UPDATE 2-Peru tests waters with jumbo LM trade

(UPDATES throughout)

NEW YORK, Sept 28 (IFR) - Peru announced a 12-year bond on Wednesday as part of an exchange and tender for US$13bn equivalent of securities, as it looks to reduce its dollar debt and please the rating agencies.

Books on the sol-denominated bond swelled to S10.8bn (US$3.2bn), allowing leads to ratchet in the yield to 6.375%, 25bp tighter than guidance of 6.625% area.

At that level, Peru was offering an approximately 3/8s concession to its local currency debt curve, where its 2026s and 2031s were respectively trading at around 5.87% and 6.19%, a banker told IFR.

The international bond - Peru’s first since former banker Pedro Pablo Kuczynski assumed the presidency in July - continues the country’s longstanding practice of favoring local currency plays over dollar deals.

“This is certainly the largest (liability management transaction) they have ever done,” said Sean Newman, senior portfolio manager at Invesco.

“It will have a positive impact on their vulnerability to currency swings ... and if they get everyone involved it could have a transformative (impact) on ratings.”

Rating agencies have long encouraged the country to de-dollarize its debt stock, and swaps such as these only support the country’s case for an upgrade.

Moody’s already has lifted Peru’s foreign currency rating to A3, but S&P and Fitch still have the country at BBB+ with stable outlooks.

Through the new operation, Peru hopes to extend duration along its local currency curve and rebalance its debt stock to include more sol-denominated bonds.

“They want to stay cash-neutral,” said the banker. “No new money is expected from this trade.”

Holders are being offered the chance to sell back their existing bonds for cash or switch into the new security.

The borrower is targeting sol denominated sovereign bonds maturing in 2017, 2020, 2023 and 2026, as well as dollar bonds maturing in 2019, 2025, 2033 and 2037.

Purchase prices on the tender were set at 104.50, 116.50, 101.20, 118.15, 115.30, 139.15, 161.10 and 140.30.

Dollar investors may like the pick-up to switch to a higher yielding local currency bond, as long as they are comfortable with the medium-term outlook on inflation and rates, say bankers.

“Peru is trading at around 3% in dollars and this is offering 6%,” one investor said. “There is a pick-up, but you will need to manage your FX properly.”

Markets have cheered the market-friendly Kuczynski, who was elected earlier this year amid promises of tax cuts and higher infrastructure spending.

Peru’s central bank has a history of keeping inflation in check, while the sol has steadied around 3.37 against the dollar after hitting recent peak of 3.52 at the height of the commodities rout in February.

“Peruvian rates have rallied a lot since Kuczynski was elected and people like the story,” said another banker.

BBVA, Bank of America Merrill Lynch and HSBC are leads on the transaction. Its local currency ratings are A3/A-/A-. (Reporting by Paul Kilby; Editing by Marc Carnegie)