International investors are increasingly looking at Latin America’s local currency markets, but foreign exchange volatility makes the buyside wary of losing any potential gains, as has happened with some recent deals. The mixture of currency and credit risk may be too heady a cocktail for some. Last year investors feasted on Latin American credits in the international markets.
A record volume of $185.2 billion was issued, beating the previous year’s record by 9%. The average deal size also set a new record, up 23% to $453 million. That was all seemingly great news for companies, bankers and investors, but there was a sting in the tail: fourth quarter issuance fell to $30.4 billion – the lowest quarterly volume since the second quarter of 2012. And it has got worse in 2015. By late February, the first quarter (usually the strongest for issuance) had produced just $15.8 billion worth of volume from 12 deals. By comparison, in the first quarter of 2014, 48 issuers raised a total of $43.6 billion, according to Dealogic data.
The main reason for the slowdown is the fallout from the Petrobras saga. The oil company’s inability to publish audited financial results has led to a huge spike in premium for Brazilian credits that, to date, no other company has wanted, or needed, to pay. Other countries have been taking advantage – Mexico’s government opened the markets in January and was followed by quasi-sovereign Pemex. Argentina has already printed two transactions (the same number as in all of 2014), with the issue from the City of Buenos Aires clearly demonstrating the continuing liquidity for Latin American credit. It was four times oversubscribed, despite carrying a rating of Caa2/CCC- and coming to market in an election year. Energy company YPF’s deal was also interesting, in that it generated large demand but showed the greater importance of establishing a decent benchmark rather than capturing size. Bankers close to the deal reported that YPF could easily have sold more than the $500 million it printed but it preferred to close with a tighter price.
The transparency of international issuance makes it the preferred asset class for judging investor appetite for the region. But it doesn’t tell the whole story. International investors have increasingly been participating in local currency transactions – some through offshore global local currency transactions, some through synthetic structures such as global depositary notes (GDNs), but also as buyers of local currency debt in local markets. That trend has been developing for a while and is, in some markets, being encouraged to add competition to concentrated local markets’ buysides, with the aim of producing better pricing levels for local corporates and governments.
Mexico is leading the way. Its sovereign deals have been Euroclearable for years but it has just opened up this international investor-friendly feature to corporate issuance in the local market. In February, Pemex became the first corporate (it is classed as such) to issue a Euroclearable tranche, which incorporated other international investor-friendly features such as gross-up withholding taxes (essentially paying the international investors’ taxes). Again in Mexico, AMX – a true corporate – has pioneered a Global MXN bond which links international and local investors in a completely homogenous structure – denominated in local currencies. Both deals ticked many of the international boxes: scale, liquidity and issued in a fully-convertible currency. These innovations crucially built on the growing international interest in local market deals as investors – starved in yield in the developed markets – looked for EM sovereign returns.
International investors now hold more than 40% of local sovereign debt and as they became comfortable with the local currency risk it led many to hunt for yield pick-up, and a quasi-sovereign oil company and one of the world’s largest and strongest Telcos were natural targets for added local currency risk. Critical question However, the critical question for the development of Mexico – and other Latin American local debt markets, which have all, albeit to a lesser extent, seen an increase participation of foreign holdings of local sovereign debt, is whether international investors will want to extend into private credit markets. In essence, will these investors start to mix currency risk with credit risk?
“In our dialogue with investors, their response to this question is that they can only deal with one of the variables at a time,” says Carlos Corona, director of global finance, Latin America at Barclays. “So if they are taking currency risk then they can’t also be worried about credit risk, and that means they will not look to extend outside the sovereign risk. But on certain occasions, where appetite is so strong for yield and for risk, they have been willing to put that strategy aside and mix local currency and credit risk.”
Appetite rose in the middle of 2014, says Corona, “when we actually received quite a lot of reverse enquiries from real money accounts – big investors – who wanted local currency credit product.”
Dan Vallimarescu, head of Americas DCM, Santander Global Banking and Markets, says the jury is still out on whether the international investors will mix the two local risks. “There have been differing initiatives in the past couple of years,” he says, emphasizing that a third risk – liquidity – has also been preventing a large increase in international participation in local markets debt.
“For example a Mexican company used the GDN process to get investors in and I think this new Euroclearable format is an improvement on the GDN construct, which quite honestly doesn’t provide the necessary liquidity for international investors as it is complicated to unwind.”
He says that although the new Euroclearable corporate structure is an improvement, it is not yet clear whether pure corporates will be able to use it or not. “Initially that deal worked well in terms of the amount of foreign interest that was generated but it remains to be seen whether pure corporates will be able to avail themselves of this structure,” he says.
For the full article – and for articles about the domestic debt capital markets in Argentina, Brazil, Chile, Colombia, Mexico and Peru visit Euromoney’s website