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The market's new safe haven

01 Mar 1998

Any lingering doubts about Mexico's strength as an international borrower have been well and truly erased over the past six months, as the country has risen from the Asian-induced mayhem to become the safe haven of the emerging market world.

In a spectacular reversal of fortune, the country which sparked emerging market chaos only three years ago with its own currency and banking crisis is now the emerging market borrower seen as most likely to get a rating upgrade this year.

Mexican bonds are the only emerging market sovereign securities which have recorded a positive performance since the Asian meltdown struck last October, trading at tighter spreads than bonds from several better rated countries.

And the country's ability to finance itself on attractive terms was demonstrated by the success of its $1bn global bond issue in March -- a deal which bankers believe has reopened the dollar market for Mexican borrowers from the public and private sectors and gone a long way to restoring confidence in the emerging market sector generally.

MEXICO PROVED ITSELF TO BE THE emerging market's most favoured borrower in March when it became the first Latin sovereign to launch a new $1bn global bond since the October downturn.

Taking advantage of its position as the most sought after Latin American safe haven and the emerging market credit voted as most likely to get a rating upgrade this year, the United Mexican States (UMS) decided to pounce on signs of improved investor interest with a $1bn 10 year global bond led by Morgan Stanley Dean Witter.

The deal was not only priced close to Mexico's underlying dollar spreads, but provided the best all-in cost the UMS has ever achieved for 10 year paper -- attracting very broad distribution across all investor types and geographic spread. About a third went into Europe, 40% to 50% into the US and the rest into Asia and Latin America.

The deal was the culmination of months of market scrutiny on the part of the Hacienda's borrowing team. With only $1.5bn of borrowing needs for this year, the UMS was only prepared to return to the marketplace when it saw a definite turnaround in investor appetite for Latin bonds.

The last thing it wanted to do was to launch a deal which gave the impression that the country needed to come to the market, which paying a premium over its secondary market dollar yield curve would have signalled.

"A lot of people have been questioning market access and whether investors were prepared to invest," says Rodrigo Ocejo, director of external credit for the UMS. "A lot of people were talking about potentially paying a premium to get deals completed. We thought that it was the right time to get a dollar transaction done -- based on the fact that absolute yields were low, spreads had recovered pretty much to levels that we had not seen for a very long time and, on an absolute all-in cost basis, this deal is the cheapest 10 year deal we have ever done."

The deal was launched at a spread of 288bp over Treasuries, just a few basis points over the spread on its 2007 bond, which was around 282bp to 284bp at the time of launch.

On an all-in cost basis the deal was a coup for Mexico, as well as arguably providing investors with an important new benchmark. Although at launch the spread was only a few basis points away from the 2007 bond, the latter had widened out temporarily just before launch -- from around 267bp before the deal was announced -- and tightened back after syndicate broke to close on the day of launch at a bid level of around 270bp.

More importantly for Mexico, the issue proved that it is now considered an elite borrower in the world of emerging markets. The deal was a gamble because Mexican spreads had rallied so much prior to launch, leaving investors concerned about the amount of upside left in the market.

The deal nevertheless attracted almost $2bn of orders and came at a time when bankers were still warning other Latin sovereigns that they would probably have to pay a premium over their dollar curves to get a major new deal done in the US market.

What helped the Mexican deal was the expectation that this was the only chance that investors would get this year to get into a bond that gives them a play on the country's expected credit improvement.

"Here you have a situation where Mexico doesn't have many financing needs this year and it will probably not be back to the dollar market again in size," says one investment banker.

"Institutional investors therefore know that this is pretty much the last chance to get Mexico and that obviously creates a great buying demand. That interest is spurred on by the fact that Mexico is viewed as one of the best emerging market credits and the one with the best potential to get upgraded, so people want to make that trade."

UMS bonds have also proven to be the best Latin American investments in during times of crisis. By the end of February they were the only emerging sovereign securities to record a positive performance since October 23, when the Asian meltdown began.

Many of its benchmark global bonds have traded tighter than other emerging market sovereigns rated several notches above it in the past four months; in late February its Brady bonds were 30bp to 100bp narrower than spreads for Argentina, Brazil and Venezuelan Brady bonds.

By the end of February, Mexico's 2027 global bonds were quoted at a spread around 326bp, only 50bp off their levels last October -- compared with spread widenings of 70bp, 100bp and 127bp respectively for the similar maturity long bonds issued by Argentina, Brazil and Venezuela.

Both S&P and Duff & Phelps have upgraded Mexico's outlook to positive from stable and UMS bonds are accordingly outperforming comparables.

Bankers say the improved outlook is Mexico's for years of painstaking economic turnaround and backbreaking efforts to use booming market conditions in 1996 and 1997 to improve its image and its liability profile in the international debt markets.

"The Mexican government used the recent period of global liquidity more prudently than virtually any other emerging markets country to change the structure of its debt liabilities," says Joyce Chang, director of emerging markets fixed income research at Merrill Lynch.

"The improved debt service ratios have contributed to the US credit rating agencies, S&P and Duff & Phelps, upgrading Mexico's outlook to positive from stable."

In 1997 the UMS pre-paid $14bn of external debt and retired $4.46bn of Brady bonds through a series of successful bond issues. Highlights included the completion of its dollar yield curve in January 1997 with a $1bn 10 year global bond maturing in 2007.

Although it had completed its 1997 financing needs by the first quarter, it spent the rest of the year in quest of better liability management involving debt reduction, maturity extension, refinancing on better terms and all the while ensuring it diversified its investor base.

In June the UMS went on a $2bn bond issuing spree to help refinance a $6bn hybrid loan/bond FRN backed by Pemex revenues which it launched in 1996 to repay a loan granted by the US Treasury during the 1994 peso crisis.

The $6bn refinancing included a $500m addition to its 10 year global and a $1bn five year FRN -- both of which were executed at significantly better terms than the 8.39% cost of the $6bn note.

One of its objectives in 1997 was to get a better foothold in Europe before Emu and the introduction of the single currency. Of the 13 bonds issues launched by the UMS last year, only three were in dollars.

The rest were denominated in a range of currencies including lire, Deutschmarks, yen, euros, sterling and Canadian dollars. The country extended maturities in lire out to 20 years, made its debut in the sterling market with a £300m five year issue and became the first emerging market borrower to tap the Canadian dollar sector, launching a C$500m six year global bond.

Most significantly, perhaps, Mexico paved the way for a slew of emerging market euro deals in 1998 with its ground-breaking Ecu400m seven year deal in September last year, which redenominates into the new single currency.

Since then Argentina and Brazil have both tapped the fast-developing euro market, while other emerging market sovereigns from eastern Europe are also eyeing the new sector.

By the beginning of the third quarter last year, Mexico had fully paid off its debts to the US Treasury, paid the IMF $2.7bn ahead of schedule for the assistance it received during the peso crisis and filled its $1.5bn debt amortisation requirements for the year.

Still keen to take advantage of buoyant market conditions in the international capital and credit markets, the UMS turned to the syndicated loan market -- putting in place a $2.5bn 18 month liquidity facility for emergency use only.

The timing of the deal underscored Mexico's market savviness. Just weeks later, Asia's currency disaster sent world markets reeling and dealt a heavy blow to the emerging market sector.

Mexico's policy of making hay while the sun was shining has left the country with very little debt to raise in 1998. The UMS and its government agencies only need to raise a total of about $4.5bn to meet amortisations in 1998, compared with $9.8bn worth of new bonds the public sector issued in 1997. Of the $4.5bn, the UMS will issue $1.5bn; Pemex $1.47bn; Nafin about $1bn; BNCE around $360m; and Banobras $100m.

The $1bn 10 year global bond takes care of about two third's of the UMS's 1998 borrowing needs. Ocejo says that for the rest of the year the borrowing team would keep a keen eye on opportunities in the European markets for well priced issues, as well as any signs of the Samurai market reopening.

The most obvious next move would be in lira, given that Mexico has an outstanding mandate with Deutsche Morgan Grenfell for a new lira bond dating back to last summer.

This year it is likely that Mexican corporates will substantially out-borrow the public sector -- with bankers estimating that the private sector needs to raise around $5bn in 1998, similar to the sum raised by the public sector in 1997.

Before the UMS global issue, only four Mexican deals had been launched since January: Pemex's Lit700bn 10 year reverse floater through Chase and Deutsche Morgan Grenfell; a Lit250bn five year offering by commercial bank Bancomer via Chase; a $320m six year US offering by satellite company Satelites Mexicanos (SatMex) led by DLJ and Lehman, which was launched at 468bp over Treasuries; and a $175m seven year deal by sugar manufacturer Grupo Azucarero Mexicanos (GAM) led by CSFB, which came at 645bp over Treasuries.

Bancomer was the first Mexican issuer to come to market and its lira deal, priced at the equivalent of 254bp over Treasuries, was attractive enough to warrant an increase from Lit200bn.

Pemex's price and structure was considered more aggressive and the deal did less well accordingly. Although it had a catchy 11.25% upfront coupon for the first three years, investors were not keen on the idea of a reverse floater from an emerging market issuer.

After the first three years of 11.25%, the coupon became 11.25% minus 12 month Libor. The deal was launched at a very aggressive level that swapped into 265bp over Treasuries, inside the UMS's 2007 bond which was trading around 280bp at the time of launch.

Bankers are hoping for a surge in Mexican corporate issuance now that the UMS has broken the ice. "I expect to see several Mexican public and private sector issuers entertaining the possibility of a dollar issue, now that the UMS has done this deal," says a syndicate head at one of the top Wall Street firms. "This is a very important deal for Mexico generally."

In early March Mexican mining and auto parts manufacturer Sanluis Corporacion was on the verge of pricing a highly successful $150m 10/put five year deal, led by Chase, which had been price talked at 325bp to 350bp.

Although the price talk was considered tight, given that top Mexican corporates in that maturity were trading around the 350bp region, the lack of Mexican corporate issuance was fuelling strong demand.

Investment bankers say investors in the US are generally more comfortable with Mexican than other Latin corporate credits. "People are willing to buy Mexican corporates more than other (Latin) corporates right now because the perception of Mexico is that its economy is looking very good. Just because of the proximity to the US, investors seem to feel more at home with Mexican names," says Rick Liebers, director in debt capital markets at Deutsche Morgan Grenfell in New York.

Corporates should be warned however, that US investors can still be very choosy about the type of credits they want to buy -- as witnessed in the very different performances of the Satmex and GAM deals.

Satmex, being in the favoured telecom/media industry, was snapped up quickly by US high yield bond buyers, while GAM barely raised interest with its sugar story and needed to work hard to get its deal done at a significantly wider spread.

"Compared to what we had before October, this is a very dramatic change," says a credit analyst at JP Morgan. "Last year we had as broad a range of Latin issuers as we have ever seen."

Mexican corporates made the most of strong market conditions last year, with a number of corporates issuing Yankee bonds -- including TV Azteca, Corporación Geo, Copamex, Ahmsa, Bepensa, Cydsa, Imsa TFM and Vitro.

In mid-February this year, Latin corporate bonds began to catch up to the sovereign bond rally that started in late January and certain Mexican corporates were among the biggest beneficiaries.

TV Azteca's 2004 bonds, for instance, experienced about a 70bp spread tightening by the end of February compared with the beginning of January, while its 2007 bonds tightened 60bp. Televisa's 2006s tightened 50bp in the same period, while Coca-Cola Femsa's 2006s tightened by about 80bp.

Mexican corporates might also be more interested in tapping the syndicated loan market while they wait for secondary bond spreads to tighten further. Although margins have widened for many Mexican corporates in the loan market, top names appear to be getting aggressive pricing by opting for shorter dated deals.

In early March SBC Warburg Dillon Read was repricing a $350m three year loan to Femsa for which it was mandated last year -- having shortened the tenor to two years, with a new spread that steps up from 100bp in the first year to 112.5bp for the next six months and 150bp for the last six months.

That compares with the planned pricing on the three year loan last year of 162.5bp for year one, 175bp for year two and 225bp for year three.

In February Tubos de Acero de Mexico (Tamsa), the seamless tube company, was in the market with a $100m one year bridge loan arranged by Citibank, BT and Bank of America. Priced at 87.5bp over Libor, the deal was expected to be oversubscribed.

Sanluis Corp is also in the market for a $75m backstop to a pending bond deal due in November 1998, presumably to roll over bond debt that reaches maturity around that time.

The HSBC-arranged loan has a 50bp commitment fee on the undrawn line of credit. If Sanluis draws on the facility it will become a two year term loan paying 250bp over Libor in the first year and 350bp over in the second.

Reasonable size is also being achieved by top Mexican corporates in the loan market. Carso Global Telecom, for instance, was recently given a $500m two year loan, arranged by Citibank at 60bp over Libor.

Although the tenor is short, the pricing is still very aggressive. It compares with parent company Grupo Carso's attempt last summer at the peak of the market to execute a $500m five year deal at 70bp over Libor. Arrangers SBC Warburg, Chase and Bank of America struggled at the time to get that loan done and ended up having to reduce it to $360m.

In the bond market, semi-sovereign credits looking to return to the market before the second half include Banobras with a $200m-$400m issue, Bancomext with a $250m-$300m five to 10 year deal and Pemex with a major dollar global bond in the 12, 15, or 20 year maturity.

The UMS will also be concentrating on developing its local Cetes market as part of its overall strategy of improving the domestic capital market.

"A key objective of the government is to deepen the domestic debt markets and increase domestic savings through the recently created private pension system," says one banker.

"More than $7bn a year is expected to be invested domestically through the new pension funds and the government hopes to increase domestic savings by 5% over the next five years," from current levels of about 22%.

Plans are to fund the government's fiscal deficit with local debt issues, including an extension of Cetes maturities out to three years this year, beginning in March.

The projected fiscal deficit of 1.25% of GDP is expected to be about 98% financed by Cetes issues and the Mexican authorities have announced that they may expand their sales of treasury bills by auctioning an additional Ps200m of Cetes bills each week.

For all its progress internationally, Mexico has moved cautiously on its development of the domestic debt market, in large part because foreign investor interest evaporated after the Tesobono repayment scare in 1994.

Much of the panic surrounding Mexico's peso devaluation was due to concerns about how the UMS would repay foreign investors who had bought the dollar denominated Tesobonos. At the time about 73.7% of all Cetes were held by foreigners.

Now only about 9.5% of the Cetes market is held by international investors and the UMS has had to wait for its private pension fund system to reach critical mass before it can further develop the local market. Currently the average maturity of domestic debt is around 342 days, up from 202 days in 1994.

Considering the strength of the Mexican fundamentals now versus 1994, bankers are confident that the three year Cetes issues will attract international investor interest.

Thanks to its liability management and debt reduction activities, Mexico's gross external debt dropped by $10bn to $88.3bn in 1997 and net debt fell to $79.3bn in 1997, just 19.3% of GDP. The country's net public external debt to exports ratio is around 70%, compared with 130% in 1994.

The biggest short term economic concern is an expected worsening of its current account. Mexico's trade deficit is expected to worsen this year because of lower oil prices, increased Asian imports and Asian competition in export markets.

Market estimates are that the current account deficit will come in at around $15.8bn or 3.4% of GDP from a 1.8% deficit in 1997. Even so, that is nowhere near as bad as the 8% deficit in 1994. Merrill Lynch is forecasting a trade deficit of $7.2bn for this year, for instance, compared with the pre-devaluation trade deficit of $18.5bn which Mexico recorded in 1994.

Mexico's worsening current account deficit is also in the context of a stronger economy: it recorded a 7% GDP growth rate in 1997, its best in 16 years, up from a 4% original target and better than the 5.1% achieved in 1996. Expectations are for slower but still robust 5.1% to 5.5% growth in 1998.

Despite higher growth rates last year, Mexico brought its inflation down to 15.7% in 1997 compared with 17.7% in 1996 and has targeted a 12% rate this year.

Bolstering its current account balance in 1998 is a healthy level of international reserves, at around $28.3bn at the end of January. On the fiscal front, Mexico is expected to record a small 1.25% fiscal deficit as a percentage of GDP, very small considering that oil represents 40% of fiscal revenues.

The Mexican government has responded strongly to the drop in the oil price, by announcing cuts in current expenditures, a reduction in investment outlays and a drop the budgeted Mexican oil price average to $13.50 per barrel from $15.50. Total spending cuts announced so far to offset the oil shortfall amount to $2.3bn, or 1.12% of GDP. EW

Top 15 Mexican bond issuers (March 1, 1997 to date)

IssuerAmount ($m)Issues
1United Mexican States5,608.1110
2Petroleos Mexicanos2,300.317
3Vitro425.002
4Grupo TFM391.402
5Innova S de RL375.001
6Satmex320.001
7Fideicomiso Petacalco308.801
8=Alfa300.001
8=Bancomext300.001
10Azteca Holdings255.001
11GRUMA250.001
12=AXA200.001
12=Copamex Industrias200.001
12=Cydsa200.001

Source: Capital Data Bondware

Top 15 bookrunners of Mexican bonds (March 1, 1997 to date)

ManagerAmount ($m)Issues
1Morgan Stanley Dean Witter1,775.635
2Deutsche Morgan Grenfell1,246.164
3JP Morgan1,082.595
4Chase Manhattan1,041.426
5Union Bank of Switzerland858.803
6Nikko805.541
7Merrill Lynch680.352
8Goldman Sachs675.003
9SBC Warburg Dillon Read667.253
10Salomon Smith Barney627.502
11Citicorp550.003
12HSBC500.001
13Barclays485.831
14Lehman Brothers410.002
15Bankers Trust300.001

Source: Capital Data Bondware

01 Mar 1998