Emerging market debt higher on pause in Brazil scandal; PTT, Russian Bank for Development tap market

By Reshmi Basu and Paul A. Harris

New York, July 27 - For the second straight session, emerging market debt showed composure as Brazil regained traction on a pause in the "bribes for votes" scandal.

Fears that president Luiz Inacio Lula da Silva would be implicated in the corruption scandal sparked a sell-off on Monday. High beta names in the region, in particular Ecuador, were hardest hit that day.

However, the market took a less jittery tone following Tuesday's congressional hearing where Lula emerged unscathed, said sources.

During Wednesday's session, emerging market debt moved up, led by Brazil. The Brazil bond due 2040 rose 0.35 to 116.35 bid.

A sellside source said the Brazilian scandal has caused some spread widening, but he added: "The market has to realize how far this can go. I think they haven't priced it in as they should."

"People are going to be looking at those kind of developments and if there is something really negative, it's really going to be quite bad, regardless."

Meanwhile Ecuador stumbled once again after rallying on Tuesday. The Ecuador bond due 2012 dropped a half a point to 97½ bid while the bond due 2030 lost three-quarters of a point to 86 bid. The Venezuela bond due 2027 gained a quarter of a point to 103.45 bid.

Nonetheless, investors should brace themselves for one choppy summer of trading as the corruption story is far from over, said sources.

"The combination of volatility in the corruption scandal in Brazil - one day it looks like Lula will get dragged down, the next day he's safe - and the low trading volumes as we go into the summer doldrums makes for a volatile outlook," said an emerging market analyst.

"Very low U.S. rates should help prop up the market, though. Even after the recent sell-off in USTs, 10Y rates are still just 4.25%, a level which historically has been enough to keep the bid for yield alive," he added.

Meanwhile in the primary market Wednesday, Thailand oil and gas conglomerate PTT PCL priced an upsized offering of $350 million in 30-year bullet notes (A2/BBB+) at 97.281% to yield 160 basis points more than Treasuries.

The deal, increased from $250 million, came in the middle of price guidance. Guidance was set at 155 to 165 basis points over Treasuries.

JP Morgan was the bookrunner for the Rule 144A/Regulation S offering. Bear Stearns & Co. was the joint lead manager.

Proceeds will be used to refinance long-term debt and help finance the company's 2005 through 2009 investment plan, which includes a third pipeline.

And The Russian Bank for Development priced an upsized $170 million issue of three-year loan participation notes (Ba1/BB+) at par on Wednesday to yield 6½%.

The yield came on top of the 6½% area price talk, which had been revised down from 6 5/8% to 6¾%.

Barclays Capital ran the books for the Regulation S-only issue.

The issue was upsized from $150 million.

The Moscow-based financial institution is 100%-owned by the government of the Russian Federation.

Liquidity coming down

Recent gains by dedicated accounts are making investors complacent about lowering exposure, according to a market source. Even with all the amortization payments and coupon payments, liquidity is coming down. And U.S. Treasuries are unlikely to be a driver for further upswings in the asset class, given the belief that U.S. Treasuries have peaked for now, said the source.

Even if Treasuries do rally, the source expects to see more spread widening as emerging markets underperform. A Treasuries rally has more of a productive affect when spreads are relatively wide and when the tone is negative.

A rally in this case may aggravate spread widening in emerging markets. The source is recommending a defensive position.

A sellside source added that there is some liquidity in the market, but he noted that most of it is coming from Asia and Eastern Europe.

"The benchmark for liquidity is when Latin American names come to the market and how well they perform in the after market. But so far we haven't had any transactions," he replied.

Choppy primary market as well

A myriad of economic data in the United States Wednesday showed an upbeat U.S. economy, which will keep rates on the upswing, said the sellside source.

Orders for durable goods were up for the third straight month. U.S. new-home sales surged by 4% in June to a record 1.37 million seasonally adjusted annual rate. And according to the Beige Book, seven of the Federal Reserves 12 district banks said the economy was improving or at a solid pace.

That news helped pushed the yield on the 10-year note to 4.26% from 4.23% late Tuesday.

The sellside source said: "People should rush into the market if they want to lock in low Treasury rates, but that will depend on how the market is doing."

If the primary market is quiet next week, one can expect to see a choppy August, he added.

More Reg S deals

Regulation S deals have been making up much of the already quiet pipeline.

"Some of these deals are only targeted towards non-U.S. investors. The perpetuals that have been coming out from Brazil - all of those are directed towards the retail base in Asia, mostly because of the coupon they pay.

"It doesn't make sense for them to do 144A. That would just undermine the distribution among the investor base that they want.

"These things are not very liquid," he said.

Furthermore, he added that the Asian investment base is playing a bigger part in emerging markets.

"Rates are so low there and they continue to go down - not only in the sense of Japan but in other emerging markets.

"They are playing diversification," said the sellside source, who added that the market will see more Regulation S deals in the future.

The most recent perpetual came from Unibanco SA. The Sao Paolo, Brazil-based bank priced an upsized offering of $500 million in perpetual non-step tier I notes (Ba2) at par to yield 8.70% last Friday. The notes will be callable at par on July 29, 2010.

Merrill Lynch & Co. and UBS Investment Bank were the bookrunners for the Rule 144A/Regulation S transaction.

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