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Latin America | Sorting through the wreckage

| May 1, 2020

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

Issuance of debt in Latin America has surged with sovereigns pursuing deficit financing to compensate for the Covid-19 shock. But only issuers with ‘BB’ or higher ratings have had this option, with lower credits leaning toward forced savings through default. Credit quality has shifted with consistent rating downgrades across the region, the negative ratings a lagging indicator of the intensity and duration of the external shock. Low commodity prices remain a serious constraint on liquidity and solvency for the region, especially for credits without domestic financing options or with large gross financing needs. The IMF emergency funds are insufficient and government programs inconsistent, with tension between spending on social services and averting downside risks to growth. It is not pretty.

The uncertain policy management of the larger credits like Brazil and Mexico raises political risk from their inability to immunize their economies against these shocks.  The broad decline in credit ratings suggests no quick reversion back to previous spread lows and a continuing eifr divergence between the higher quality credits such as Chile, Peru, Panama, and the lowest quality credits such as Ecuador and Argentina. This argues for careful credit selection and caution around higher idiosyncratic risks and lagging downside credit risk despite the improving tone across external markets.

There has been resurgence in debt accumulation with a line-up of sovereign issuance including Paraguay, Mexico, Guatemala, Peru and Panama. The emerging markets issuance in April reached $90 billion after only $19 billion in March with select issuers taking advantage of the relative external stability. However, many credits had to offer hefty premiums of 50 bp to 100 bp with spreads adjusting wider to absorb the supply for all the new issues except Peru and Mexico, at least in a month-over-month comparison.  The market access has also been restricted to only credits above ‘BB’ ratings or yields below 6%.  These new issues are all trading above re-offer in the secondary markets; however only Mexico and Peru are trading at tighter average spreads compared to weighted pre-issuance levels on April 1.   This suggests higher funding pressure for the ‘B/BB-‘ credits if they are unable to rely on domestic capital markets or multilateral lenders, with the larger of these weak credits more vulnerable for their higher gross financing needs.

The credit quality has shifted across the region with nine countries downgraded this past month and two countries, Columbia and Mexico, now on the lowest tier for investment grade at ‘BBB-.’ Four countries are in the de facto default category: Argentina, Belize, Ecuador and Suriname. This Covid-19 shock represents more cumulative rating downgrades than any year since the 2008 and 2009 global financial crisis, with Latin America more vulnerable after not fully adjusting to the secular commodity shock post 2014.

The deterioration in credit quality suggests some permanent damage to credit spreads without a quick reversion back to previous levels, especially as the cycle continues with commodity prices still low.  It’s not just the intensity but also the duration of the external shock and the effectiveness of crisis management with Brent oil futures not expecting a near full recovery until mid-2026. The cumulative rating downgrades implies risk-adjusted higher EMBIG-D credit spreads compared to the pre-crisis levels of 300 bp. Mexico 5Y CSD, at the lowest tier ‘BBB-‘ investment grade rating, now rationalizes a de-coupling from the historic 45 bp spread premium to USIG.

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