Latin American borrowers have experienced a dramatic reversal of fortune since the start of this year. At the end of 2000, bond markets were largely closed off, as investor sentiment turned against emerging markets credits of all kinds. The financial crises in Turkey and Argentina reverberated through Latin America and sent investors diving for cover.
Already, 2001 has reflected a complete somersault in investor attitudes. In the fourth quarter of last year, Latin borrowers raised just $1.7 billion. In January alone this year, the figure was $6.7 billion. What Tom Trebat, head of Latin American economics at Salomon Smith Barney in New York, describes as an “absolutely amazing” turnaround is the result of a favorable coincidence of several factors.
The likelihood is that these positive conditions will last for several more months and could allow the sovereign borrowers to clear the decks and get their borrowing done in the first quarter of the year. This will open the way for more of the region’s corporate borrowers, which were largely excluded from bond markets last year, to issue in much greater volumes.
However, Peter Geraghty, managing director at Darby Overseas Investment Corporation in Washington, cautions that borrowers need to resist the temptation of going too far in offloading paper onto the market. To illustrate the point, points to the differing reception for Brazil’s two deals in the first five trading days of the year: Brazil’s institutionally-targeted $1.5 billion, five-year issue in early January was quickly absorbed in large parcels, while the subsequent ?1 billion, retail-targeted 10-year issue did not trade so well.
Similarly, says Geraghty, there was a contrast between the strong appetite for Mexico’s $1.5 billion, 10-year global issue and the “tremendous” demand the $1 billion maturity offering from Mexico’s telecoms giant Telmex – a large proportion of which went to high grade US investors – compared with the weaker reception for the follow up by Pemex’s $1 billion, seven year issue, which came hot on its heels.
“There is a temptation for them to come as quickly as they can, which also applies to US high-yield issuers,” says Geraghty. But the underlying market is still relatively fragile and there is a danger in overloading it too early in the year.
But the temptation to issue bonds is hard to resist, given the extent of the change in sentiment. It also makes sense for issuers to do as much as they can while they can, especially at attractive levels. As Chris Tuffey, head of emerging markets syndicate at CSFB in London says, “In the past few years, it’s been the smart issuers who have come early. It’s not that conditions necessarily deteriorate, but you can get a logjam later as more issuers realize they still have a substantial funding program to complete.”
The initial trigger for the new mood came when the International Monetary Fund bailed out Argentina last December with a $39.7 billion dollar rescue package. Until the IMF stepped in, worries over Argentina had corroded confidence. Rising political tension in the coalition government of President Fernando de la Rúa fed rumors that he would scrap the 10-year currency board or reschedule the country’s $123.7 billion of foreign debt.
Trebat says, “I always took the view that Argentina would muddle through and be bailed out.” He says that the new regard for Argentina has had a “halo effect” that has spread its influence on markets throughout the region.
The IMF deal has set a virtuous circle in motion for Argentina. Not only is there a widespread change in sentiment, but the Fund’s rescue also means that the government in Buenos Aires does not need to refinance as much as debt or issue as much fresh paper as markets once feared. Compared to last year’s borrowing requirement of close to $11 billion, Argentina will be looking for around $3.2 billion this year. That means a lot less paper coming to the market.
Demand Should Ease
At the same time, demand from other sovereign borrowers is likely to be relatively modest. According to forecasts from J.P. Morgan, Colombia will be looking for $1.8 billion this year (compared to $2 billion last year) while Mexico’s requirement has dropped to $1.6 billion from $1.9 billion. Turkey will also be issuing far less in the wake of its IMF assistance package.
Besides a big helping hand from the IMF, Argentina has also been the prime beneficiary of developments in the US. The decision of the Federal Reserve to cut interest rates twice in January may have underlined the depth of concern over the direction of the US economy but it has also boosted global liquidity and, says Trebat, “improved conditions for spread products generally.”
Amalia Estenssoro, senior economist for Latin America at BBVA Securities in London, says as a result of the Fed’s moves there is, “a window that’s open for the Latin Americans and it’s one which they’re using.” The US interest rate cuts have meant that funding is available at what Chris Tuffey describes as “excellent” levels and this has resulted in issuance that he characterizes as “prolific.”
More specifically, the Fed has given Argentina a boost in a number of ways. First of all, it has led to sharp falls in domestic interest rate. Short-term interbank rates peaked at 21% in November, before falling to 7% early in January.
Second, by weakening the dollar against the euro, Argentine exports get a competitive boost in European markets. This improvement has come without the government needing to resort to the painful domestic budget cuts forecast last year. As Richard Fox, senior director in sovereign ratings at Fitch in London says, “The name of the game in Argentina is confidence and the external environment has turned in their favor.” Besides confidence, industrial production was up strongly in December and tax revenues were above market expectations. Fox says “Argentina has turned the corner.”
In addition to an easing of concerns over Argentina and decisive action from Alan Greenspan, the climate for Latin borrowers has benefited from a predominantly benign ratings outlook. The question now is when, rather than if, Standard & Poor’s and Fitch will join Moody’s in upgrading Mexico to investment grade status.
Tax and energy sector reform are the big variables as far as Richard Fox is concerned. The fact that Mexico is exposed to a US slowdown does not concern him greatly because the Mexican economy needs to cool down in any event. Brazil has, meanwhile, been able to use S&P’s upgrade from B+ to BB- as the lever to get its $1.5 billion five-year global into the market at the start of January.
But the other crucial factor in this year’s resurgence was the weight of money available to invest in emerging markets. A heavy slew of amortizations and interest payments in the fourth quarter of last year – perhaps on the order of $13 billion – balanced against a dribble of issues, has left investors sitting on a pile of cash that was waiting to go back into the market.
Says Felipe Illanis, sovereign analyst at Merrill Lynch in New York, “There were new monies that were not invested at the end of last year. So we are very positive in spite of such large issuance.”
Investors were ready and only needed the right signals to pour that money back into the market. As Dermot Mayes, head of emerging markets and external debt risk at Dresdner Kleinwort Wasserstein says, “There was a lot of pent-up investor demand and there is still demand out there for emerging markets product.” With a number of investors having taken underweight positions, the change in sentiment quickly propelled them back into the market.
Rick Liebars, head of Latin American debt capital markets origination at Caboto in New York, was involved in a number of the issues this year. “I expected to see the take-off this year,” he says, “because there was consistent retail demand – even if it wasn’t that strong – out there in December and very little inventory.” The sell-off in equities last year also contributed to the pent-up demand.
Chris Tuffey at CSFB detects changes in the composition of demand this year. “In the euro-denominated market, it has been very retail-driven. The percentage of institutional accounts buying this year is lower,” he says. For the ?500 million Argentina deal which CSFB led at the start of February, 30% of demand was institutional, compared with 40% to 50% last year. “Retail investors are getting more enthusiastic, especially in relation to shorter-dated deals in the two- to five- or six- year range.”
Emerging Assets on the Rise
In the US, there is more evidence of interest from global funds, while the inflow from mutual funds and dedicated Latin American funds continues to dwindle. In fact, says Mayes, investors are beginning to take a fresh look at the whole emerging markets asset class. “The EMBI has achieved returns in excess of 15% for the last two years and more people are recognizing that and realizing that they should be involved in the market.”
That is drawing in a lot more cross-over investors from the US high-yield market and from Europe a situation which, says Mayes, “is not about to change.” With 10 years of good performance behind them, the medium-term attractions of emerging markets fixed-income products are here to stay.
From the investor’s perspective, Darby’s Geraghty sees a similar story, albeit nuanced by the contribution of Treasurys and the rebound in Ecuadorian and Russian debt to recent EMBI performance. And he points also to the evidence of greater institutional investor involvement in trading activity – as opposed to inter-bank proprietary activity – as proof of the fact that emerging markets debt is becoming a core ingredient of institutional portfolios and a more mature asset class.
The emergence of a greater volume of institutional buying is, argues Geraghty, creating the conditions for successful new issuance in the longer term. Global funds looking for emerging markets exposure do so through large orders – in the $50 million to $100 million range – which have less impact on price if executed in the primary market. Furthermore, they are not subject to the same bid/offer spreads that they face in the secondary market. These “anchor buyers” are likely to underpin more issues in the future.
Returns, too, underline the extent to which emerging markets fixed income has achieved a new status as an asset class – to the benefit of Latin borrowers. Returns from the last 10 years show the EMBI delivering 13.5%, against 4.5% for emerging markets equities and 7.5% for US high yield securities.
All this has helped sovereigns to complete a substantial portion of their borrowing program in the first two months of the year. Brazil’s near $2.5 billion of issuance has taken care of as much as 40% of its needs for the year, estimated at between $5 billion and $7 billion. And, says Peter West, chief economist with BBVA Securities, Mexico, has “basically covered the public sector’s net borrowing requirements for the year” with a $1.5 billion placement in January.
Colombia, which had a relatively rough reception last year, has already been able to achieve a significant portion of its borrowing. It used an existing issue to raise ?200 million early in January in a move that Fox describes as “opportunistic” borrowing. In all, Colombia has raised ?800 million in the first six weeks of the year. It also has the prospect of a World Bank guarantee for a further $1.2 billion of funding in the pipeline though the World Bank refuses to disclose any details. This would probably be similar to the $250 million guaranteed issue Argentina made in September 1999.
The euro-denominated market has, says BBVA’s Estenssoro, “been easier to access first and, as a result, the portion of Latin American issuance in euros is higher at the start of this year.”
The Order of the Day
With a significant portion of big borrowings out of the way, the market is likely to develop in several directions. Liability management is likely to be the order of the day. In February, Argentina carried out a $4.2 billion swap of existing dollar and peso bonds to readjust maturity profiles (see Done Deal).
Argentina faces a hump in maturities over the next five years and Liebars says debt restructuring should lead to a reduction in spreads, allowing Argentina to issue at lower rates. The debate in the markets is over whether it should take advantage of the situation to raise fresh money – what Dermot Mayes calls the “classic conundrum” of a credit with an improving story.
Whatever the level of Argentine borrowing, there is now room for some of the less frequent sovereign visitors to test the waters. Jamaica has already raised ?125 million and Panama another $750 million. Venezuela will not be under pressure to borrow if – as now seems likely – oil prices remain above $20 a barrel. The government has already spent the windfall from higher prices and could find itself in a tight corner if prices fall.
More interestingly, perhaps, with the sovereign borrowings largely out of the way, it is time for the corporates to come out to play. That was the hope last year, but events conspired to dash such expectations. In reality, says Geraghty, the market was open for little more than four-and-a-half months in 2000. Once the Nasdaq crash hit at the start of April, borrowing opportunities for emerging markets credits dried up. They reopened briefly over the summer, before the August hiatus and the closure brought on by the difficulties in US equity markets from September onwards.
Any borrowers viewing the market from the sunny uplands of February this year need to be mindful of history. There could be political noise coming out of Argentina when Congress returns in March and the approach of mid-term elections in October. The region would take a knock from a sustained drop in oil prices and from any severe economic dislocation in the US.
In any event, says Geraghty, opportunities for corporates may be relatively few and far between. “You can probably count on fingers and toes the number of top, top quality corporate names that can issue from emerging markets,” he says. This reservation probably applies more stringently in Europe and the euro-denominated market, where retail investors want the kind of name recognition that only a fistful of Latin companies can boast.
That has not prevented a number of Latin corporates riding in the slipstream of the sovereign issuers. Besides the $1 billion issue from Telmex, Brazilian utility Light came out with a $150 million issue and Cesp, another Brazilian utility, was marketing a similar deal early in February. Durango, a Mexican paper company, also raised $180 million.
Trebat says the effect of corporate issuance will be “to cap the upside on spread compression.” He predicts that a “tremendous amount” of corporate issuance will compete with the sovereigns as Latin corporates free themselves from the corset of reliance on domestic bank lending and bond issuance. Besides the corporates, sovereigns will be looking at more liability management exercises and also looking for pre-funding of their 2002 needs if the issuing window stays open into the second half.
But the US remains the wildcard threat to the region – and to the world economy. While some Latin America watchers predict a third interest rate cut by the Fed, others see the risk of a serious negative impact from a US recession. For the moment, it seems that threat can be averted, or least mitigated, and that means the Latin borrowing fiesta can continue. LF