are deciding to issue,” he told OBG.

Local Bonds

In the local debt capital market, financial services accounted for the majority of bond issuances in the first half of 2014. Nevertheless, other sectors have also continued to issue debt, with Cineplex, Edelnor and Luz del Sur each placing bonds of around PEN100m ($35.7m), with maturities ranging from seven to 10 years at rates of 6-8%.

A major milestone was reached when Brazilian conglomerate Odebrecht issued $520m in senior secured bonds in June 2014 to partly finance its 30-year Rutas de Lima concession – representing the largest local currency bond offering in Peru to date. The bonds were issued under the US’ Rule 144A and Regulation S (as opposed to being issued as a local bond) and comprised a global soles tranche and a second tranche in inflation-indexed soles. Christian Laub, president of the Lima Stock Exchange and CEO of Credicorp Capital, told OBG it was significant that “these bonds were fully absorbed by local demand, demonstrating that the necessary demand does exist in the local market to be able to finance large-scale projects”.

Market Dynamics

The segmented nature of local companies is key to understanding the dynamics of the bond market. “Just like anywhere else in the world, Peru has some very large companies, medium companies and small ones. The very large ones – predominantly found in the infrastructure, energy, mining, telecommunications and mass retail sectors – issue bonds both in the local market and, increasingly since 2012, offshore,” said Escudero. These companies find it easy to issue bonds abroad, where they have found strong appetite for Peruvian corporate debt.

In Escudero’s view, more Peruvian companies do not issue bonds locally because the local market lacks players with the necessary scale to absorb bonds of the size these companies issue offshore. “Although private pension fund administrators, insurance companies and mutual funds can absorb a bond of $200m, the issue is that together they represent a group of between six and 12 institutional investors that could buy such bonds. Many issuers of bonds seek greater diversity in the range of investors that will hold their debt, which leads them to issue offshore,” he explained.

“The lack of liquidity in the local Peruvian bond market is partly because many of the investors in Peruvian corporate bonds follow a buy-and-hold strategy, rendering the secondary bond market very illiquid,” Roberto Flores, head of strategy and economic research at Inteligo, a stock brokerage owned by Grupo Interbank, told OBG. “Therefore, as in the rest of the capital markets, we need to implement mechanisms to stimulate greater liquidity in the bond market, perhaps drawing lessons from Colombia’s experience in this field, as their markets are more liquid than Peru’s.”

In spite of these obstacles, recent years have seen a steady increase in the local demand for corporate bonds in Peru. “The growth of the local asset management industry, as well as inflows into pension funds, have been the principal factors driving local demand for bonds,” Alejandro Rabanal, head of equity research at Credicorp Capital, told OBG.

Going Local

Despite rising domestic demand, Peru has not seen matching levels of local issuance. “As in the case of the equity capital markets, many companies looking to issue bonds since 2012 have preferred to go straight to the international markets to do so,” Flores told OBG. “It is logical at a time when interest rates in dollars are as low as they are now that companies should prefer to issue debt in dollars. However, this looks set to change soon, so the government should take advantage of this to encourage more companies to issue bonds in soles going forward.”

“Some large companies issue debt both locally and offshore,” Escudero told OBG. “Which route they go down will often depend on the size of the bond, with bonds under $200m being deemed too small to be worth the extra cost involved in issuing them abroad. As for medium companies, we find that they have grown accustomed to dealing with the banking sector. For them, obtaining a loan from a bank is simpler, less tedious and quicker than issuing a bond,” he explained. As such, until these companies become larger, they may be unlikely to issue bonds.

While a bond could typically prove a cheaper source of finance for some medium-sized companies than what they get from their bank, the current highly liquid state of the Peruvian banking sector means that banks have been able to offer corporate loans at highly competitive rates, reducing the potential savings that companies could achieve by issuing bonds.

However, more Peruvian firms could begin to issue bonds locally as their ambitions grow. “The capital markets offer companies significant benefits beyond just a potentially lower cost of finance, such as access to a wider range of financing options and greater flexibility in these companies’ relationships with their banks. Therefore companies will naturally turn to them once they are prepared to shoulder the responsibilities that such a move implies – such as making their accounts public and putting in place appropriate corporate governance structures,” Laub told OBG.

Regulatory Brainstorming

To encourage local issuance, it has been suggested that all companies be obliged to submit their audited financial results to the Peruvian securities regulator, the Superintendence of the Securities Market (Superintendencia del Mercados de Valores, SMV). This requirement was introduced solely for large corporations in 2012 and was initially met with some resistance. Extending the requirement to more companies would ease perceptions of the additional reporting burden faced when deciding whether to issue bonds, as all companies would be required to comply with said reporting standards regardless of issuance. While this idea is not in line with official SMV policy at present, it at least indicates that regulators are looking for creative ways to encourage the growth of the local bond market.

Authorities in Peru are already working on easing the regulatory burden associated with issuing bonds locally – which Escudero views as a prime strategy for encouraging the market – by trying to make bond issuance more of an electronic process, thereby reducing the amount of paperwork involved.

Potential For Private Markets

The government and regulators could go a step further to encourage more companies to issue debt locally by setting up a private bond market in the country. “This would allow the companies issuing debt to interact directly with qualified investors, much in the same way that banks deal with their clients,” Escudero told OBG.

Laub, however, believes this is more of a long-term aspiration than a realistic prospect for the short run. Private markets in Peru, as in the rest of Latin America, are still at the very early stages of development. “With time though, and the development of the necessary infrastructure, such as credit rating agencies and broker-dealers specialising in fixed income, we will see this area grow,” Escudero told OBG. “Indeed, I expect private markets to be the next big story in Latin American finance over the coming 20 years.” For the time being, there is still a lot of growing up to do.