LatAm looks for growth amid easy borrowing conditions
US rate cuts were, admittedly, the driver behind the Latin American international bond market’s return to form in 2019. Although regional growth remains disappointing, there are encouraging technical and fundamental signs to be found
At first glance, Latin American bond markets enjoyed a healthy recovery in 2019. Despite minimal supply from Argentina (see box) and Venezuela being out of bounds, new issue bond volumes were up, and investors enjoyed far improved returns. Yet Latin America itself can hardly take the credit.
“We did not expect such a good year for LatAm bonds in terms of volumes, but this is mostly a result of the US Federal Reserve cutting rates,” says Cristina Schulman, head of Latin America DCM at Santander in New York.
In January, few bond market participants anticipated the 75bp of US rate cuts that materialised between July and October, allowing borrowers to take advantage of lower financing costs.
Jennifer Gorgoll, co-lead portfolio manager, EM corporate debt at Neuberger Berman in Atlanta, says these rate cuts have supported “inflows and decent appetite for risk”.
LatAm bond markets cannot therefore take their eyes off the Fed, especially as economies struggle; the Institute for International Finance (IIF) expects the region’s GDP to shrink by 0.1% in 2020. Ironically, however, this sluggish performance is improving funding conditions as companies redeem more bonds than they issue.
“On the technical side, the market capitalisation of Latin American cross-border corporate bonds is shrinking year-on-year due to limited capex spending, low economic growth, and steady growth in domestic financing markets,” says Lisandro Miguens, head of Latin America DCM at JP Morgan in New York. “This means higher prices and lower spreads in international markets.”
With amortisations still due in 2020/2021, he expects a strong first half of 2020. “With absolute interest rates at all-time lows, it makes sense to [tap markets] early,” he says.
Amid this liability management focus, several Latin American borrowers have repaired balance sheets, lowered reliance on international markets and funded more locally.
This would appear to be bad news for New York DCM desks — though JP Morgan says its LatAm DCM business had a record year by diversifying beyond on-the-run public bond issues. Yet for the region’s companies and economies it is very positive, says Miguens.
In Brazil, domestic debenture issuance hit a record R$122bn ($29.3bn) in the first three quarters of 2019, according to capital markets association Anbima. Volumes were on course to beat the previous full year record of R$153.716bn, registered in 2018. As recently as 2016, there was just R$60.69bn issued in Brazil’s debenture market.
“Domestic market growth is a trend that I expect to continue,” says Schulman at Santander, which operates in several of the region’s local bond markets. “In Brazil, growth has been huge, with local investors offering lower costs of funding than international markets.
“The domestic market is here to stay, with the hedge fund, infrastructure fund, and asset management sectors all growing. This is great for Brazil.”
If the relative lack of first-time issuers and new money transactions is representative of the region’s disappointing growth rates in recent years, Latin America is far from the only part of the world where low growth is a concern.
Gorgoll says that the slowdown is “not as marked in EM as in developed markets”, meaning the developed market to EM differential is narrowing.
“In Latin America there are hot spots of potential disruption, but overall growth is stable to picking up,” she says. “Inflation is under control, current account balances are stable and this is providing a fertile ground for corporates to prosper.”
Indeed, the IIF’s regional growth forecast for 2020 might be a modest 1.1%, but it does at least represent a recovery. In fact, it would be the second best year since 2013, behind 2017, when the region grew 1.2%. Moreover, the 2020 forecast includes the expectation that Argentine GDP will shrink 1.6% and Venezuela by 13.3%.
Shamaila Khan, director of emerging market debt strategies at AllianceBernstein in New York, characterises 2019 as a year of “bifurcation both between countries and within them”.
This is particularly the case in Mexico, where “the sovereign has performed well versus expectations because it has been fiscally conservative, while Pemex has had a difficult year”, says Khan.
“The question mark for the Mexican sovereign — especially if US growth slows — is whether this fiscal conservatism is down to the inefficiencies and delays of a new administration, or whether it is genuinely disciplined policy,” she says.
Indeed, it is Mexico and Brazil that move the needle in terms of LatAm volumes, and refinancing transactions made Mexico the largest source of deals this year, with just under 30%. But excitement is mostly reserved for Brazil, where the government pushed through a landmark pension reform in October.
If there has already been a strong rally in many Brazilian names, both Gorgoll and Khan say that they like companies that could benefit from domestic growth in Brazil, among other selected names, with Khan saying that “the positive macro outlook in not fully priced in” in some cases.
“Investors still have a lot of space for Brazil, in particular, and there is a lot of expectation that this sleeping giant will wake up,” says Schulman.
So as some observers seek to link social unrest across Latin America, despite very distinct reasons behind each protest, it is important to understand the nuances in the region.
“We must work out where tail risks exist and which credits have the biggest buffers to a shock or downturn,” says Khan. “Chile has had major protests, for example, but it is a country with more than enough room to accommodate any spending demands from social pressures.” GC
Argentina’s restructuring still a guessing game
The sell-off in Argentine assets after Peronist candidate Alberto Fernández won the presidential primaries by 15 points — leaving one-time market darling Mauricio Macri with virtually no chance of re-election — made a sovereign debt restructuring inevitable.
Macri himself announced the restructuring and Fernández agrees something must be done. Yet six weeks after Fernández eased to a first round victory in October, bondholders are none the wiser on the restructuring. All options from a disorderly default to a friendly maturity extension are still on the table.
“Fernández and his people make comments but only succeed in generating greater uncertainty,” says Alejo Costa, head strategist at BTG Pactual in Buenos Aires. “There are some people in the next administration with some good individual ideas, but for now we see no consistent, collective plan.”
Lisandro Miguens at JP Morgan says that the best case would be a “quick, market-friendly” restructuring, saying “a swift NPV-negative re-profiling could bring back confidence”.
Indeed, Fernández said during the campaign that he was keen on a “Uruguay-style” restructuring mostly involving maturity extensions. Yet, Costa says, this would require “a real fiscal sacrifice, sustainable savings, and a primary surplus of 1%-2%”. There are few signs that this is on Fernández’s agenda.
While all types of restructuring are theoretically feasible, “the difficulty is making them consistent and compatible with economic reality”, says Costa.
Such a light restructuring would also require the co-operation of the IMF, which in September postponed a $5.4bn loan disbursement to the government until further notice. Finally, on November 19, Fernández had a phone call with IMF managing director Kristalina Georgieva, during which he reiterated plans to increase spending.
But contact between the Fund and government had been a long time coming. Fernández’s message suggests they are not seeing eye to eye, and — as of that date — Fernández had not even named his economic team. Sovereign bond prices have drifted below 40 cents, suggesting the market has little faith a Uruguay-style restructuring would follow. “No news has been bad news; the perception is that the new government has not realised the urgency of the matter,” says Costa.
For Shamaila Khan at AllianceBernstein, a haircut is not warranted, as it is not a “debt sustainability issue”. But the more important factor to consider, she says, is the discount rate.
“This will depend on the economic policies of the new government and the level of credibility it can regain.”
Beyond the sovereign, there is a world of Argentine corporate issuers who could find themselves plunged into the harsh — if familiar — reality of operating under a sovereign default.
As Jennifer Gorgoll at Neuberger Berman points out, several companies survived the 15 years of the last sovereign default; some even started up during that period. But bondholders must now work out which credits can deal with the pressure.
“Argentine corporates may need to get creative with their funding, but we feel several companies have enough liquidity to withstand the volatility,” says Gorgoll.
Though she acknowledges bondholders of some companies may suffer restructurings that offer very low recovery values, Gorgoll says others will “just need a haircut to right-size their bonds”, while others will survive without restructuring.
Companies with government contracts are considered most vulnerable, with concern over some utilities, in particular. “The questions at the moment are whether there will be a delay in payments from [electricity sector administrator] Cammesa, whether this will trigger liquidity issues for any credits, and whether the PPAs are going to be modified,” says Gorgoll. GC