Once considered a safe haven in global credit crisis, Latin America’s domestic debt markets are losing their lustre
The local debt markets in Latin America have been anything but an oasis of calm during the global credit storm. So far this year, poor regulation, risk aversion and illiquidity have exposed the structural weaknesses of the much-touted asset class.
“Domestic capital markets developed in a supportive external environment. Now suddenly, when there are liquidity issues, you are seeing significantly less interest from international players to buy domestic rates,” says Max Volkov, head of Latin American debt capital markets at Merrill Lynch.
Spurred on by falling interest rates, currency appreciation and strong economic growth, last year local fixed income issuance pushed new highs while trading volumes in local securities hit a record of $3.7 trillion, a 16% year-on-year increase. But international market jitters have tempered this bull run.
In addition, regional central banks are grappling with food price pressures, with monetary tightening on the cards in Brazil, while Chile and Mexico look set to continue their run of successive rate hikes. Higher borrowing costs could curtail new issuance over the coming months in a market once dubbed the safe haven in the global credit meltdown.
Brazil
Brazilian debt – despite a robust economic backdrop – has already been hit this year, with local spreads widening and new issue premiums hiked by an average 30bp, according to one local debt capital markets head. The first two months of the year saw thriving activity, with R31.75 billion ($18.48 billion) of new deals, but this was overwhelmingly dominated by leasing company transactions.
Despite ample liquidity, institutional investors are now demanding more expensive coupons and shorter tenors from lower-rated Brazilian corporates, partly as a way to recover from last year’s over-exposure. The credit crunch has reawakened investors to the inherent weaknesses of domestic markets. “They are not as liquid or as deep as international markets in terms of size and tenors,” says Volkov.
Foreign sentiment toward local fixed income investments has also taken a beating in the wake of a move in March by Brazil’s finance ministry to impose an IOF (financial transactions) tax of 1.5% on offshore investors. The action was partly an effort to stem the appreciation of the real to protect export competitiveness and deter speculative capital from short-term investors. But the measure is likely to deter foreign investors at a time when local fund managers have reached their maximum permitted allocation to local corporate debentures this year, according to one banker.
In a further indication of the market tumult, the government has now postponed plans to create a 30-year curve in the local space after fears the benchmark could be affected by the lack of secondary market liquidity.
Mexico
In Mexico, the story of vibrant local markets bucking the trend in November boosted market confidence. In that month alone, $3 billion was issued bringing the end of year total to $15 billion, a year-on-year increase of $2 billion.
But since then the market has virtually frozen. Fixed-rate offers from investment grade market darlings Cemex and Mexico City were downsized, pushing lower rate names into the syndicated loan market. Local funds are in defensive mode while foreign investors do not see current spreads reflecting the market volatility. “The market was very active at the end of last year, so we have been surprised. Investors and issuers are simply waiting to see what happens in the US,” says Adolfo Osorio, head of structured finance at BBVA Bancomer in Buenos Aires.
The first significant transaction of the year occurred at the beginning of March when America Movil breathed life into the local bond mart, issuing a Ps2.5 billion, 10-year, priced to yield 8.11%, or 65bp over the Mbono 2017 – a 6bp concession.
In a similar vein to Brazil, Mexican investors are now choosier, shunning fixed-rate deals as the country’s inflation and growth prospects are held hostage to global market forces. Foreign investors are now in retreat. “Liquidity is dreadful in the local Mexican peso market; it’s all buy and hold. We are especially put off by tax and regulatory hurdles,” says Eric Ollom, head of LatAm corporate debt research at ING.
No doubt in the long run the region’s local markets will continue their upward momentum, but this near-term rut should jolt regulators into liberalizing investment opportunities for all. —S.V.