The Big Idea

Costa Rica | Eurobond issuance

Siobhan Morden | October 14, 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.

Eurobond issuance is finally making progress in Costa Rica with the Legislative Assembly finally reaching consensus on a larger-than-expected but far from disruptive $6 billion issue. Improving demand, reflecting improving credit risk, should absorb the multi-year supply of Eurobonds. The issuance also requires Costa Rica to meet fiscal and debt targets while also using proceeds to rollover external debt or substitute for domestic debt. The funding program, if approved on final vote, should also provide financing flexibility and stronger governability that itself could translate into positive action from rating agencies.

The Assembly committee just reached consensus on granting approval for $6 billion in Eurobond issuance at a pace of $1.5 billion a year through 2026. The majority approval included support from the PUSC, PLN, PNR and PLP and overall representation that would reach the required two-thirds majority approval for a floor vote.

It’s never straightforward to reach absolute consensus, especially considering the party dissenters from within the commission and the untested governability of the minority Chaves administration. The PLN support with their 19 out of 57 deputies will be critical. There is still latent pushback among several parties to downsize the transaction maybe closer to $3 billion. However, the debate is not if but how many bonds to approve. The Eurobond authorization should encourage lobbying from the Chaves administration and provide flexibility to negotiate revisions necessary for compromise support. The timing of any new issuance would be opportunistic and dependent on favorable market conditions with bridge funds already allocated for the January Eurobond payment in case final approval or launch delay too late into the year.

Revisions to the program could focus on either the size of the transaction or the conditions attached to the Eurobond issuance. This includes specific fiscal and solvency metrics that serve as pre-requisites for annual $1.5 billion Eurobond issuance and a sole funding purpose to replace domestic debt or redeem external debt maturities. This should reassure about the concerns of doubling the debt stock and undermining the scarcity value of current outstanding $5.5 billion Eurobond stock. The initial tranche of $1.5 billion should rollover the $1 billion maturing in January.

The initial conditions through 2023 seem quite “light” and serve as minimal thresholds that are below conservative official targets and slightly above IMF targets. The later targets then more quickly escalate beyond the 2% primary surplus necessary for debt sustainability. The fiscal criteria seem motivated to reassure for fiscal discipline after the mixed signals from the Chaves administration on revisions to the fiscal rule. This also serves the interests of bondholders that would uniquely benefit from the conditionality and subsequently motivate more demand for the new issuance.

Cooperation from the Assembly could also catalyze a review from rating agencies that have been reluctant to recognize the smooth political transition, successful fiscal consolidation and broad access to financing options that includes unprecedented strong IMF relations. The shelf registration for Eurobond issuance would expand financing beyond the deep local markets, the potential ESG-related funding, and the unparalleled access to the IMF through a normal access loan program and now one of the first countries to tap the resilience and sustainability trust (RST) loan facility.

This RST funding capacity would contradict the assessment from Fitch on “restricted access to external credit” or the S&P rating weakness of “securing approval for external debt financing.” There is also a clear divergence on the path towards fiscal consolidation with none of the rating agencies expecting a 1%-2% of GDP primary surplus over the next few years. This contradicts from latest IMF statements that risks are biased to stronger fiscal performance and the 1H22 actual primary surplus of 1.3% of GDP. The rating agencies may all soon review the stable outlooks of the B/B2 ratings with larger funding access after the staff-level IMF agreement, broader governability and financing flexibility from the Assembly after approval of Eurobond issuance and fiscal performance that suggests a minimum 1% of GDP primary surplus this year.

The next debate shifts to valuations and whether all of the good news is already discounted on the convergence of Costa Rica with ‘BB’ credits in the region. The 10-year sector of the curve definitely supports this view with Z-spreads trading through liquid ‘BB’ credits (DomRep) and approaching illiquid ‘BB’ credits (Paraguay, Guatemala). This sector of the curve should be particularly vulnerable to new issuance on a steep curve with Costa Rica careful to minimize funding costs as debt service crowds out 47% of the 2023 budget. The longer tenors offer higher relative premium and less vulnerability to supply risk. The longer tenors would also express a medium-term bullish credit view. The rules-based culture under the fiscal rule and public employment reform should push the primary fiscal surplus to 2% of GDP and lower the debt ratios near 60% of GDP comparable to ‘BB’ credits. If Costa Rica can resolve its structural fiscal deficit, then the country would then be unique for this ‘BB’ credit category as the most ESG-friendly country with the strongest institutions, equitable social indicators, and the greenest environmental initiatives for highest ESG rating agency relevance scores.

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

U.S. Fixed Income Trading Commentary Disclaimer

This commentary has been prepared by the U.S. fixed income trading desk of Santander Investment Securities Inc. (together with its affiliates, “Santander”) for its institutional investor clients only, and may under no circumstances be redistributed beyond the recipient in whole or in part. The recipient is an “institutional account” as defined in FINRA Rule 4512(c) that (i) is capable of evaluating investment risks independently, both in general and with regard to particular transactions and investment strategies and (ii) will exercise independent judgment in evaluating any potential investments and any recommendations of any broker-dealers. For the avoidance of doubt, this commentary is not suitable for or intended for retail investors.

This commentary has not been produced or reviewed by, and does not otherwise reflect the views or input of, the Research Department of Santander (“Santander Research”). This commentary may conflict with the views of Santander Research, is not subject to all of the independence and disclosure standards applicable to research reports prepared for retail investors and is not independent from the interests of Santander. Santander may have positions (long or short) in, effect transactions in or make markets in the subject securities (or related derivatives) mentioned in this commentary, and such positions or trading may be inconsistent with this commentary. However, Santander is under no obligation to make a market in or otherwise provide liquidity in any security discussed herein. This material may have been previously communicated to Santander’s trading desk. Santander may have in the past or may in the future provide investment banking services (including underwriting activity and loans) or other services for the companies mentioned in this commentary.

This commentary has been provided for informational purposes only and is not a recommendation, offer or solicitation for the purchase or sale of any security or related instrument. This communication is intended to be short term and brief in nature, and therefore does not provide a full analysis of any issuer or security or a sufficient basis upon which to base an investment decision. The individual circumstances of the recipient’s investment objectives and needs have not been considered in this commentary, and nothing in this commentary constitutes investment, legal, accounting or tax advice or a representation that any investment strategy or service is suitable or appropriate to the recipient’s individual circumstances. Information contained herein has been compiled from sources believed to be reliable, but no representation or warranty, express or implied, is made as to its accuracy or completeness. The recipient should not rely on this commentary for any investment decision or other action, and Santander expressly disclaims any liability for any losses arising from any reliance on or otherwise related to this commentary. This commentary reflects the personal views of the individual sender of such commentary, and no part of his or her individual compensation was, is or will be directly or indirectly related to its content. This commentary is provided as of the date and time thereof, and Santander does not undertake any responsibility to update or revise any of the information contained herein, which may change without notice. Past performance is not indicative of future results.

Fixed income securities, including those described herein, are subject to many risks, including, but not limited to, interest rate risk, the credit risk of the issuer, inflation risk, liquidity risk and risk of a downgrade by rating agencies. Emerging markets investments are additionally subject to political, economic, legal, regulatory, market, settlement, execution, currency and other risks. Fixed income, and specifically emerging markets, investments are not suitable for all investors.

Santander Investment Securities Inc. is an SEC registered broker-dealer, FINRA member and SIPC member. Santander Investment Securities Inc. is a direct, wholly-owned subsidiary of Santander Holdings USA Inc., which is a direct, wholly-owned subsidiary of Banco Santander, S.A

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

This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.

Important Disclaimers

Copyright © 2024 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.

In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.

The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.

In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.

Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.