by Ben Miller


Despite years of stability and solid gains, Mexico’s economy has been dragged down by troubles in the developed world, especially its northern neighbor. Crisis at several domestic blue-chip corporates has spooked investors. Swap lines from the US and multilateral backing have attempted to provide support, though the government confirmed in February that the country was heading towards recession, announcing a 1.6% contraction of the economy in the last quarter of 2008.


 

Mexico awaits signs of recovery abroad, meanwhile trying to return its capital markets to normal levels of volume, if not prices. Opinions are mixed, and few are able to draw solid conclusions as the global crisis lurches from bad to worse.
“I can’t say I see a strong recovery in 2009,” says Lupin Rahman, vice president of emerging markets portfolio management at Pimco, which had over $747 billion in assets under management globally as of December 31. She notes that an economic rebound in Mexico or EM generally is a matter of resolving core economic problems in the US and other external markets.

Rahman adds that full de-leveraging is a question of several quarters, if not years. Speaking at February’s Cumbre Financiera Mexicana, a LatinFinance event, Rahman explains that the fundamentals of the Mexican economy are strong, though all emerging markets face competition from US high-yield opportunities for investor cash. Credits backed by the US government look especially strong in comparison. Rahman declines to indicate how Pimco is positioned in Mexico, or what sectors might be the most compelling.

“I’m optimistic that conditions are going to be there in 2009,” says Gerardo Rodríguez, Mexico’s deputy undersecretary for public debt, of the local debt markets. He explains that foreign investors looking for EM opportunities could jump start the local markets. However, the key question is how the financial world is going to react to stimuli from different governments.

“From what we’ve seen, it’s going to be a slow recovery,” says Mauricio Jannet, CEO of GMAC Financiera. “Investors are not going to be jumping back into the markets.” Investors are uncertain and see a lot of downside risk in local debt, especially after the failings of several blue chip corporates in recent months. “We’ve seen a few points where it’s looked like a recovery has come, and actually it has gotten worse. That hasn’t helped to steer investors back,” Jannet says.

Suffering most are the export sectors, says Ellis Juan, the IDB’s representative for Mexico, while there may be opportunities for producers of domestic goods that might replace more expensive imports. And despite concerns about corporates following a sharp rise in defaults, he says the risk is not systemic. Balance sheets are in good shape and leverage is relatively low.

“The question is when are the credit markets going to be functioning again,” says Juan. He explains that the credit recovery would perhaps come as late as the second half of 2011, likely lagging a US recovery seen by economists sometime in 2010.

Issuing Issues
A major issue for investors is lingering concern about the corporate sector following bankruptcy amid billions of dollars in derivatives losses. While most analysts see the problem as contained, Darío Oscós, founder and senior partner of Oscós Abogados in Mexico City, says there is more distress to come. The crisis should be a good test of the new concurso mercantil framework, adds the banker, who specializes in restructuring, creditors’ rights, insolvency, litigation and arbitration.


 

“The problems have little to do with the businesses themselves, but with decisions related to derivatives,” says Felix Boni, head of analysis at HR Ratings. He notes that corporate management in Mexico has been highly regarded by international investors.

“Corporate problems have been totally revealed,” adds Jorge Alegría, CEO of MexDer, the Mexican derivatives exchange, not foreseeing any further derivative blowups. And the corporate derivative experience has not all been bad, he says, pointing to Pemex’s use of oil price hedge and cross-currency swaps.

Borrowers meanwhile have few options, and remain at a standoff with institutional investors. It is mostly a problem of confidence, say market participants. Despite the fact that investors are cash rich, issuers have not been willing to adjust to the new prices.

“We’ve gone back to 2000, in that only Triple A issuers can come,” says a Mexico City-based DCM banker, who adds that tenors are also squeezed. As before the crisis, lack of liquidity in the secondary markets complicates the situation.
“The most important problem is the lack of a secondary market,” says Leonardo Pin Fernández, CIO at MetLife Mexico, which manages more than 100 billion pesos. If the secondary market were more developed, confidence would be higher now. Issuers have not accepted the new terms, which is why Pin Fernández says he and his fellow institutional investors are not buying.

Lack of information and transparency compounds the problem, explains Sergio Méndez, CIO at Afore XXI, which manages about 60 billion pesos. Investors will discriminate more than in the past, even among Triple As.

In late January, Coca-Cola Femsa priced a 2.0 billion peso 13-month bond at the TIIE rate plus 80 basis points, the first corporate bond of the year. Pricing came 82 basis points wide of where sister unit and fellow AAA issuer Femsa placed a 1.5 billion peso 2011 bond in May. As much as half of the Coca-Cola Femsa deal was bought by leads Banamex and HSBC through their retail divisions, according to a banker who managed the transaction.

Retailer Liverpool, one of a small number of AAAs making use of the commercial paper market, sold 700 million pesos in one-year CP at TIIE plus 150 basis points in February. A 13-month bond from bottler Arca was set to issue in late February, expected by local DCM bankers to price between both. Pricing will be more difficult than Coca-Cola Femsa without similar retail support, according to bankers.

“To be successful now, you have to be generous on pricing to get the volume,” says a Mexico-based DCM banker. When issuers begin to realize this, the market can open and confidence can return, the banker adds.

Confidence Shock
“You have an issue of confidence that needs to be broken by good names accessing the market,” Rodríguez says, noting that Hacienda is working with quasi-sovereigns like Pemex and CFE to try and fix this. Such issuers could get 10 year tenor in the local market, he says, but may have to look at 3-5 years first. He explains that other corporates should follow, provided they accept a new pricing scenario, and this would return confidence to markets, resulting in more issuance, perhaps as soon as the second quarter.

Pemex managing director of finance and treasury Mauricio Alazraki says Pemex is considering a local markets issue this year, though he declines to state target tenor or price. International markets are still open for high-quality names, adds the official, whose company issued $2 billion in 2019 bonds in February. Relationships with banks will be more important than ever, characterized by a need to establish a strategic alliance with an institution that can deploy balance sheet in support of an issuer. In both the international and domestic markets, dialogue with the buyside is also more important than ever.

“Issuers are going to have to be responsible and work with investors,” Jannet says. He adds that there is a need to show that the issuer’s capitalization levels are sufficient and provide enough data to let investors see for themselves, rather than blindly relying on ratings, as in the past.

Javier Nájera, managing director at Ixe’s corporate bank, notes that retailer Comerci was still rated AAA on a local scale when it first filed for the concurso mercantil bankruptcy process. In addition to increased transparency, there is also opportunity to get rid of a few lingering bad practices.

“I can’t believe we’ve had issues of three, five or 10 years that don’t have covenants,” Pin Fernández says, noting that the same issuers would put them on their overseas deals, because foreign investors demanded them. Specific covenants depend on different issuers and structures, he says. Greater negotiation is now taking place between investors and issuers.

“If you look at the Afores before the crisis, the most diversified one had 30%-35% in government securities,” says Pin Fernández, when asked how much longer he and other institutional investors could continue purchasing government paper instead of corporate issues. A pension fund in any other part of the world will only have about 5%-10% in government securities, he explains.

“Here in Mexico we need more papers to diversify the portfolio,” Pin Fernández says. “This is especially important now, but the problem was out there before the crisis.”

Some Mexico-based bankers speculate that Europeso issuance could lure investors back. However, issues by Lehman and Kaupthang Bank will make the buyside think twice.

More Support Please
More help could also come from outside. Multilaterals in particular need to show greater flexibility and creativity in aiding Mexico and other countries, explains Rodríguez.

“They could do a lot more,” the Hacienda official says. “These institutions need to prove their worth in current times – supporting sovereigns and supporting financing packages. When you look at the different initiatives in some of the developed markets, we have not seen anything from multilaterals to take them out of their regular lending programs in the order that the current situation requires.”

Rodríguez says there are a number of products that his government has been trying to engage the multilaterals in on a bilateral basis. The IDB’s Juan agrees that more needs to be done, noting the unprecedented scale and quick timing of the crisis has complicated multilaterals’ efforts to act quickly.

The IDB has been active so far in aiding Mexico’s mortgage sector. It signed a $500 million 25-year loan for Sociedad Hipoteca Federal (SHF), part of a $2.5 billion credit facility, and made $150 million available to Mexican mortgage lenders along with a similar IFC facility. SHF is working on a return to long-term debt markets, perhaps international, to help meet around $1 billion in medium and long-term funding needs this year.

“We are talking with the IDB about a guaranteed product to issue overseas,” says Pedro Guazo, CFO of SHF, adding that the target tenor would be 10-15 years. He explains that SHF will maintain short-term debt auctions and raise medium-term funding. Guazo says SHF not been in the long-term markets since 2005.

Guazo says SHF is very close to offering mortgage issuers’ crédito puente construction loans the same guarantee it can for RMBS. SHF hopes such a “borhipuente” will be more attractive to investors, and hopes to have it ready by mid-year. Mortgage issuers have struggled to issue this product, a key source of funding in the homebuilding process.

SHF will continue its backstop of up to 80% of issuances to issuers. It did this for Su Casita’s issue in December. Guazo could not say whether it will use this facility again this year, given the uncertainty issuers face. Before the crisis SHF saw 2009 mortgage demand at 1.2 million, and now is at looking at 1.0 million for 2009, Guazo says. With lenders such as Metrofinaciera having difficulties raising funds, some in the market have question how far SHF should go in propping up the market

“We don’t think it’s an artificial market, we think the demand is there,” Guazo says. He explains that demand from the market makers for the paper SHF has bought has increased since November.

Solid Fundamentals
Investors remain confident in Mexico’s fundamentals, and say strong growth and continued improvement in the local markets will continue. “Mexico is definitely a country that most investors would feel comfortable in, as it has great fundamentals versus the rest of the EM space,” Pimco’s Rahman says. However, for non-dedicated investors, making the case for Mexico is much more difficult, especially in a risk-averse environment. Providing competitive returns versus known US names will be a challenge for all EM, Rahman adds.

“Opportunities for investment are very large,” says Juan. “There is a huge need for local suppliers of goods and services to accompany international investment.” He cites investments that Pemex will have to make in the next 5-10 years as an example. Even as the crisis has delayed many projects lined up in the government’s plan, infrastructure still has the largest role to play in drawing and maintaining foreign investment.

“On a risk-adjusted basis, given the nature of the contract we have, we’re happy with the returns,” Jonathan Hunt, vice president in Goldman Sachs’ Infrastructure investment group, says, speaking of his shop’s participation in a 44 billion peso Farac road concession won in 2007 with builder ICA. He highlights the quality of local investors and interaction with policy makers as positive versus other markets worldwide.

Goldman remains bullish in its long-term view of Mexico, Hunt says, despite the effects of the current crisis. He adds that banks have yet to take out the 32 billion peso seven-year financing obtained to purchase the roads concession.

“We took a view that the market [Afores and other institutional investors] would be there until refinancing, and we have enough term on our loan that we think that is going to happen,” Hunt says of the Farac takeout. Ideally it would be done locally, he explains, but Goldman is prepared to look everywhere.

“I think [the loan holders] appreciate that we’re incredibly focused on refinancing in a reasonable timeframe. This will be done over time, and we will be opportunistic,” he adds. Hunt believes Farac could be replicated in the future – if not necessarily under current market conditions – as the assets will remain attractive to the local markets. “In order to be an investor in Mexico, one must have a long-term view,” he affirms. LF