In 1988, there was no Latin corporate bond market to speak of. Instead, companies took opportunistic shots at the market, while sovereign borrowers struggled to pull themselves out of, yet often fell back into, crisis.
A quarter century later, Latin America’s debt capital markets – now the most advanced of any emerging region – offer a sophistication few could have imagined back then. And today, corporate debt markets represent an asset class that is not only a central funding vehicle for increasingly many companies, but also an attractive investment for institutional accounts.
Chile was roundly applauded when it nabbed Latin America’s first investment grade rating in 1992. Now, around three-quarters of the region’s sovereigns have escaped junk terrain. As the sovereign ratings have risen, so have the credit ceilings for corporate borrowers, allowing Latin companies the opportunity to fund through the bond market
The figures prove the point. In the year to July 16, LatAm high-yield and investment grade corporates borrowed $43.9 billion from 66 cross-border deals, according to Dealogic. In 1995, corporate borrowers sold just $1.7 billion from 16 deals.
Cemex was an early pioneer, finding demand for a $100 million 12 non-put three year convertible bond in 1990, the year after Mexico signed its Brady bond restructuring agreement. Petrobras was the first Brazilian company to issue after the 1980s meltdown, selling a $250 million two non-call one year bond yielding 13.5% in 1991 – even before the sovereign rescheduled its debt.
Today, some predict the LatAm corporate bond market will continue growing as sovereigns increasingly borrow in local markets and cross-over investors allocate more to emerging markets to capture the spread on offer.
“Overall the credit markets have developed dramatically and there is no doubt that we’ve experienced a paradigm shift,” says Alexei Remizov, head of capital markets Brazil at HSBC. Investors, he says, can now see the macroeconomic outlook more clearly and have a better understanding of, as well as more certainty and confidence in, the regulatory frameworks for Latin borrowers.
Yet debt from first-time issuers makes up more than a quarter of EM bonds. That offers chances to invest tactically and selectively – but also difficulties, says Robert Abad, emerging markets portfolio manager, at Western Asset Management.
“While the asset class itself may have earned an investment-grade rating years ago – which has served as a magnet for more diverse and sizable inflows in the asset class – under the hood lies a veritable soup of economic and political risk that should not be underestimated given the propensity for it to boil over at any moment,” he says.
Part of that soup includes a growing LatAm high-yield bond market, which brings with it a higher likelihood of default. Already OGX, Grupo Rede, Lupatech and the Mexican homebuilders are notable examples of borrowers missing their obligations. The proliferation of high yield issuance could mean more secured deals, or more aggressive structures, are used.
Many now expect market volatility to rise, after an extended period of abundant liquidity, which encouraged a greater number of low-rated issuers to tap the markets, Abad says.
LatAm blue chips
While the riskier names are growing, so too is the pool of top-quality Latin issuers. The JPMorgan Corporate Emerging Market Bond Index (CEMBI) shows issuance from Latin corporates grew from $11.5 billion in December 2001 to $235 billion in June 2013 (see chart, p12). It has also overtaken the Latin sovereign component of the JPMorgan EMBI Global index, which was $228 billion in mid-2013.
The development of corporate EM bonds has been one of the most important market innovations of the past 25 years, says Cynthia Powell, managing director of fixed-income syndicate at BTG Pactual. “As investors started to identify EM corporates as a distinct subset of the larger asset class, with its own benchmarks and investors started managing distinct, separate EM corporate bond funds, then the market opened up more broadly for a wider range of issuers,” she says.
External issuance by Latin American corporate borrowers has accelerated and is expected grow in 2016, when debt maturities pick up, JPMorgan says. Latin American companies are in acquisitive phases, expanding and investing more than ever before.
Mexican blue-chip América Móvil is a good example. The company increased its stake in Netherlands-based Royal KPN over the years, before announcing in August 2013 a bid for full control. In the debt markets, América Móvil has tapped a variety of funding sources, developing yield curves in dollars, sterling, and euros – in addition to the global-local security that offers the same ease of execution afforded to the Mexican sovereign.
“For the first time, many Latin American companies are beginning to expand internationally and obviously a source of funding for this expansion has been the international debt capital markets,” says Carlos García Moreno, chief financial officer at América Móvil. Local currency markets will grow in importance as demand from institutional investors increases, he says.
But local market development is not comprehensive: high-yield borrowers – especially in Mexico – still turn to the international bond market for funding. “The relative importance of the local markets is growing, but at the same time, we will see more integration with international markets,” BTG Pactual’s Powell says.
The size of institutional investors has increased significantly over the past 10 to 15 years with the growth in particular of the region’s pension funds, says García Moreno. “The growth of institutional investors has outgrown probably the supply of new securities in their local markets and many local players are increasingly pushed to invest in names abroad.”
Factors hindering international debt issuance include: competition from the local markets; domestic bank lending; commodity price moves; exchange rate volatility; political risks discouraging M&A or large investments; and the lack of clear frameworks encourage long-term issuance.
With US interest rates set to rise, and with the economic situation in a number of Latin American countries deteriorating, prices could suffer and yields rise, particularly in local debt markets.
Yet equally, LatAm issuers may face less headwinds than in previous cycles; moreover, international investors are more comfortable than ever with regional credit – a fact that speaks in favor of continued local currency funding.
“Some 15 to 20 years ago issuers had to run a mismatch of currencies to get tenor and size,” says Roberto D’Avola, head of LatAm DCM at JPMorgan. “The development of the local markets has helped reduce mismatches and has been an important force in moments of volatility.” LF