Vale Treated Like Junk as Default Risk Reaches 2008 HighsBoris Korby and Juan Pablo Spinetto
Vale SA’s perceived creditworthiness versus its competitors is sinking to the lowest since the financial crisis as swaps traders treat the mining company’s debt as junk on Brazil’s deteriorating finances.
The cost to protect holders of Vale bonds against default for five years has climbed 52 basis points, or 0.52 percentage point, to 236 basis points since touching a four-month low Oct. 16. The contracts are now more expensive than the average for commodity companies globally for the first time since 2008, according to data compiled by Fitch Solutions Inc. Default swaps from Vale, rated A- by Standard & Poor’s, trade in line with those of companies ranked five levels lower at BB.
The world’s biggest iron-ore producer is selling assets and cutting costs to boost margins and as a deadline approaches to settle a $13 billion tax dispute in Brazil. The country’s second-largest overseas issuer is being dragged down by concern the government won’t be able to avoid its first downgrade in over a decade next year, said Fabiano Santin, a fixed-income analyst at Kondor Invest in Sao Paulo.
“It’s more Brazil uncertainty,” Santin said in a telephone interview. “If you want to get out of Vale exposure and can’t at a reasonable price, you buy the credit default swaps. It makes sense.”
A Vale press official, who asked not to be named in line with company policy, declined to comment on the performance of its credit default swaps.
The cost to protect $10 million of Vale debt from non-payment for five years widened yesterday to $236,000, or a record $152,000 more than for London-based Rio Tinto Group, which share’s the company’s A- rating from S&P, according to data provider CMA. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent if a borrower fails to adhere to its debt agreements.
It costs an average $61,000 to insure debt from A- rated companies against default, according to Fitch Solutions, compared to $207,000 for BB rated bonds and $206,000 for companies in Fitch’s global basic resources index, which includes Vale, Rio Tinto and BHP Billiton Ltd., the world’s largest mining company. The three companies dominate the seaborne iron-ore market with a combined 63 percent share, according to Bloomberg Industries data.
Thirty-nine percent of analysts say Brazil will probably or certainly be downgraded after Moody’s Investors Service and S&P cut their outlooks for the country this year, according to a Bloomberg Global Poll published last week, compared with 10 percent who see the country avoiding a credit-rating cut. Fifty-one percent of 750 respondents were pessimistic about President Dilma Rousseff’s policies, compared to 13 percent who were optimistic.
Brazilian government five-year credit-default swaps have surged 94 basis points this year to 203 basis points, according to data compiled by Bloomberg. Brazil’s Finance Ministry declined to comment on the possibility of a rating downgrade.
Vale credit default swaps are more liquid than 97 percent of contracts globally, according to Fitch Solutions, which examines trading volume, bid-offer spreads and other data to rank activity around specific contracts.
“Increased activity is not necessarily negative or positive, but it does signify increased uncertainty about the future direction of the credit,” Diana Allmendinger, a director at the company in New York, said in a telephone interview. “It’s widely accepted that the CDS market gives early warning signals to investors because the market reacts very quickly. But it can be very volatile.”
Brazil’s Superior Court yesterday suspended Vale’s appeal of a 30.5 billion-real ($13.3 billion) government tax claim on its profits from overseas units. The case will probably resume next week, Roberto Duque Estrada, a lawyer for the company, said at the tribunal in Brasilia. That would be after a Nov. 29 deadline for companies to accept a government proposal to settle the case.
Vale posted its first profit jump in more than two years earlier this month as rising purchases from steel mills in China, the biggest metals buyer, follow the company’s cost cuts and asset sales. Still, iron-ore prices are about 30 percent below February 2011 highs.
The performance of Vale’s bonds is similar to other mining companies such as BHP that are suffering from weaker demand growth from buyers including China, said Michael Roche, an emerging-market strategist at Seaport Group LLC.
“It’s underperforming, but the path of its trends are not divorced at all from BHP,” Roche said by telephone from New York. “The cyclical sector is not a favorable one.”
Yields on Vale’s $2.25 billion of 2022 bonds have jumped 1.43 percentage points this year to 4.95 percent, according to data compiled by Bloomberg. The yield on similar BHP notes gained 1.12 percentage points to 3.45 percent in the same span.
Vale has about $15.8 billion of dollar- and euro-denominated bonds outstanding, second only to Petroleo Brasileiro SA among Brazilian corporate issuers, according to data compiled by Bloomberg.
A sovereign credit downgrade will probably prompt rating companies to cut Vale as well, according to Klaus Spielkamp, a fixed-income trader at Bulltick Securities LLC in Miami.
“Brazil isn’t hitting its targets and investors are losing confidence in the government,” Spielkamp said in a telephone interview. “This will only get worse next year. I’m very confident we’ll see a downgrade next year.”