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Latin America | High yield issuance

| April 23, 2021

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.

The normalization of ‘B’ sovereign credit spreads may invite new Eurobond issuance from Latin America. The International Monetary Fund has provided an anchor and encouraged weaker credits to reenter capital markets.  IMF programs also typically assume private financing, either forced or voluntary, to complement official sector loans. The ‘B’ sovereigns may want to lock in low absolute cost of funding after the recent yield normalization, especially in light of weak liquidity and slow economic recovery.  Investor appetite should be good. Adding high yield new issuance with carry looks like an increasingly dominant strategy.

The potential candidates are El Salvador and The Bahamas with Ecuador likely delayed until next year at the soonest while Argentina focuses exclusively on its domestic funding markets. This creates a structural shortage of high yield sovereign bonds with the benchmark issuers like Argentina and Ecuador out of the markets and their restructured bonds offering near-zero coupons.  The high yield issuance mostly targets frontier, off-index or smaller countries with low market capitalization within EM indices.  The favorable supply and demand dynamics should reduce the new issuance premium and reinforce the core long positions across the ‘B’ credits. The bottom line is that supply should not disrupt the secondary curve with oversubscribed books and tight new issuance premiums.

COSTA RICA | NOT UNTIL 2022.

The supply and demand dynamics remain favorable with an outstanding stock of only $5.5 billion bonds—a low market capitalization in EM indices—and disproportionate reliance on domestic and official sector funding.  This is perhaps the main technical and fundamental advantage for Costa Rica with external debt at 15.7% of GDP versus 52.1% of GDP of local debt in 1Q21, low rollover risks and market perception of low restructuring risks for external debt.  The gross financing program estimates a shift towards Eurobond issuance of $1 billion A year from 2022 TO 2024 and then $500 million a year from 2025 to 2026.  This would increase stock by $2.5 billion in net terms with the supply risk premium dependent on the ability to adjust the structural fiscal deficit and stabilize debt dynamics. These financing estimates also depend on legislative approval with a bias for lower than programmed issuance on a typically reluctant legislature to authorize Eurobond issuance (that reinforces the low external debt ratios and favorable technicals).

EL SALVADOR | YEAR END?

The confirmation of the IMF program should provide the medium-term financing plans; however, the assumption is that funding needs now mostly rely on external markets with a mix of Eurobonds and multilateral loans. There are pros and cons on the external funding strategy – it increases rollover risk with uncertain access, but this typically reinforces policy discipline compared to countries complacent with captive local markets.  The low gross financing needs—a smaller economy at $27 billion nominal GDP and smaller structural fiscal deficit at 4% of GDP relative to Costa Rica—should also minimize the overall issuance with $7.5 billion outstanding Eurobond stock. Our assumption was for re-entry to Eurobond markets this year on an underfunded 2021 financing program with potential issuance of  around $700 million.  This would target the intermediate to longer sector of the curve to lengthen the debt maturity profile and potentially steepen the curve on subsequent lower re-financing risk of the shorter tenors. This may explain the recent outperformance of the 2025 and faster El Salvador/Costa Rica convergence on the shorter tenors and slower convergence on the longer tenors.  However, the demand for high yield issuance may minimize any supply risk premium or, similar to Costa Rica, the Eurobond issuance may postpone if other multilaterals complement the IMF program disbursements.

THE BAHAMAS | FY2021/22.

The slow cyclical economic recovery should sustain high fiscal deficits and consistent dependence upon Eurobond markets.  However, the small size of the economy  with around $11 billion nominal GDP translates into small gross financing needs that lowers rollover risks. The laggard performance of an off-index credit without the anchor of an IMF program has shifted the Bahamas to now the highest yielding performing LatAm/CAC credit.  These valuations should provide technical support as well as scarcity demand of an infrequent issuer with a small stock outstanding of bonds at $2.5 billion. The latest fiscal strategy report from December 2020 did not release a breakdown of the financing program in FY21/2022; however a similar large $1.8 billion financing program suggests similar dependence on Eurobond issuance. The country did a $825 million Eurobond issuance of the $2 billion FY20/2021 financing program. There is no rush from a liquidity standpoint to re-enter external markets on still high foreign exchange reserves and a fully financed program for FY2020/21. We cannot rule out a pre-financing strategy to avoid rising US Treasury yields and capitalize on recent credit spread normalization.  The latest 2032 sinker reaffirms debt liability strategy to lengthen the debt maturity profile with bonds trading almost 10 points above par and opportunity to further develop liquidity on the longer tenors.

ECUADOR | NEXT YEAR?

There has been some early inquiry about the prospects of Ecuador re-entering Eurobond markets after the huge rally post elections that have compressed yields to below the 10% distressed levels. There are also large gross financing needs of 10% of GDP, or around $10 billion, with the IMF program initially assuming private sector funding beginning in 2022 at $500 million that increases to $1.5 billion in 2023 and $2 billion each year in 2024 and 2025. The ability to re-access private sector credit is the standard assumption of any successful IMF program. The debate about Eurobond issuance is only secondary and dependent upon a successful economic stabilization program when yields are closer to 8% as opposed to 10%. There is no context for any “desperate” issues without clarity on IMF relations for a large, benchmark credit with recently restructured bonds and a track record of serial default. The Eurobond issuance should only arrive at a later stage of normalization.  The absence of Eurobond issuance from these benchmark credits like Ecuador should reinforce the favorable supply and demand dynamics for the smaller and off-benchmark issuers.

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