The Big Idea

World: El Salvador | Victory lap

Siobhan Morden | September 30, 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.

The latest tweets from El Salvador’s President Bukele promising to pay back debt arguably had more impact than the country’s buyback of $565 million of its own debt. But both have triggered a bounce in El Salvador’s Eurobonds and the unwind of rollover and liquidity risks. There is still no clear economic plan for debt sustainability. Still, there’s good reason to stay constructive on bond payments in the near term. El Salvador’s debt likely has another 10 points of upside across the curve and maybe another 25 points on the 2025s as the country commits to paying for longer.

Investor skepticism has been extreme lately with selling of Eurobonds after the Bukele administration failed to commit to an IMF program or an alternative medium-term economic framework—one including the IMF’s recommended 4% of GDP fiscal consolidation. Bond prices reached lows in the 20s without any obvious sponsorship from real money or crossover investors. This now looks to be shifting as the Bukele administration reaffirms their willingness to pay bondholders.

The initial buyback offer was mostly brushed off as irrelevant with only a lukewarm reaction and relatively unchanged bond prices. Bond prices then adjusted much higher after President Bukele announced a follow-up transaction to again buyback more 2023 and 2025 bonds within eight weeks. The almost violent bounce in bond prices reflects an underweight positioning of investors as well as the sudden realization that there is commitment to pay Eurobonds.

The commitment to pay Eurobonds is typically stronger in the early phase of cash flow stress. This should favor the shortest tenors including the 2023s and the 2025s. The prepayment of the 2025s should offer significant cash flow relief with no other large amortizations until 2027. The most important takeaway is that the Bukele administration is prioritizing external over domestic liabilities. It’s not clear whether El Salvador will launch another transaction in two months; however, there is strong commitment to pay the final maturity within four months.

It’s important to understand the motivations of the transaction. There are obvious cash flow benefits from buying back heavily discounted bonds trading in the 50s. These dynamics almost unwind on pre-announced transactions with the 2025s initially moving from 35 to 50 and now approaching 60. There are still some savings compared to the NPV of other 2Y maturity bonds in Latin America that trade near par.

Perhaps more important than the cash flow savings for the Bukele administration is the prestige factor. The low bond prices and high implied probability of default were a vote of no confidence from the markets. This contrasts against a country that seeks international prestige and legitimacy. El Salvador has hosted various Bitcoin-related international events with frequent diplomatic trips abroad including the recent presentation from President Bukele at the UN and a high-profile TV interview in the US. The headline event of default wouldn’t coincide with the image of prosperity under the Bukele administration and the transition from gangs and violence to tourism and financial freedom. There may not (yet) be a coherent medium-term economic plan for fiscal consolidation; however, there has been a slow improvement on the fiscal accounts with forced austerity from a deceleration in spending. To prioritize Eurobond payments, the Bukele administration could source pockets of liquidity at the central bank or re-prioritize budgetary revenues and financing sources over the next four months.

The next transactions should have a meaningful impact on bond prices. The next buyback transaction may not prove as successful on lower turnout and less cashflow savings; however, it would still reaffirm the willingness to repay. And there are only four months remaining for the 2023 stump amortization payment. This would then alleviate the payment calendar with only 50% of the 2025s remaining and a still latent threat of another buyback that should create a floor on bond prices.

If we reference the PdVSA 2016 on two years until maturity in the early phase of cashflow stress of the Maduro administration in 2014, then rough guidance suggests the 2025 should trade near 75. The rest of the curve should also re-price on the optionality of upfront payments with average 18 points of coupons through January 2025 allowing for overly conservative recovery value at 20 against the historical lows of 30. This suggests optionality for prices to trade still another 10 points higher towards 50, especially if there are prospects to avoid default beyond 2025. We have been bullish on a short-term tactical view ahead of the buyback operation last month and remain constructive through the January 2023 payment.

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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