A new reality is being forced upon Latin America as the
regions cross-border debt markets remain all but seized
In recent months the markets key variables pricing
levels, deal structures, as well as borrower and investor
profiles have changed beyond recognition. And the
regions most prolific borrowers are finding it nigh on
impossible to issue long-dated debt while at the same time
being forced to pay punishing premiums on what they can push
The speed and scale of the collapse even relative to the
ongoing rout in developed markets is staggering. For the
first time since spring 2005, spreads on Latin sovereign bonds
have widened well above non-investment grade US corporate debt.
Latin spreads in JPMorgans emerging markets bond index
global (EMBIG) rose from 209bp in January 2008 to a staggering
693bp a year later; their emerging market corporate index
(CEMBI) shot up to 965bp from 320bp in January last year.
The bull years have ended dramatically, says Luis
Costa, EM debt strategist at Commerzbank. The marketplace
has now forced the asset class into completely new territory in
terms of risk premiums, liquidity as well as bid/offer
At the onset of the credit crisis in August 2007, sell-side
analysts for months persuaded their clients that markets once
again would become hospitable to high-rated private-sector
borrowers willing to pay the premium. Debt bankers meanwhile
argued that the new issue market would bounce back before too
long, and that higher premiums would be manageable for
low-leveraged investment-grade borrowers.
They were living in a different world before Lehman
Brothers collapsed, claims Costa.
The new reality since September 2008 is a far cry from the
preceding era of abundant liquidity: between 2002 and 2007,
investors ventured down Latin credit curves, and emerging
market issuers were able to demand aggressive pricing terms;
even conservative investors were snapping up corporate paper
and local currency assets.
But as Wall Street imploded following Lehmans demise,
emerging market cross-border debt issuance ground to a halt.
Markets remained closed until the end of December when Mexico
surprised investors with a $2 billion, 10-year global bond,
priced to yield 5.98% or 390bp over US Treasuries, representing
a premium of around 40bp. A year earlier, Mexico priced a $1.5
billion issue due 2040 with a 170bp spread in January 2008,
with an impressive 9bp10bp premium.
The first full trading week of this year saw a flurry of new
issuance as Latin borrowers sought to fulfil their funding
needs for the year, taking advantage of what they saw as a
moderate recovery in risk appetite.
Brazil launched a $1 billion, 10-year bond to yield 6.127%,
370bp over US Treasuries, paying around a 50bp premium. The
same day, Colombia priced $1 billion, 10-year notes with a 40bp
concession to yield 7.50%, or 502.9bp over US Treasuries.
Quasi-sovereign companies Petrobras, Codelco and Pemex also
took the opportunity to issue $4.1 billion in total an
amount that compares favourably with the $9.5 billion issued in
34 corporate deals in 2008.
Some saw the dealflow as evidence of a resurgence in risk
appetite for high-rated borrowers. These large deals show
there is an impressive amount of cash on the sidelines for
high-quality credits, said one US investor who snapped up
Mexican, Brazilian, Colombian and Petrobras paper.
But Brazils January deal was far from ideal, dogged as it
was by a dispute over pricing. Bankers were forced to widen
their pricing guidance from 330bp to 375bp. And a tussle
between the lead banks and investors over the size of the
premium meant the deal took a whole day to execute
compared with two or three hours under normal market conditions
for typical Latin sovereign transactions.
The deals fraught execution underscores the perils of
determining market clearing levels for new benchmarks in the
wake of Latin primary markets closure late last
A month later Mexico, having successfully opened the door to
Latin issuers in December, came to the market again. This time
the sovereign sought to issue between $1.5 billion and $2
billion through a five-year tranche and a new 21-year
benchmark. But the latter idea failed: there was only $600
million of interest in the long-dated paper, even with a
proposed new issue premium of around 65bp. Instead Mexico was
forced to price a large $1.5 billion 2014 bond bucking
its six-year trend of issuing benchmarks with strategic
extensions in the long-end of its yield curve.
In contrast, that same week Cisco Systems, the investment-grade
US communications company, printed $4 billion of new paper,
showing up the divide between prolific US high-grade borrowers
and emerging sovereigns deprived of market access for new
long-dated paper. Ciscos 10-year, $2 billion notes paid
4.95% with just a 200bp spread, and its other $2 billion bond
was priced with a 30-year tenor and a spread of 225bp.
The primary culprit [for Mexicos cancelled
long-dated bond] was supply indigestion, says Siobhan
Morden, Latin American debt strategist at RBS Greenwich
Capital. She argues that an oversupply of Mexican risk was
deterring fresh cash following its $2 billion deal in December
and the $2 billion offer from Pemex, the quasi-sovereign oil
company, at the end of January.
The Pemex deal was the largest dollar-denominated Latin
corporate bond since the first half of 2006. But even here the
market cheer was muted: the deal was supported by local funds
that helped in wangling a 13% all-in yield in pesos through a
As Anne Milne, head of Latin American corporate bond research
at Deutsche Bank, explains, the deals high spread
at 570bp over US Treasuries reflects the
less-than-supportive environment for corporate
Sam Finkelstein, emerging markets portfolio manager at Goldman
Sachs Asset Management, notes that investors were disappointed
by Mexicos perceived lack of transparency about its
funding plans as the sovereign unexpectedly flooded the market
with new paper as well as Pemex risk. It is important to
know what your funding needs are before you come to the
market, he says.
Emerging sovereigns are likely to raise more international cash
this year to fund fiscal stimulus programmes and provide dollar
liquidity for corporates deprived of capital market access.
HSBC estimates that borrowing requirements for Latin sovereigns
will rise from an average of 1.1% of GDP to 2.8% over the next
year. A glut of sovereign issuance could curb the investor
capital available for corporate paper. Finkelstein allows
worries that the anticipation of new supply could cause
volatility in secondary market allocations to outstanding
If supposedly safe Latin sovereigns are facing a
struggle on both execution and pricing of their debt, its
hardly a surprise that prospects for the corporate bond market
are ever more dim.
In the fourth quarter of 2008, investors redeemed $8.3 billion
from dedicated EM debt funds, according to ING. This savaged
Latin corporate debt trading volumes and sucked the liquidity
from the marketplace. Practically every yield curve repriced
higher, and so reduced the appetite to place new paper, notes
Costa at Commerzbank. After the tumult, there has been a
moderate improvement in market tone and some hard trading in
cash bonds in the first few months of the year. After exploding
to over 1000bp in November, JPMorgans EMBIG is now around
But questions remain over whether investor enthusiasm for
credit risk is back, or whether as seems more likely
improved technicals are simply causing a bear market
rally. Joyce Chang, head of emerging markets strategy at
JPMorgan, argues: More supportive technicals, including
oversold positions, high cash flows, and a cessation of
outflows, have contributed to allow EM sovereigns to tap the
international capital markets [in January].
Kieran Curtis, fund manager of around $750 million in two
emerging market debt Sicavs for Morley, notes that the
slowing pace of redemption requests and cheapness
of some cash bonds has led to spread compression but the
primary market is essentially in cardiac arrest.
Despite global monetary and fiscal action, negative feedback
loops from the financial world to the real economy are
intensifying, and markets are day by day stunned by the flurry
of negative data.
The market is awaiting an avalanche of rating downgrades and
debt defaults over the next 18 months that will affect pricing
and risk appetite for corporate credits. As a result, investors
are now underweight Latin debt and are reluctant to add
new risk for corporates, says Blaise Antin, head of
research for the $1.9 billion TCW Emerging Market Fixed Income
Fund in Los Angeles.
In fact, the recent supply of sovereign paper may not pave the
way for high-quality companies to launch new deals anytime soon
since recent issues are trading below their fixed reoffer
prices. Getting any significant traction out of the
non-investment grade corporate market is highly unlikely,
says Victoria Miles, co-head of EM corporate research at
She says there is a possibility that cash-strapped lower tier
credits might issue if there were big reverse enquiry offers
and the deal was small between three to five years in
maturity and provided extremely tight debt
The emerging market investor base has shrunk dramatically as
cross-over investors retreat and as smaller EM bank franchises
and institutional funds beef up redemptions and plough into
The high-yield issue in March from Jamaican phone company
Digicel is a case in point. The single-B rated issuer issued
$335 million from an initially proposed $435 million to yield
15% on a conservative five-year maturity that can be redeemed
by the issuer in three years.
Bankers estimate the new issue premiums range between 200bp to
300bp for high-yield emerging corporates. Even the perennially
optimistic sell-side admits prospects are dire for primary
market access for debut issuers or lower-rated borrowers.
I would be totally irresponsible if I told these guys to
come to the bond markets, given the persistently high
yields, says one Latin debt syndicate banker from a US
bulge-bracket firm in New York. The political
consequences of entering the external debt markets would be
difficult for any funding official trying to justify high
premiums to their CEO.
Despite the structural strength of many Latin borrowers with
their low leverage and improved risk management, issuers are
now being severely punished by the violence of global credit
markets. Cross-border debt markets are now seen as an expensive
funding source for corporates rather than a lucrative means of
raising large amounts of cash to a global investor base.
The million-dollar question is how many years this crisis
has knocked back the emerging debt market, says Costa.
I think it will take many, many, many years for spreads
to normalize and for primary markets to open once again for