The Big Idea

Latin America | Relative value trends

Siobhan Morden | August 12, 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.

Recent performance across Latin American sovereigns suggests a rally with low conviction, perhaps the natural result of thin summer trading and uncertainty around the US economy. But some things have started to change. The Bahamas have moved up. Argentina has outperformed. Debt arguably trading below recovery value has drawn in investors. There is clear relative value across the region.

Things have started to shift after the strong consecutive gains with the illiquid off benchmark bonds, like the Bahamas, starting to catch up. The high yielder relative performance is mostly on specific event risk with Argentina the outperformer on the positive spillover of economic management under Minister Massa. There is also a coincidental shift towards debt liability management to address what still appear as oversold bond prices amongst the high yielders. The historic low cash prices also provide an anchor with several credits still trading at or below historic low recovery value. These distressed valuations should remain supportive for the high yielders even after recent gains. The BB credit relative performance is more a function of supply risk ahead of the seasonal issuance while this credit category still provides a defensive investment strategy to immunize against the uncertain and opposing SPX/UST contagion.

The liquid BB benchmarks like DomRep have led the MTD total returns at 2.9% with its high beta status logically most sensitive to the rebound in external risk. There has been a clear trend on relative performance via liquidity segmentation between the DomRep/Costar pair. The outperformance has since stalled with Costa Rica starting to rebound after having traded 50bp inside COSTAR’45-DOMREP’49 in later June to now +50bps. The markets are now starting to arbitrage this spread premium that represents important technical support on the firm YTD trading range.

There are many parallels between Costar and DomRep with positive credit momentum and plans for new Eurobond issuance. DomRep is more opportunistic on the funding program while Costa Rica requires 2/3 congressional approval. The pre-funding program should kick off this fall with net minimal issuance for Costa Rica on expectations of only small-sized approval just sufficient to fund the $1bn amortization in January 2023. Costa Rica should also still benefit from its relative illiquidity versus DomRep. The BB rated (or aspiring BB) credits should continue to differentiate for their lower beta to external risk and the higher carry relative to the UST sensitivity of the investment grade credits.

There has been coincidentally a shift towards debt liability of the B-rated credits with a proactive strategy to not necessarily target savings as much as lower the credit risk premium (and secondary shocks on financing and sentiment). The prospects for debt liability are marginal for distressed credits that still need to prioritize near-term financing over medium-term savings. However, small-sized transactions to capitalize on perceived price distortions are logical under the current market conditions.

El Salvador was the first to announce plans for a debt buyback of the 2023s and the 2025s to reinforce their commitment to pay and push back against the distressed market prices (that weighs on the country prestige and international reputation). There have also been discussions in Argentina about debt liability but nothing overly realistic considering their inability to access USD and multiple priorities for USD demand (foremost FX reserve accumulation). The Bahamas could be another contender for small-sized debt buybacks, especially after contracting Rothschild and the laggard underperformance of their bonds. El Salvador bonds jumped 20 points on the front end and 10 points on the back end, The commitment to repay should anchor the 2023s while the rest of the curve remains dependent upon the successful follow-through of the transaction with prices trailing off after the initial gains.

The relative performance has also been a function of relative liquidity with the Bahamas a laggard either for its off-benchmark status or the lost-in-translation after contracting Rothschild as a financial advisor. The illiquidity is a handicap for the lower rated B credits for the high vulnerability to unfavorable externals. The latest bounce this week was a predictable laggard rebound to reconverge with similar comps like Ecuador. The initial underperformance is easier to blame on technicals with the markets ignoring the strong fiscal performance and recovery in tourism. The further gains remain dependent on external risk for a small open economy dependent upon favorable external trends.

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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