The Big Idea

Latin America | About valuations

Siobhan Morden | July 15, 2022

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. This material does not constitute research.

The most sensitive credits typically start to decouple from external risks once valuations reach recovery value. Valuations now below historic 30% recovery value across the high yielders almost look like a capitulation trade. There is a disconnect between fundamentals and valuations. Latin America stands apart from other similarly rated emerging markets credits, showing the lowest cash prices. These dislocations should persist until country liquidity improves or overall external risk stabilizes. Despite the uncertainty, it is tough to be bearish medium-term with valuations already discounting the worst case for the high yielders. Coupon payments alone start to offer a significant cushion for El Salvador and Argentina as long as default is not imminent.

Argentina and El Salvador’s sovereign debt now trades below 30% historic recovery value with Ecuador not far behind. These prices assume worst case scenarios of a of high probability of default, historic low recovery value and no or low valuations on coupon payments. This pessimism is unusual considering the restructured low coupons in Argentina and Ecuador and only near-term coupon payments in El Salvador after the litmus test of El Salvador’s January 2023 amortization.

There is a strong near-term “willingness to pay” for various reasons across these countries. For Argentina’s Fernandez administration, the standard approach with creditors has been to postpone payments to the next administration, whether the payments are going to bondholders, the IMF or the Paris Club. The restructured coupons do not suggest a financing burden, although the Fernandez administration would be reluctant to admit policy failure as the administration restructured the debt in 2020.

Ecuador’s Lasso administration would also be highly reluctant to default on low coupons. Ecuador has put a priority on investor relations to attract foreign direct investment and avoid a backlash of economic crisis. Ecuador is also unique for its stronger fiscal finances, results of an oil windfall and strong IMF relations as a lender of last resort.

El Salvador is also soon to test its willingness to pay ahead of an $800 million Eurobond amortization in January. El Salvador has committed repeatedly to honoring Eurobond payments, notable for an administration that’s reluctant to admit policy failure and seeks international prestige as a global Bitcoin financial center. The still high 73 dirty cash price of the ELSALV’2023 reflects near 50/50 probability of payment/nonpayment, based on 30% recovery value/107 payment.

If El Salvador honors the January 2023 Eurobond amortization, then the next amortization hurdle is not until January 2025, with average 13.5 points of coupons contributing a significant portion of breakeven returns on recovery value against current prices around 25. For Argentina and Ecuador, it would require extreme scenarios for either country to default under the current administrations, especially with low pending Eurobond payments a priority. The higher coupons for ARGENT’38 and ARGENT’41 at 3.875% and 3.50% offer a significant buffer on breakeven returns against low cash prices of 25 and 23, especially if a restructuring postpones beyond 2023 with the ARGENT’35 coupons also stepping up in 2024.

Each credit involvew a unique discussion of recovery value, and it is too early to discuss El Salvador and Ecuador. There is no context for recovery value analysis when the medium-term economic program remains undefined, each country balancing policy adjustment and debt relief. The IMF has made its recommendations of a 4% GDP cumulative fiscal adjustment, but the Bukele administration has yet to commit or propose a viable alternative. Bond prices around 25 not only assume historic low recovery value but also discount any prospects of 7 points of annual coupon payments. There has been no investor support at distressed bond prices, with extra coupons insufficient motivation without commitment to a medium-term plan for debt sustainability. This may change after the January 2023 payment. There is still latent optimism for Ecuador under the orthodoxy of the Lasso administration and high oil prices. However, the political and policy risk premiums remain high without broad commitment among the political establishment and broader society to investment-led growth and fiscal discipline. The burden for the Lasso administration is to manage social and economic pressures and attract FDI for higher trend growth in strategic sectors over the next three years. That is a necessary model for debt sustainability and a smooth political transition.

There are a few core assumptions that allow for early estimates of recovery value in Argentina. The renewed commitment to an IMF program under the Fernandez administration reaffirms a structural shift towards policy moderation and a marginalization of Kirchnerismo radicalism. This should reassure investors for a few reasons

Equitable burden sharing under economic policy moderation, and
Reasonable exit yields post political transition in 2024.

The formula would argue for liquidity over solvency relief and reasonable, say, 12% exit yields assuming a moderate political transition, leading to recovery value in the mid-40s. The current bond prices below 20 reflect worst-case scenarios of a severe economic crisis that undermines liquidity and solvency ratios and requires another round of relief from bondholders. This is not yet the scenario after Argentina’s reaffirmation of the IMF anchor and commitment to policy moderation after a leadership change in the economic team. Argentina valuations offer the most attractive risk and reward among the high yielders on not only the breakeven returns of step-up coupons and low cash bond prices but a continuing base case view of reasonable recovery value after political transition.

Siobhan Morden
Santander Investment Securities
1 (212) 692-2539
siobhan.morden@santander.us

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Siobhan Morden
siobhan.morden@santander.us
1 (212) 692-2539

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