Category: Corporate & Sovereign Strategy

Rafael Correa’s government has little to gain by missing a $31m interest payment on 2012 dollar bonds due this past weekend, analysts say. The government announced Friday that it would skip the payment and use the 30-day grace period to decide whether to honor the debt. The government has been threatening to stop paying its 2012, 2015 and 2030 bonds, after a special commission report – due to be made public November 20 – found the debt to be “illegitimate.” “Ecuador has much more to lose than to gain by defaulting,” says Eduardo Checa, CEO at Ecuadorian boutique Analytica Securities. He says the risks are future credit lines to the country being closed and a further weakening of interest from foreign investors. “This is not a problem of cashflow or reserves,” Checa says, noting that falling oil prices have not yet impacted the country’s budget plans. “There is little upside (financially or politically) and, potentially, a large downside from not paying the public debt service. If Ecuador were to default, holders of defaulted bonds could try to attach the assets of the government abroad (for example, Petroecuador’s oil tankers),” Credit Suisse says in a report. A debt moratorium would only save Ecuador about $470m in 2009, according to Analytica. The sovereign is also heard preparing to challenge creditors in Ecuadorian and international courts in an unorthodox pre-emptive strike.

S&P has cut its sovereign rating on Ecuador to CCC minus from B minus and Moody’s chopped to Caa1 from B3, both implying a very high default probability. The moves were motivated by the government’s announcement Friday that it planned to miss a $31m payment due the following day, and use a 30-day grace period to determine whether to pay. “The combination of sharply lower oil prices and an expected hit to economic growth resulting from lower exports and remittances is expected to pressure fiscal accounts in 2009. However, willingness, not capacity, to pay is currently the overwhelming credit weakness,” S&P says. Ecuador has repeatedly emphasized that if faced with a trade-off between implementing its ambitious social agenda and meeting debt obligations, it would forego debt payments. However, “given the extraordinarily good performance of Ecuador’s fiscal accounts so far this year and the sizeable accumulation of government deposits, the timing of this decision is surprising as it is clear that such a trade-off does not currently exist,” Moody’s says. Both shops have the sovereign under review for further downgrade.

Moody’s predicts that the global speculative-grade issuer-weighted corporate default rate will climb to 4.3% by the end of this year, leaping to 10.4% a year from now. “Speculative-grade corporate default rates are expected to climb sharply throughout 2009 as our baseline forecast now incorporates a deep and protracted US recession. Corporate default rates in this cycle will likely match or exceed the peak levels reached in the previous two US recessions of 1990-91 and 2000-01,” says Moody’s director of corporate default research Kenneth Emery. The default rate edged higher to 2.8% in October, from September’s revised level of 2.7% and 1.1% a year ago. Measured on a dollar volume basis, the default rate remained unchanged at 2.4% from September’s revised level. A year ago, the global dollar-weighted bond default rate stood at 0.7%, says Moody’s. The agency’s speculative-grade corporate distress index – which measures the percentage of rated issuers that have debt trading at distressed levels – rose more than 60% from September’s 29.7% to 48.5% in October, marking the highest level since Moody’s launched the index in 1996. A year ago, the index was 4.6%. There were a total of 10 rated corporate debt defaulters in October, including one from Mexico.

While the bankruptcy of Brazilian seed company Selecta Sementes appears to be an isolated incident, more derivative and refinancing-related distress is seen coming in Brazil’s agricultural sector, say advisory experts. Beef processors and sugar and ethanol companies are particularly vulnerable, they add. Glauco Abdala, advisory specialist at Brazilian restructuring boutique Galeazzi Associados’ said recently that an abundance of credit to the sector is generating a rollover crisis at a number of agricultural companies. Generally in LatAm, currency volatility has hurt exporters’ hedging mechanisms and more fallout could still be coming, say credit analysts. “To the extent [LatAm continues to see] high volatility and capital markets remain frozen, the risks [of defaults and bankruptcies] will be higher,” says Daniel Kastholm, corporate credit analyst at Fitch. He adds while Fitch believes most of the large derivatives-related losses in the region have been announced, it is still unclear how much counterparty loss remains unreported. In Brazil, Votorantim, Sadia and Aracruz announced close to BRL5bn in losses, while in Mexico Comerci filed for bankruptcy amid derivatives implosion. Durango also filed for creditor protection. Prior to these incidents, LatAm’s most recent defaults occurred in 2003, with Durango, Avianca and Argentina’s CLISA, according to Fitch.

Creditors of Brazilian seed specialist Selecta Sementes stand to take an average haircut of around 38% on roughly $400m worth of debt following its restructuring, say people close to the matter. The private company went into bankruptcy in May following losses stemming from CBOT-traded soy options and two days ago received judicial approval to sell itself to Argentina’s Los Grobo for $55m. Total outstanding debt, which includes several facilities – local, cross-border, secured and unsecured – is being reduced to $250m, says an executive close to the workout who declines to be named. Some lenders are being paid back in full while others are taking reductions. Among the main creditors are Santander, ING, BES Investimento and Credit Suisse, which participated in an $80m secured capex facility to Selecta prior to its implosion, says the executive. The Swiss shop also had a mandate to take Selecta public on the Bovespa, though this was halted when the company ran into trouble. More than 20 other banks are also heard involved. Selecta has recently received an additional $30m line from a bank group to continue building out a seed crushing facility, which is heard paying close to Libor plus 300bp. Selecta hired Rothschild to advise it through the restructuring.

The combination of Argentina’s souring economy and the fallout from the government’s pension fund takeover plan make an agreement with holdout creditors proposed earlier this year unlikely in 2008, according to a banker on the deal. Argentina pleased investors in September with talk of a workout plan with holdouts from its 2005 restructuring. The sovereign hired Citi, Barclays and Deutsche Bank to run the talks, which involve renegotiating terms on ARP and USD debt. However, President Kirchner’s plan to nationalize $26bn in private pensions – passed in Argentina’s lower house Friday and headed for the Senate – has jolted the country’s markets, hurt investor sentiment, upending the tenuous stability that had made such talks even a marginal possibility. “The par bonds, which are part of the USD denominated bonds, are trading at 17 [cents on the dollar,]” says one hedge fund investor whose shop has historically bought Argentine bonds. “If I’m holding untendered debt at levels below the 2005 renegotiation, it’s not a good time to come to me with these kinds of talks,” he adds. It is crucial that the workout happen at the same time as Argentina implements its promised Paris Club debt and local liability renegotiation, says the banker. It does not make sense to proceed with only one of those three items, he adds. Argentine watchers say that in mid-October Nestor Kirchner, former president and Cristina’s husband, who is widely believed to hold the reins of power in the country, felt that a deteriorating international environment meant that even if it reconciled itself with markets, Argentina would not be able to raise additional finance. “Nobody knows,” says a banker working with Argentina, asked about what the sovereign will do next.

LatAm CFOs still have appetite for derivatives, despite a recent high profile default and hefty losses from abuse of the product, say bankers and analysts. “You will still need to hedge, no matter what,” says the head of a major Wall Street shop’s LatAm derivatives desk. “You are going to see a little bit of back to basics,” he adds. “It’s a viable product that has been abused,” says another regional head of investment bank. “It will still be sold where it makes sense.” According to bankers, most of the companies who had derivatives positions that went bad knew what they were getting into, though some might have been burned by a preference for higher risk at lower cost. And the speed and size of FX moves simply wrong footed CFOs, even at sophisticated blue chips like Cemex. Given heightened markets volatility, there may even be more demand for derivatives, albeit under greater regulatory scrutiny and with more conservative structures. However, Comerci’s positions – which forced the Mexican firm into bankruptcy – are widely seen as poorly advised. “A few of the companies were clearly engaged in currency speculation,” says Joe Bormann, corporate analyst at Fitch, adding that some positions were asymmetric, resulting in a much higher loss for a strong USD. “A few, after taking a look, may not have actually understood the implications of the derivatives instruments they were using.” Bormann expects more losses to be made, but also gains in operating cashflow to help offset this. “Changes obviously will be made. You’re going to see more oversight by companies on their derivatives positions,” says Bormann. “Some companies will back away from derivatives positions that did not make sense, but by and large the majority of companies will continue to hedge.” Derivatives are typically used in LatAm to limit the impact of a currency mismatch.