Lat Am bonds market to rebuild in 2016 after Brazil woes
After three consecutive years of record volumes, in 2015 Latin American bond market momentum was halted by crises in Brazil and plunging commodity prices. Though volatility will continue and issuers and investors often struggle to meet on price, the market looks mature enough for a modest recovery in 2016. Oliver West reports.
Early autumn, usually a hectic period, was perhaps when it became clear that things had changed in Latin American bond markets during 2015.
Seven issuers lifted sellside spirits by taking to the road to meet investors in September. But by the end of October just two, Bancomext and Panamá Canal Authority, had issued.
Argentine state Neuquén got as far as announcing initial pricing thoughts before cancelling, Mexican firm Control-adora Mabe went to the loan market instead, while the Brazilian airline Gol opted not to issue.
Mexican Reit Fibra Terrafina eventually sold the first non-sovereign linked deal from Latin America and the Caribbean since August on November 3. And its peer Fibra Uno was nowhere to be seen until November 30, when — nearly three months after roadshowing — it had to cut its deal from $300m to $500m after receiving a poor reception in the market.
Though some of these were officially “non-deal” roadshows, according to slightly sheepish bankers, the conversion rate to new issues still disappointed many. Apart from small illiquid credits and, since the Petrobras scandal began, Brazilian borrowers, Latin American companies had pretty much enjoyed free reign in markets in recent years.
Issuer adjustment needed
As Carlyle Peake, managing director and head of Lat Am syndicate at BBVA in New York, says, until the second half of 2015, selling a new deal generally meant conducting a roadshow, announcing attractive initial pricing thoughts, building a book and tightening it as much as possible — usually with minimal resistance from the buyside.
“Investors went along for the ride because the market was strong and aftermarket performance was good,” he says. “Now higher concessions are needed, and investors are more vocal with their price limits.”
Psychologically, Peake says, most issuers need to make some adjustments.
“Until recently, issuers have not had to be flexible in how they approach the market, but now execution risk is very high and choosing windows requires a lot more attention,” he says.
Most borrowers still have market access if they really want it. It’s just that they will have to pay much more than they have been used to in recent years.
“Bond markets are not shut for Latin American corporates, they are just selective and expensive,” says Jennifer Gorgoll, EM corporate bond portfolio manager at Neuberger Berman in Atlanta, Georgia. “Investors are demanding higher concessions for new issues, and companies are saying they don’t need our money.”
It is creating a tough environment for DCM houses covering the region.
“Issuance volumes are down significantly and, because sovereigns have provided a larger chunk of the deals, the wallet paid last year fell even more — by more than 50%,” says Lisandro Miguens, head of Latin American DCM at JP Morgan in New York. “We have therefore tried to diversify into more unusual transactions, like infrastructure, acquisition finance or illiquid deals, that don’t go on the league tables.”
However, the low fee-paying sovereigns and quasi-sovereigns will continue to take the largest share of issuance, believes Miguens, “as they offer liquidity and a low risk of unpleasant surprises”.
After three years of record issuance until 2014, sellside bankers suggest that corporates with big financing needs have become an ever rarer breed.
“Low issuance is not just a result of volatility,” says Peake.
But undoubtedly, higher costs are making it much harder for issuers to find a suitable use of proceeds.
“For issuance to really pick up, either investors will have to stop demanding such high concessions, or the companies will need better opportunities to put money to work — such as higher IRRs on prospective projects — that mean they become willing to pay more to raise debt,” says Gorgoll.
But with the IMF forecasting negative growth across Latin America for 2015, finding such enticing investments is likely going to be difficult for corporates. And Peake highlights a further factor that could keep new issue premiums high.
“As the market has sold off, when investors look at comps for a new deal they are often comparing bonds of similar maturity with dollar prices well below par,” he says. “This means you have to entice investors with much higher concessions in the primary market.”
JPM is predicting Lat Am volumes to increase from $85bn in 2015 to around $95bn in 2016. In 2014, the figure was nearly $140bn, with Argentina — where pro-business candidate Mauricio Macri won November’s presidential elections — Colombia and Peru contributing more.
In addition there may be an increase in structured deals, such as export financing or collateral-backed bonds, to enable borrowers to get a lower cost of funding. Indeed, although last year’s 40% drop in volumes may initially look shocking, there is no sense of panic among market participants. For a start, rate rises in the US does not seem to be of too great concern.
“Unlike when tapering began I don’t think we will see a general shutdown when the Fed hikes,” says Peake at BBVA. “For countries that are more or less stable and positive, there is still demand.”
NB’s Gorgoll shares this view on rate rises.
“I think we’re on a relative good footing as regards rates hikes,” she says. “Rates are no longer at the forefront of our concerns; our main focus has turned to currencies and commodities.”
Issuance windows will open and shut very quickly, according to JPM’s Miguens, as — even though the rate rises should be gradual — the market will continue to analyse every single data point.
However, Miguens points to a potential stabilising factor.
“2016 fundamentals in Latin America will remain weak, but technicals will continue to drive investment in Lat Am bonds,” he says, highlighting that amortizations and coupon payments in 2015 reached $85bn — roughly the amount of new issuance.
“Effectively, we have just seen a recycling of the same money,” he says. “This is set to continue, with amortizations and coupon payments expected to be around $85bn.”
Additionally, although there have been headline outflows in Lat Am bonds, since the autumn, most of this has been from local markets.
“For foreign currency markets flows continue to be supportive,” says Miguens.
Crisis management: Brazil battles to start recovery
After battling economic slowdown, the vast OGX bankruptcy and the start of the Petrobras corruption investigation, Brazilian bond market participants probably ended 2014 thinking things could not get much worse.
Alas, they did. The Lava Jato investigation continued, the economy kept shrinking, issuance plummeted, dollar defaults increased thanks to a flailing currency, bond spreads hit unthinkable highs, and Standard & Poor’s sent the sovereign into high yield territory.
“We were already quite worried in Brazil at the start of 2015, but things have just got worse,” says Cristina Monteiro Duarte Schulman, managing director, DCM, at Santander Brasil in São Paulo. “For international bond markets it has been difficult: there have been just seven or eight transactions, and we have not seen a year like this for a long, long time.”
With such trouble in international markets, some issuers have looked to domestic markets, where private investors have started switching to fixed income.
“This has helped domestic markets become very cost-effective, though they do not offer the same volume of financing,” says Schulman.
This means that, sooner or later, Brazilian issuers will have to return to international markets. JP Morgan’s Lat Am DCM head Lisandro Miguens expects issuance to pick up somewhat, but remain low compared to previous years.
And although she expects another difficult year, Santander’s Schulman believes there “will be issuance windows” in 2016.
“Brazil is starting to offer value,” she says. “My impression is that investors are trying to find a reason to come back.”
Indeed, some feel Brazil’s economic problems may be approaching a nadir.
“From a fundamental perspective, we think we’ll see the bottom in Brazil early this year,” says one EM bond investor. “There has already been a huge adjustment, not least in the currency. On the growth front we expect a smaller contraction this year, and that the outlook will improve after that.”
He says investors are “getting well paid” for going into Brazil, and that “relative value is attracting investments and creating opportunities”.
But investing in Brazil is ridden with uncertainties. Concerns remain over the possible impeachment of President Dilma Rousseff, while rumours persist that finance minister Joaquim Levy, who has struggled to implement his economic recovery plan, will soon be out of office.
Moreover, the Lava Jato scandal continues to uncover unpleasant surprises. Investment bank BTG Pactual’s bonds sank in late November when chairman and CEO André Esteves, one of the most respected financiers in Latin America, was arrested for allegedly attempting to interfere with a disgraced Petrobras executive’s testimony.
“Companies that were on nobody’s radar are suddenly involved, and it is impossible to know which company could be the next to be implicated, making it very hard to price risk,” says Revisson Bonfim, managing director for EM at Stifel.
Investigations are going to continue far into this year, believes Bonfim, a Brazilian national.
“With all these uncertainties it is hard for Brazil to attract investors back and hard for investors to be certain about any credit,” he says. “A wave of investors may come into Brazil, but it would not be restricted to bond markets: we may also see private equity firms look to pick up assets on the cheap.”
Bonfim highlights another uncertainty facing investors: the outcome of rating actions on the sovereign.
S&P cut Brazil to BB+ in September, but other agencies remain more lenient. Moody’s downgraded the sovereign to Baa3 in August, but the announcement was positively received as it placed the country on stable outlook. Fitch cut Brazil’s rating by one notch to BBB- in October, but maintained its negative outlook.
Some see Brazil being granted a clean sweep of junk ratings during 2016 as an inevitability, though Bonfim says that there are still investors hoping the government will be able to implement the changes needed to avoid losing more of its investment grade rating. In any case, clarity is urgently needed.
“If two more downgrades do arrive, it might actually lead some investors to jump back in as there will be a repricing and uncertainty would be removed,” he says.
This likely depends on politics: both continuity within the leadership and the government’s ability to pass economic measures that have so far mostly been blocked by congress.
“The main issue for 2016 is whether we see some sense of stability in the political environment,” says Schulman. “Right now the market is waiting for some kind of signal that things will be resolved.”