Category: Corporate & Sovereign Strategy

Moody’s has downgraded Ecuador to Ca with a developing outlook from Caa1 on review for possible downgrade and expects significant losses for bondholders. “The new Ca rating for Ecuador, the second lowest in Moody’s rating scale, expresses the likelihood that expected losses will be very high to bondholders, placing Ecuador’s default much closer to that of Argentina in 2002 than that of Uruguay in 2003,” says Moody’s senior analyst Alessandra Alecci. “We expect negotiations with bondholders to be complicated and drawn out with bondholder participation in an exchange perhaps limited by the country’s solvency and its unclear grounds for default,” she adds. “We expect the government to propose a very aggressive 80%-90% reduction in principal and a strong and likely protracted legal battle to ensue, with bondholders trying to enforce their claims against an admittedly solvent and liquid debtor that is not experiencing any form of financial distress,” says Goldman Sachs in note Tuesday. “That is, the default was triggered by manifest ideological and dogmatic unwillingness to pay not any clear economic or financial need for debt relief,” it adds. Ecuador’s debt indicators are among the most favorable in the region and compared to similarly rated peers around the world, says Moody’s. The debt-to-GDP ratio stands at around 23%, well below the 85% level during its previous default in 1999 and Argentina’s 150% prior to the 2002 default, according to the agency. Measured against central government revenues, Ecuador’s debt burden is small at 100%, compared to over 500% in 1999.

Despite concerns that an Ecuador default sets a dangerous precedent for other sovereigns whose willingness rather that ability to pay is in question, analysts do not expect others to follow. “Investors will remain largely unconcerned about default risk in Brazil, Chile, Colombia, Mexico and Peru. Investors will likely continue to worry about Argentina and Venezuela, given their weaker institutional frameworks. However, we expect that both of these countries will continue to service their debt in 2009,” says Credit Suisse. It adds that Ecuador has been a LatAm trouble spot for a long time and is relatively small, with 1.3% of regional output and 2.5% of total population. “Collateral economic damage from the default should be small, as well as the demonstration effect, as most other countries in the region probably will not even consider the default route,” Credit Suisse adds. “No other Latin American country will follow the Ecuadorian default,” Barclays chimes in. Credit Suisse notes that defaulting LatAm governments have run into political difficulty and that not paying the debt could have negative implications for Correa’s reelection in April. Credit Suisse says some investors will likely try to take action against Ecuador in US courts, possibly also seeking to attach Ecuadorean assets abroad. Only 2015s have collective action clauses, which should complicate the restructuring process. Others are not so sure the impact is contained. “This default is significant because the country actually had the funds to make the payment but decided against it,” says Merrill Lynch. “The risk here is that other countries, such as Venezuela, may follow,” it adds.

President Correa of Ecuador says he will not pay a $30.6m coupon on the sovereign’s 2012 bonds that is due today, putting the country in technical default of all of its sovereign debt. The move will allow holders of the 2012 notes to seek an acceleration of full payment of the $510m in bonds, and triggers cross default clauses on its 2015 and 2030 notes, which brings the total amount of sovereign debt in technical default to $3.8bn. The announcement coincided with a 10 point drop in the country’s three classes of sovereign bonds to around 23 cents on the dollar Friday, according to sellside trading desks. In calling for a renegotiation of terms on its sovereign debt, some of which it has declared illegitimate, the Correa government may seek a larger haircut than the 66.3% Argentina achieved in its 2005 renegotiation, says Siobhan Morden, LatAm debt strategist at RBS. “Ecuador officials have said the Argentine level wasn’t enough,” remarks Morden. The analyst says Ecuador’s decision to default is driven by the fact that next year’s oil revenues will likely drop by $3bn, and that national elections will be held. As such, the government is seen diverting money away from debt service to finance its short term political objectives, she notes. Debt service accounts for only 7% of Ecuador’s budget. As such the country would have to achieve a substantial haircut to realize any financial benefit from the default. “The decision to go into default is not due to fiscal pressures, falling instead straight into the category of unwillingness to pay given that external debt service payments are minor (just US$400 million in 2009) and the government is still in a comfortable cash-flow/liquidity position,” notes Goldman Sachs analyst Alberto Ramos.

Ecuador’s economy will be the chief victim of its government’s decision to default on $3.8bn in sovereign debt, say analysts. “International banks will starting to close off lines to local banks, independent of how good they may be,” notes Ramiro Crespo, a partner at Quito-based Analytica Securities. “The logical thing to do would be to pay the coupon and then sit down to talk,” he adds. The longer term implications of the debt moratorium will also be substantial. “The default decision coupled with a mix of nationalist, inward-looking, heterodox policies is likely to lead to sub-par economic performance in coming years which significantly increases the risk that dollarization as an FX regime might not survive in the medium term,” according to Goldman. The move is likely to lead to fast and swift action from the ratings agencies, which already have the sovereign rated at CCC. Ecuador’s default marks the region’s second default in only seven years. But since the country has already long been on the fringes of LatAm’s political and economic spectrum, the move is unlikely to spook investors into fleeing the rest of the region’s economies and markets, say sellside analysts. “One concern is that this lowers the bar for defaults,” says RBS debt analyst Siobhan Morden, who notes Ecuador is already using Argentina’s default level as a reference point from which his discussions on renegotiation will depart. Correa said over the weekend he would seek a far larger haircut than what Argentine bondholders took in that country’s debt restructuring.

Thanks largely to liquidity support from governments, EM corporates should see low default rates in 2009, says Anne Milne, head of Deutsche Bank’s LatAm corporate bond research group. “We see almost no default next year in Latin America,” she tells investors at an EMTA event in New York, adding that her shop forecasts a 4.0% default rate in EM. JPMorgan and Merrill expect 1.0% and 3.0% respectively, versus 0.3% currently. The most probable candidates are Argentine corporates having difficulties long before the credit crisis, she says. Milne places Brazil and Mexico as among the best EM corporates going into 2009, citing the Brazilians’ low short-term debt and available BNDES support and Mexico’s liquidity support. She says her shop likes industry leaders and quasi-sovereigns like Petrobras, Vale and Televisa in a conservative portfolio, as well as Braskem, CSN, Embraer, Gerdau and Odebrecht for the moderate investor. She also tips top tier Argentine oil companies that have not defaulted, and TGS, for more aggressive allocation. Though hedge funds and others with a shorter-term view may be mostly gone, Milne sees the buy-side slack next year picked up by local market investors. Generally in EM, analysts are concerned about the private sector. “The sovereign looks great, the problem is the corporates,” says Joyce Chang, head of global EM and global credit research at JPMorgan. “They have about $210bn to roll over,” she adds.

Fitch has affirmed TGI’s foreign and local currency issuer default ratings at BB and cut its outlook to negative from stable. The cut reflects the weakening prospects for Argentina’s TGI to reduce debt leverage over the near to medium term as originally expected, says Fitch. TGI has $750m of outstanding senior unsecured notes due 2017. Fitch says that TGI’s leverage level is 4.2x Ebitda of $215m. Elsewhere, Fitch says Telefonica Chile’s outlook is stable, citing strong liquidity position, cash flow and manageable debt maturity. The agency believes the company, which is 97% owned by Spain’s Telefonica, will generate cash flow of $100m to $150m over the next few years. It also expects total debt to Ebitda to remain stable at or below 2.0x. Fitch also affirmed the company’s local and foreign currency issuer default rating at BBB+.

Merrill Lynch has cut its Ecuador exposure to zero in its model external debt portfolio. The shop says it believes bond prices have further downside in an eventual default or restructuring scenario. It also cut Uruguay to underweight from market weight, as it sees the credit as expensive and says deteriorating fundamentals in Argentina will weigh. Jamaica was also downgraded to underweight from market weight as the country is expected to be severely affected by slowdown in the US economy. Merrill says keeps its market weight recommendations for Argentina and Mexico and its overweight recommendation on Peru, but cuts excess exposure versus recommended allocation in the three countries.