Moody's shocked bond investors this week with a surprise two-notch downgrade that put Brazilian oil company Petrobras in junk territory. The move was seen by some investors as overly assertive, leaving them to add exposure incrementally.
"It was aggressive," said Jack Deino, head of emerging market portfolio management and senior portfolio manager at Invesco. "It just reflects the rating agencies' proclivity to shoot from the hip. Ever since the global financial crisis, they have been clamped down on and now they seem trigger-happy."
In late January, Moody's demoted the company to Baa3 from Baa2, warning more ratings actions were on the horizon if the company failed to release audited results. It stuck to its word, exceeding expectation with a cut to Ba2 late on Tuesday.
So far, the massive wave of forced selling out of high-grade account portfolios has yet to truly transpire. Bonds tumbled in response to the Moody's rating cut, but not as dramatically as some had thought was likely.
Spreads on the company's benchmark 6.25% 2024s widened about 40bp during the two days following the announcement to reach a wide of around 572bp before tightening back to 570bp, still south of the recent 609bp peak seen in early February when Fitch placed the company a notch above junk at BBB- with a negative outlook.
The coming month could see some further spread-widening as JP Morgan prepares to disqualify some US$42.5bn of Petrobras's US$55.7bn bond debt from its US Liquid Index (JULI) on March 2. Bank of America Merrill Lynch will do the same next month on its US dollar high-grade benchmark index C0A0.
Rules governing Barclays high-grade maintain Petrobras's current standing - but would exclude it if another ratings agency were to demote it to junk. That agency could be Fitch, given the negative outlook on its BBB- rating.
S&P has a stable outlook and considers strong government support when assessing its BBB- rating. It has already lowered its standalone credit to BB from BBB- and said that would have to drop to B to impact on the broader rating.
"I think there will be another downgrade by another agency but not immediately," said Jorge Piedrahita, CEO of brokerage Torino Capital. "I think prices are reflecting that scenario."
A kick-back scandal has left the state-controlled entity delaying the release of audited results as it struggles to calculate the size of writedowns associated with the corruption, but some accounts felt the Moody's timeline for action made little sense.
"We have an issue when Moody's gave an arbitrary deadline when the company still had some time to release the financials," said another US-based investor.
While the SEC requires audited results to be filed by April 30, the ultimate cut-off date to avoid breaching bond covenants would be June 30, she said.
"That is when the 60-day grace period with bondholders ends and they will need a waiver with 50% plus one for each series of bonds," she said.
Fitch has essentially given Petrobras similar leeway before it acts.
However, the company may not have until then before it faces challenges from bondholders.
Hedge fund Aurelius Capital has already said that the company's failure to publicly release write-off information is a violation of IFRS rules, and Deutsche Bank in a recent presentation warned that subsequent litigation could start as soon as March.
Talk of a consent solicitation has been bounced around, say bankers, in case bondholder talks are required. However, compared to negotiations with a handful of banks in the loan market or with regulators - groups that are expected to be relatively flexible - corralling investors holding some US$55.7bn in outstanding bonds will prove complicated.
"The company will do whatever it can to not pass the April 30 deadlines, but with such a large amount of debt they must look at a plan B, C and D to be ready," said a senior banker in Sao Paulo. "They may consider a consent solicitation to buy some time but there is nothing concrete."
Still, some investors were adding exposure to the name in the wake of last week's sell-off partly on the assumption that many investors constrained by ratings have already been flushed out or simply can switch the credit to their high-yield portfolio should another ratings agency act.
Deino expects the belly of the Petrobras curve
to eventually tighten back to the 400bp-450bp area currently seen on similarly rated Latin American Ba2 credits, but foresees more price volatility on the horizon.
"There is a modicum of crossover money that didn't expect the situation to deteriorate so quickly and they could exert further technical pressures," he said. "It is not a problem Petrobras can solve overnight, but there will be some good opportunities to add."
EM accounts are also adding given their underweight position and the credit's relatively large standing on JP Morgan's corporate emerging market bond index, the CEMBI broad index.
"If Petrobras is downgraded a second time, there will be a sell-off from high-grade accounts in the near term," said a EM-dedicated investor. "But like Cemex, it will eventually become a big play for US high-yield."
(Reporting By Paul Kilby; additional reporting by Davide Scigliuzzo; Editing by Matthew Davies)