ROUNDTABLE CAPITAL MARKETS: Window watching

Mexico was one of Latin America’s first sovereign borrowers to access dollar funding in 2016, pricing a $2.25 billion 2026 bond ahead of anticipated market volatility. The Fed lifted the federal funds rate target to between 0.25% to 0.5%, from 0% to 0.25% in December last year, citing stronger employment figures. The Fed’s median forecast interest rate for 2016 is 1.375%, which would translate to four rate hikes by the end of the year. An acumen for timing will be imperative for successful issuers, panelists say.“We want to take the dollar out of the way early in the year given that we see potential increase in interest costs,” says Jorge Mendoza, head of internal and external debt issuance at Mexico’s ministry of finance. “We see volatility arising from the Fed decisions, and we think that a window in the dollar market is going to be much more limited than in the other markets.”

A3/BBB+/BBB+ rated Mexico, which has been looking at alternative currencies to dollars, had completed 80% of its 2016 financing plan by March.

For B1/BB-/B+ rated Dominican Republic, developing its yield curve through regular cross-border and local issuance is part of the sovereign’s strategy to maintain a stable presence in the international and local markets. Pricing of a benchmark dollar bond in January showed investors still have appetite for higher quality sub-investment grade paper as it became the first Latin American high-yield sovereign to successfully tap the dollar markets in 2016.  The Dominican Republic’s $1 billion 2026 note drew more than $2.5 billion in demand.

“As rates increase in the international markets, if we improve our ratings, we will be able to compress yields,” says Magín Díaz, head of public credit at the Dominican Republic’s ministry of finance. “The opportunity is there, and we always have to be ready to go to the markets. It is a good opportunity for countries like the Dominican Republic, which is not investment grade, to keep improving fundamentals.”

Díaz sees potential windows to issue debt in the first two quarters of 2016, despite expectations for rate increases.

High yield picture

As investors put money to work mainly for higher-rated credits, cross-border financing will be more challenging for sub-investment grade corporate borrowers, at least in the first half of the year, says Darío Arango, chief financial officer at Telefónica Colombia.

“Market conditions are really different today than the times that we issued a hybrid bond. At least for the first half of the year, we don’t see an opportunity in the capital markets for a company like ours that is not investment grade. If we have some needs, we expect to access the local banks.” 

Telefónica Colombia sold in March 2015 a unique B/B+ rated 8.5% $500 million non-call five-year hybrid perpetual bond — the first of its kind in the Colombian market and the first-ever hybrid perp in Latin America. Diversifying funding sources through alternative markets, structure and currencies is prudent for sovereign and corporate borrowers, as they look to manage liabilities, extend duration of debt profiles and improve liquidity.

“We are seeing bankers spending time on financial engineering and creatively trying to come up with novel products, which I think generally is a good thing,” says Jorge Juantorena, partner at Cleary Gottlieb.

Mexican global automotive parts manufacturing company Nemak has not ruled out a cross-border high-yield bond issuance, but strengthening its balance sheet is a priority. The company raised nearly $750 million in June 2015 in the region’s largest initial public offering of the year. Some of those proceeds, along with a recent syndicated loan, will be used to improve Nemak’s balance sheet.

“Certainly we want to be open to see if there are any opportunities in the moment and competitive rates to explore the possibility of potentially looking for another bond,” says Nemak Chief Executive Armando Tamez. “We will be open and receptive to see pricing in the market, and based on that make our decisions.”  

Clear view

Transparency will be imperative for Latin American issuers as communication and management credibility becomes increasingly important due to challenging market conditions.

“The only way you can be successful is if you are transparent, because you have a lot of stakeholders that are certainly investing potentially in your country or company. It is key,” says Nemak’s Tamez.

Matthew Riez, head of liability management at HSBC says investor relations activity has increased, including non-deal roadshows and regular annual meetings with investors.

“In terms of trends, we just see so much increase in professionalism in that function, and getting CEOs and CFOs much more involved, people being much more focused on it. It is more for the better, but you should expect to see a continued trend that way.” 

“For many years, corporates in Latin America thought activism wasn’t going to hit them, and increasingly you’re going to see that it definitely does, and you’re in a much better position if you’ve got a good communication strategy and if you’re thinking carefully about how to communicate with your investors,” Riez says.

Transparency can be particularly difficult for companies in distress, says Orlando Loera, former chief restructuring officer at Mexican construction company ICA.

“Generally, I find that companies do a poor job of that. When they’re in distress, the house is burning,” says Loera. “My own philosophy to that is to hide behind the truth. Be absolutely transparent as to what’s going on. What the problems are, what the causal situation is, why the promise can’t be made much less kept, and also indicate plans that are going to take the company out of its problem.”

Sarvjeev Sidhu, global head of emerging markets at Aegon Asset Management, says investors’ highly value continued access to management. Increasing interaction between issuers and their banks is also significant, Sidhu notes, adding that underwriters should regularly report to issuers on how the respective company’s bonds are performing in the secondary market.

“That should be one of your key measures, because if they are not doing that and they are just coming in to underwrite a deal and just walk out of the way, from an investor’s mindset, it becomes problematic whether or not we should be a part of it.”

Lowered volume

Despite expectations for a difficult first half due to volatility and slides in commodity prices, especially oil, Katia Bouazza, HSBC head of capital financing Latin America, says there will be a supply of new dollar issuances and deals in other Latin American currencies and markets.

“We can’t deny that the backdrop is tough, mainly due to commodities driving some of the effects of volatility. But we will see deals getting done, one by one, but we will get them done,” Bouazza says, adding that Latin American issuers that have worked to broaden their investor base will stand out in this year’s market.

Cross-border issuance in January totaled $9.84 billion over four transactions compared to $12.7 billion over seven transactions during the same period last year, according to Dealogic. Cross-border and local issuance in the debt capital markets from Latin America totaled $120.3 billion in 2015, a 41% decline over the previous year, and the lowest volume since 2009. 

Bouazza attributes lower 2015 volumes to lack of deal flow coming from Brazil — historically the region’s largest source of transactions. However, most of the transactions that needed to be completed, ultimately crossed the finish line last year, she says.

“They got done in the equity market, and the loan market remained quite active,” Bouazza says. 

“It depends on market conditions, but issuance [in 2016] is going to be lower than in 2015, and 2015 was lower than 2013 and 2014,” says Aegon’s Sidhu.

Depressed commodity price expectations are leaving many emerging market countries to figure out their growth models over the next few years, while heightened concerns about emerging market private sector debt in US dollars are also prevalent, panelists say.

Argentina presents a brighter picture, however, and is drawing attention from major market players who are eagerly watching the sovereign’s approach to the capital markets after a long hiatus.

“This is real, it is happening. We expect Argentina to come back to the scene, both as an active participant at the sovereign level and the corporate level,” Bouazza says. “I don’t doubt that this year we will see the return of Argentina and Argentine corporates to the market.” 

Aegon’s Sidhu says Argentina must overcome a number of hurdles before it returns to the market. “A resolution to the holdouts is obviously key to get that process rolling, and I think the signal that’s coming out of the new government is that they want to get that process rolling sooner rather than later.”

Stemming the flow

Institutional investor reallocation of funds out of emerging markets will continue to have a significant impact on demand for Latin American credits.

The Institute for International Finance expects that net EM outflows, albeit moderately paced, will be spurred by broader concerns about EM growth performance and corporate debt expectations, it says in a January 2016 report.

“I think the key risk is obviously institutional investors. And reallocating from emerging markets assets into some other assets,” Sidhu, from Aegon, says.

Carlos Legaspy, president at Insight Securities, a private wealth management firm, says 2016 will be “a tale of two markets,” split between the first and second halves of the year. He explains that Brazil, and countries that trade with Brazil, will be in more challenging macroeconomic situations than the Caribbean, Central America, and Mexico – countries that are linked to the US.

“One of the winners from low energy prices is the Caribbean; it is a huge beneficiary and they’re all energy importers apart from Trinidad, and so this is a huge positive for them,” says  AJ Mediratta, co-president of Greylock Capital.

Insight Securities will concentrate on Latin American high-grade corporate and sovereign credits for half of its portfolio and select distressed or troubled credits for the other half.

“We believe that the valuation of some of those securities that are trading on cents on the dollar, it’s attractive in combination with high-grade balance. That is where we are going to navigate in 2016. That is what we are doing right now,” says Legaspy. 

Luc Gerard, founder and CEO of Tribeca Asset Management, a Colombian private equity fund, says the next few years will represent a buyer’s market for equity investments. Gerard sees infrastructure opportunities in Colombia and opportunities within the consumer and industrial goods space across Latin America as the most interesting in 2016.

“If you are looking at Latin America, some of the countries’ current weakness versus the dollar seems temporary versus others that are more structural. So any industry or equity or opportunity currently hurt by the devaluation becomes attractive for buyers,” Gerard says.

Delroy Warmington, managing partner at Delwar Capital Management, a private investment firm, sees potential equity investments within the Latin American telecom industry.

“It is an asset in which scale counts a lot. They do have pricing leverage, because more than a point solution, they are selling a complete solution.”

Mediratta says similar opportunities emerge on the debt side of Latin America’s telecom industry as the sector sees re-pricing as a consequence of money retreating from emerging markets.

Greylock continues to see opportunity in high-yield and distressed credits this year specifically in the energy and commodities space. On the distressed side, Greylock will keep a close eye on restructurings in Brazil, Colombia and Mexico and is evaluating potential high-yield investments across all of Latin America. Greylock, which has both performing and nonperforming Argentine debt exposure, is monitoring discussions between the Argentine sovereign and holdout creditors.

Mediratta adds although US high-yield investors are pulling back from emerging markets, this round of reversal could have a different impact than from the past.

“In the past when we saw that happen, that would shut down the new issue market for high-yield. We will see if that is still the case, because I think that dedicated funds for Latin America are bigger than they were,” says Mediratta. LF