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Archive, 1998: The Debt Roulette

Jan 1, 1998

Asia’s crisis shocked investors and drove liquidity out of the market and volatility through the roof. Will Latin American debtors be able to refinance or repay their maturing obligations in 1998?

By Leon Lazaroff

Faced with $170 million in debt coming due in 1998, Guillermo Gotelli, the straight-shooting president of Argentine athletic footwear company Alpargatas, had a cold realization: because the extreme turmoil in Asian markets was likely to keep international volatility high and liquidity low well into the year; unusual measures would have to be taken if his company were to cover its debts. In short, extraordinary conditions required extraordinary actions.

Instead of going to the international bond markets in December for a previously planned sale of $176 million of seven-year bonds, Gotelli went to his board of directors to lay out a three-part plan: early in 1998, Alpargatas would issue $80 million in new equity, followed by the sale of some $50 million in real estate assets, and later a syndicated bridge loan for roughly $100 million.

"The markets are not there, and they won’t be there for a while," said Gotelli, whose company’s operations also include textiles, engineering, retail and fishing. "Right now, you have to be more creative in adapting some of these instruments to the current realities of our countries."

And right now, those realities are harsh. While Asia has all but tanked, Latin America is feeling the wrath of rising interest rates, plunging bond prices and markets with less liquidity than the Sonoran desert. With global investors wary of emerging markets and suspicious of highly leveraged firms, the region’s corporates and sovereigns are taking whatever actions are necessary to prepare themselves for what could be a very trying year,

Ironically, 1998 wasn’t shaping up to be such a tough year for debtors, either corporates or sovereigns. Take Brazil, the region’s economic powerhouse and its biggest domino. After watching his country make good on $22 billion in external debt, public and private, in 1997, Banco Bozano Simonsen fixed income analyst Armando d’Almeida insists that Brazil should have little problem financing the $12 billion in maturing obligations ($3 billion in international bonds, and $9 billion in bank debt, long-term trade finance, Ex-Im Bank, World Bank and Paris Club debt) that will come due in 1998. D’Almeida argues that interest rates—lowered to 38% in mid-December after having been increased from 20% to 43% in late October—should continue to fall, that direct foreign investment should top $25 billion, and most Brazilian companies already have enough cash on hand and projected revenues to meet their obligations.

"We won’t have the same pressure that we had during this year," said d’Almeida. "We will not have the same number of companies accessing the international markets, and the companies that will do that will be the top companies in their sectors."

That’s the upside. But while many Brazilian firms are respected as worldwide caliber, investors nonetheless remain cautious. Brazil’s domestic debt is $70 billion, public sector and current account deficits are 4% to 5% of GDP, and talk of a currency devaluation—even after the November $18 billion fiscal package—continues at a steady and annoying beat, More important still is worldwide liquidity. Regardless of the strength of individual corporates, for the short term the money just isn’t there.

The bottom line is that Latin American corporates and sovereigns are squarely on a collision course with the world’s other emerging markets for a limited supply of cash. Not only will Latins be competing this year against each other to issue and refinance billions of dollars of debt—some $18 billion in Latin bonds alone will mature in 1998, not counting bank debt and other bilateral and multilateral obligations—but Asians, Russians and Eastern Europeans will be battling for that money as well. Korea alone is estimated to have over $90 billion in external debt, public and private sector, coming due in the next year.

"All these countries are competing for the same pool of capital at approximately the same price range," said Allen Vine, Latin American corporate debt analyst at Merrill Lynch. "What used to be a seller’s market is now a buyer’s market. Everyone is raising rates and everyone is saying 'please pick me.’"

With their backs against the wall, Asian corporates and sovereigns will start the year under heavy pressure to meet gigantic short-term debt obligations from private creditors, neighboring countries and international lending organizations. Throw in demand for dollarized Russian GKO bonds and liquidity looks very tight. On the financing side, spreads are likely to widen and volatility to remain high, leading to expensive pricing. Commercially, Asian corporates are expected to heavily discount their exports, thereby putting additional pressure on competitors in Brazil, Mexico and the United States.

"Even if there are no more exogenous shocks, i.e., problems with Asia’s IMF rescue packages or turmoil in Japan’s banking system, Latin American markets will still be hard pressed to supply the type of financing corporates are hoping to access," said David Tapp, vice president in emerging markets research at ABN AMRO Bank.

All this adds up to a bruising debtor’s battle. Across emerging markets, high spreads for sovereign debt have all but pushed corporates out of the market—at least for the short term. While Argentina did manage to pull off a 300 billion lira note followed by a $500 million bond, those deals were viewed as isolated cases owing as much to the demands of the lira market as Argentina’s solid reputation in bond markets. Besides those two issues, emerging market borrowers spent the final 100 days of 1997 in a deep freeze,

The dried up liquidity became apparent in late October when Globopar, the Brazilian pay-TV group, was forced to pull its $300 million bond deal. Investors liked the deal, but not the timing—the launch was scheduled for the day Hong Kong’s troubles signalled more problems in Asia. Globopar, though, was able to get bridge financing. In Argentina, steel maker Siderar was forced to postpone a $100 million bond issue. And Peru, which expected to sell about $260 million in bonds at the end of the year, also shelved its plans.

Other issuers, such as the Mexican cement maker Cemex, sit on the bubble. While the Monterrey-based firm has historically shown proficiency at surviving crises by using revenues from exports and foreign subsidies to offset foreign currency shortages, the year-end market situation has prompted red flags to be raised about Cemex’s overall debt—a whopping $5.2 billion. Of that, $757 million is made up of short-term obligations—bonds, commercial paper, trade finance loans—that will come due in 1998. For its part, Cemex argues that its diversified geographic cash flows, $402 million in cash on hand and a $600 million banking facility secured last spring, are good enough to relieve investor worries. (It was apparently enough to convince Standard & Poor’s to upgrade Cemex to BB+ from BB on November 25.) Nonetheless, Cemex is being closely watched.

"In the case of a recession, they would have problems," said Anne Milne, head of Latin American corporate debt research at ING Barings. If the markets are open, fine, but if there is a situation like '95, how would they finance that debt?"

That’s a question being asked throughout the region. Few doubt that in a normal year, if there is such a thing, Cemex and companies in similar situations would have little problem paying off their debts. But the crisis in Asia changed the rules of the game, and in the process brought Latin America’s impressive comeback to a wrenching halt.

Surprise Setback

Ironically, Latin America thought its most formidable financial battles had already been fought. Having paid dearly for the "Lost Decade" of the 1980s, and the "Tequila Crisis" of 1995-1996, Latin companies large and small took comfort in 1997 as the region enjoyed 18 months of liquidity and investor favor. The coming year will likely have little in common with the one just finished.

During 1997, Latin sovereign issues tallied in excess of $30 billion by mid-October, $5 billion more than the entire 12 months of 1996, according to Steven DeSalvo, managing director of emerging markets debt syndicate at BankBoston. Latin corporate debt issues totalled $15 billion for the first eight months of 1997, nearly matching the $16.4 billion total for the previous year. In fact, corporate debt as a percentage of total issuance in the region increased from 35% in 1995 to 48% in 1997.

The story of a recovering Latin America played particularly well. Brazil’s $8 billion in corporate issuance accounted for 24% of all emerging markets corporate debt, followed by Argentina at about 16%, and Mexico in third place with 14%. Indonesia and India were next in line. For 1998, however, most observers don’t believe corporate issues will even reach $8 billion.

"The pipeline for new financing, for all but the top-tier companies, is shut," said Chris Taylor, Latin corporate bond analyst at Bankers Trust. "And even those top companies are going to have to pay significantly to issue bonds or refinance maturing debts."

Such talk has become commonplace. The lingering possibility of further global economic shocks has degenerated into the expectation that the end of Asia’s bloodletting is not yet in sight. During the final months of 1997, spreads tripled on many of the most well-respected Latin bonds and a number of bond issues had to be postponed.

"It’s very difficult for anyone to go out and borrow," said Arthur Byrnes, president of Deltec Asset Management, whose firm manages $800 million in the region. "The crisis has made everything expensive. It makes it very hard for good companies to pay off maturing debt. And when companies do go looking to roll over debt or access new money, investors will be looking for higher-than-usual premiums."

Without question, Brazil remains the country most susceptible to "Asian contagion." Although investors reluctantly applauded Brazil’s decision to double interest rates in late October, thereby strengthening a currency some viewed as being on the verge of a devaluation, Brazil continues to be seen as a currency risk where a recession is likely. As a result, economic forecasters had little choice but to downgrade growth expectations from 4% to the 1.5% to 2.0% range. Brazil’s future—and to a certain extent that of South America—will depend on how long Brazilian interest rates are kept high to stave off worries of a devaluation.

Before March alone, Brazil’s corporate and sovereign borrowers combined will have to find a way to roll over some $5.5 billion in overseas debt (including bank and bilateral debt). The early signs are worrying. At year’s end, spreads on Brazilian bonds were precipitously high. Steel firm CSN’s 9.125% bond due in 2007, priced at 275 basis points over the 10-year US Treasury in June, was being offered at 750 bps in December. Brazil’s 8.875% global of 2001 illustrates the volatility in the market— the issue was trading at 145 bps over Treasuries in early October, but by mid-November had widened to 625 bps, before tightening back to a spread of about 330 in late December.

And concerns about Brazil are likely to spread to Argentina, which sends over a third of its exports to its Mercosur partner. Argentina needs to raise roughly $13 billion over the course of the year.

"Corporate issuance out of Argentina will be particularly difficult at this stage in the ball game," said a somber Ashwin Vesan, portfolio manager at Oppenheimer.

Bank Market Steps In

With international markets all but shut down, banks will be leaned on heavily to supply a variety of bridge loans. Already, Mexico’s Grupo Elektra received a syndicated five-year credit for $150 million in a deal led by Citicorp, and Telecom Argentina was forced to secure a $100 million loan from Swiss Bank Corp. to help repay a maturing bond. But these were two well-structured deals for firms with excellent track records. On a larger scale, can domestic banks be expected to pick up the slack caused by the virtual year-end shutdown in world bond markets?

While Argentine banks held deposits of a record $67 billion in mid-November, interest rates had doubled to as much as 30%, putting a tight squeeze on the private sector, especially smaller companies which have been forced to pay interest rates 200 basis points higher than those charged to large companies with good credit ratings.

"Ironically, Argentine banks have had the money, they just haven’t found that many worthy borrowers," said Buenos Aires economist Pedro Lacoste. "The triple-A companies have been able to go to foreign markets while small and medium companies have a very short track record and don’t have the necessary transparency to make good risks."

For larger companies with good borrowing records, Lacoste is confident Argentine banks, led by foreigners Banco Santander, Banco Bilbao Vizcaya and HSBC, can cover the difference, "These are new banks eager to get new business," added Lacoste. But that’s money available for the top-tier international players. Meanwhile, small and medium companies throughout Latin America are feeling a particularly tight squeeze.

Take Mexico. With vivid memories of the $45 billion in bad loans the government was forced to take over following the 1995 peso crash, Mexican banks are greeting smaller firms at arm’s length—at best. As a result, loan growth in Mexico has been decreasing as domestic banks try to shore up their balance sheets. But large companies, aware that international markets usually can be counted on to provide better financing, often are able to negotiate acceptable financing terms with domestic banks eager for good clients.

Overall, Latin banks are seen as a source of refuge. In the larger countries, analysts are confident that at least for the short term, domestic banks, will be able to meet the refinancing needs of larger corporations. "Where market financing isn’t available, bank financing will be," said Matthew Peck, vice president in corporate bond research at Salomon Smith Barney. Of course, rates might be higher and there might be certain conditions placed on loans.

As a result, corporates are likely to turn to an old standby—structured deals that tie some revenue stream into the bond issue, such as export receivables. Brazilian steel company Acesita received $50 million from Bank of America in early November collateralized by export receivables, and Aerolineas Argentinas secured $50 million in bonds backed by future ticket sales.

But even with spreads high and volatility rambunctious, Latin corporates can take solace in knowing that they are not in Asia. While the lessons were hard, and in many cases fatal, Latin companies have spent much of the past three years learning to appreciate the importance of market liquidity and a clean capital structure. That is, avoid lots of short-term debt. "The Mexicans learned the hard way, and face it, they’ve been excellent students," added Taylor.

Hylsamex is a good example. Last summer, sensing that markets were peaking, the firm, a subsidiary of Grupo Alfa, refinanced a $175 million obligation that was to come due in February. Gruma, Mexico’s largest corn flour producer, was faced with $125 million in maturing debt in 1998 but pulled together a $250 million issue in early October, also receiving a ratings upgrade to BBB- from Standard & Poor s. "They were smart to take advantage of good market conditions knowing that those conditions don’t last forever," said Peck of Salomon.

Mexico successfully refinanced some $22.6 billion in public and private debt that came due in the second half of 1997, according to economist Jonathan Heath of LatinSource. In the coming year, Mexico’s obligations will be a relatively more manageable $18.4 billion—most amortizations are with multilateral creditors. "Mexico should have no problem at all," agreed Oppenheimer’s Vasan.

Room for Optimism

While the market will be competitive, the prospects for Latin American borrowers is by no means apocalyptic. Barring a frightful turn in global markets, observers contend that most of Latin America’s major corporates should be able to find ways to pay off or roll over maturities in 1998.

By a stroke of fate, Brazilian corporates, which only entered international markets in big numbers starting in 1996, may have escaped a severe economic crisis simply by having been refused access by world financiers. "They just really haven’t had a chance to leverage themselves to the hilt and get into trouble," said Taylor. Although Multicanal Participações and Companhia Siderúrgica Nacional (CSN) both have a high level of short-term debt, Taylor argues that their equally high levels of cash should serve as a sufficient cushion, barring a severe economic slowdown. "The gamble is that there isn’t a devaluation, which I think is a reasonable gamble," he added.

Keenly aware of the pressure on corporates to pay off maturing debt in the first six months of 1998, Brazil’s central bank reduced the minimum maturity on debt issued to roll over maturing paper to six months from three years, and shortened the required tenor on new deals to one year from three years.

Still, the $8 billion issued by Brazilian corporates in 1997 seems minor compared to Korea, whose corporates issued $35 billion in debt during the first nine months of 1997. While Brazilian firms must be careful about their debt obligations, the country does not face the much harsher remedies of Korea, which faces short-term debt of $60 billion. "Brazil doesn’t have those kinds of numbers," said Joyce Chang, director of emerging market research at Merrill Lynch. Argentina, meanwhile, has the benefit of a healthy banking system and the knowledge that its government has secured a $2 billion back-up facility should the Asian crisis get out of control.

Paul Tregidgo, managing director for Latin American capital markets at Credit Suisse First Boston, likes to draw a portrait of a region increasingly able to financially fend for itself. Unlike 1993, he says, Latin American corporates and sovereigns have a much healthier and liquid commercial bank sector to turn to for syndicated loans. As long as the markets don’t slip too far, Tregidgo argues, investors are almost certain to bite into bonds issued to pay for the privatization of Brazil’s massive energy and telecommunications sector as well as large scale infrastructure projects.

As tight as liquidity may ultimately become, Latin America could emerge from the current crisis far faster than Asia, or the region itself following the Tequila Crisis. For as much as liquidity dried up during the final quarter of 1997, a lot of money remains on the sidelines looking for good investments. "If you get the feeling that I’m somewhat sanguine about this, I am," said Tregidgo. "Come the new year, it will be very interesting to see where that cash that has built up will be put to work."

In the age of globalization, getting one’s own fiscal house in order isn’t always enough to withstand financial shocks. Ultimately, the ability of debtors—corporate and sovereign—to cover their obligations will depend on how quickly a mood of ambivalence can turn the corner with a surge of confidence. Those who can wait a little while longer may find financing themselves out of the Asian contagion a whole lot easier.

"The market win clearly be much more selective in the early stages, but provided you have a credit rationale linked to payment of a strong credit statistic or to a concrete story, then the market is going to be there for you," said Milne of ING Barings. "The problem is going to be timing, and therefore flexibility will be so important." LF

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