Bank deleveraging in Latin America: no harm done
European banks have sold some of their Latin American assets, but others are quick to snap them up
These are good times for Latin America: golden years for a continent that time (along with democracy, prosperity and Lady Luck) once seemed to have forgotten.
Economic growth, so elusive in Europe and North America, is a plentiful resource in a region written off 10 years ago as a basket case. Latin America gross domestic product (GDP) expanded 4% in 2011, and is set to grow by 3.6% and 4% this year and next, after dipping in 2012, according to forecasts from the Institute of International Finance (IIF).
Drill down and the data, if anything, looks better. Brazils economy is set to expand by an average of around 4% over the next two years, the IIF predicts. The same goes for Mexico, riding high on a wave of United States-directed foreign investment.
Smaller states have also flourished in recent years, notably Colombia and Chile, with Peru coming up hard on the rails. Barring a few troubled holdouts notably an increasingly protectionist Argentina this is a region on the rise.
Nor has deleveraging in the wake of the financial crisis hurt it much. Fears that foreign funding torn from the region as weakened western lenders sought to shore up capital on home turf would hurt Latin America were wide of the mark.
Its true, European banks have withdrawn from the area, some marginally, some wholesale, but any holes have quickly been filled, notably by expansion-minded regional lenders.
North American banks (Citi, Scotiabank) remain devout believers in the local growth story; Chinese and Japanese banks sniff around for under-valued financial assets.
HIGH CAPITAL INFLOWS
Popular stories on Emergingmarkets.org Emerging markets outlook 2013: more bulls than bears Big risks are lurking in emerging markets: consultants Capital flows to emerging markets to increase this year
Nor are local banks struggling to access capital, as many of their peers are across large parts of Europe, the Middle East and North Africa. Indeed, in a January 22 report, IIF chief economist Philip Suttle wrote that capital flows into Latin America are now more than 30% above pre-financial crisis levels.
Neil Shearing, chief emerging markets economist at London-based Capital Economics, notes that while capital flows into the region eased last year, after peaking in late 2011, they remain at high-but-not-dangerous levels, and substantially above the levels of 2007. Early signs in 2013 show, if anything, a slow uptick of capital into the region.
But not all is rosy: while private capital is flooding into politically stable Mexico and Uruguay the latter benefiting from a strong peso strict capital controls have recently checked investment into Brazil; Argentina, unsettled by issues both internal (slowing growth) and external (ongoing litigation by sovereign bond holders), is actually battling capital outflows.
Nor should data always be taken at face value. While inflows of private capital into Latin America jumped by 16% last year to $288 billion, much, notes the IIFs Suttle, was merely diverted to a few Caribbean tax havens before repatriation to the likes of China.
LOCALLY SOURCED CAPITAL
Yet what is often forgotten amid all the hoopla is that much of the new capital sloshing around wasnt created by financial institutions based in New York, Madrid or London, before being piped into the region. In many cases it was generated by Latin American institutions tapping local and foreign markets for capital put to work across regional markets.
Money flows have returned to Latin America, but the source of the money has really changed, notes Giri Jadeja, Latin America and the Caribbean senior manager, financial markets, at the International Finance Corporation (IFC). It used to come from the western world, but increasingly this is being replaced by local flows. Latin American capital is now being created here, in Latin America.
Of the 10 largest parcels of regional financial assets sold on the open market since the start of 2011, seven were snapped up by local institutions. In so doing, many have actively crossed borders, indicating a level of neighbourly competition-cum-aggression rarely seen among regional lenders.
Note here the $3.7 billion July 2011 sale of INGs Latin American pensions and life insurance operations, covering a region stretching from Uruguay to Peru, to Colombias Grupo Sura. Or the acquisition of HSBCs Panama division, completed in February 2013 for $2.1 billion, by Medellín-based Bancolombia.
This money trail is clear to see. Many regional institutions have proven unusually bold about flagging up their intentions. Another rising Colombian financial star, Grupo Aval, raised $1 billion through the sale of 10-year senior notes in September 2012. Three months later, it swooped to buy the Colombian pension fund operations of Spains BBVA, for $530 million.
Latin American [banks] are raising capital any way they can, whether through medium-term bonds, subordinated debt, rights issues, or pure equity [sales], says the IFCs Jadeja.
According to data from financial information provider Dealogic, debt capital raised by Latin American banks jumped nearly four-fold between 2009 and 2012, to $28 billion.
LACK OF DEBT PROBLEMS
One of the key reasons for this new-found audacity lies partly in Europes retreat (Dont underestimate the confidence local banks have gained [from the realization that] the West can muck things up as well, notes a senior Brazilian investment banker).
Another is indebtedness, or lack thereof. Latin America spent the last two decades of the 20th century stumbling from one financial and debt crisis to another.
Yet in the decade since the last major crisis Argentinas three-year shambles culminating in rioting and default Latin America has quietly turned the ship around.
While mean public debt in Europes seven largest nations topped out at 85% of GDP in 2011, in Latin America that average comes in at just shy of 40%, according to International Monetary Fund data.
Or compare those figures to the United States, with its ratio of gross government debt-to-GDP of 103%, Canada (85%) or Japan (230%). Latin America no longer has high levels of public debt to service, says Jadeja. This has helped [regional] governments develop deeper capital markets, [while enabling regional] banks to raise investment capital at much lower rates.
Nor are local financial institutions yet done with the current buying cycle. Deleveraging may be on the wane but it isnt over yet, notes Capital Economics Shearing.
And while most of the big transactions have been completed, as European banks retrench to shore up capital in their home markets, there still remain, reckons Marcos Brujis, chief investment officer at IFC Asset Management in Washington, a few good deals to be done.
There are still some solid opportunities out there, adds the Brazilian investment banker. Santander...would like to get out of a few countries, or scale down in Uruguay or Argentina.
One option for the Spanish lender would be to sell a slice of its operations in those countries through a local listing, emulating the trailblazing $8 billion initial public offering of Santander Brasil in 2009. Britains HSBC might be keen to sell its Argentina operations assuming a buyer can be found, which is a big ask, the banker adds.
HUNGER FOR YIELD
Despite bank deleveraging, as well as capital controls and tariff hikes imposed in recent months by the likes of Brazil, yield-hungry foreign investment is increasingly drawn to the region.
Capital has continued to flow into Latin America attracted by the regions solid medium-term growth prospects and relatively high interest rates when compared to mature economies, Ramon Aracena, head of Latin America research at the IIF, told Emerging Markets.
We are seeing [western] hedge funds and private equity firms, European institutional investors, Asian corporates, all taking a punt on the regions solid economic prospects and high interest rates.
So for many foreign investors, the question now becomes: what to buy in this booming part of the emerging world.
That depends who you are and what youre interested in. In recent years United States corporates, in an attempt to cut wage bills while narrowing Washingtons trade deficit with Beijing, have relocated production to neighbouring Mexico.
Elsewhere the picture is mixed. Foreign investment is pouring into Brazil on the consumer and the natural resources sides. Core retail sales jumped 8.4% year-on-year in 2012, against a 6.7% rise the previous year, according to the Brazilian Institute of Geography and Statistics (IBGE).
Latin Americas governments also recognize the need to improve their social fabric while commodity prices remain high. Resource-rich Latin America remains heavily reliant on the export of everything from copper and silver to nickel and iron ore: if sales (or prices) tail off, so will economic growth.
Hence the push to boost infrastructure spending across the region, improving everything from social mobility to communication. Nor can this drive come soon enough.
RAIL, ROAD, AIR
Take Brazils aviation sector. The country is home to the worlds two fastest-growing airports. Yet the quality of the countrys air transport infrastructure has fallen from 57th place in 2007 to 93rd place in 2012, according to the World Economic Forum. Indeed, airport infrastructure deteriorated markedly over the same period in all major Latin America economies.
Brazil, host to the 2014 World Cup and the 2016 Olympics, along with its regional peers, is starting to recognize the pressing need for first-class infrastructure, from roads to health facilities, and schools to retail stores.
Elsewhere, the picture is the same: Chile, like Brazil, is committed to generating more energy from hydropower; Colombia is embarking on an ambitious $8 billion project to link cities in the interior with ports on the Caribbean and Pacific coasts.
Peru plans this year to award $10 billion in infrastructure contracts, including to private enterprises, in a concerted effort to build new roads and airports, as well as a pan-Peruvian natural gas pipeline.
Foreign investors are increasingly attracted to infrastructure projects, from megadams to pan-regional highways, says Jadeja, who believes their advances will be warmly received by regional governments.
There is, of course, much yet to do. One in 10 Brazilians ekes out an existence below the international poverty line. Latin America has yet to scratch the surface of its infrastructure needs. Colombias main highways, for all the countrys ambitions there, are regularly closed by mudslides.
Moreover, Latin Americas growth story remains a brittle one, dependent on a few, very large, contributory external factors. The biggest risk is the regions dependency on commodity prices, notes IFC Asset Managements Brujis. If they fell, you would certainly see less growth.
The region also needs a host of improvements and upgrades, big and small. Individuals need access to longer-term money; regional capital markets are crying out for longer-term yield curves.
All must come wrapped in better infrastructure, governance and communication, providing challenges for governments and opportunities for investors.
But few doubt, as things stand, that Latin America will get there. Youll see Latin America achieve all its ambitions in the years to come, says Jadeja. Of that, I have no doubt.
- Like every year, Emerging Markets daily newspaper covers the Inter-American Development Banks annual meeting, held in Panama in mid-March. Pick up your copy at the meeting, read the news on our website and follow us on twitter @emrgingmarkets
- You can watch the IDB's live broadcast of events by clicking here.