The Big Idea
Panama | A Fitch downgrade
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.
There has been no public debate about Panama’s loss of its Fitch investment grade rating, and valuations look stretched compared to other ‘BB’ credits like Colombia. This suggests risk of underperformance not only from potential downgrade by other agencies but also from primary and secondary supply. Other rating agencies most likely will wait until after elections in the fourth quarter this year before reassessing the situation. This could provide some breathing room for the credit with the markets still focused on high carry. However, it’s hard to be optimistic.
There hasn’t been much fallout after the shock of the Fitch downgrade. The timing was somewhat opportune given strong market appetite for high yield credits. Valuations have fully recovered from the knee-jerk 20 bp in initial spread widening, with Panama ’36 spreads back to pre-downgrade levels on an absolute basis and also back to tights on a relative basis against the Colombia’37s. There has been no specific catalyst for this optimism. There has been no reaction across the political establishment or the social sectors in the aftermath of the loss of the investment grade ratings.
Imminent elections have left politicians reluctant to debate or commit to any controversial measures. However, its worrisome that weaker fiscal finances are not part of the broader discussion in any of the presidential debates (themes of corruption, decentralization, youth employment, social development, water, and sustainability).
The official response was to criticize Fitch for the timing of the downgrade without taking responsibility for the policy actions that led to the downgrade or the lack of any corrective measures to prevent further downgrades. Dollarization has left Panama complacent and local funding markets under-developed with almost all financing sourced abroad from Eurobonds. If there is limited fallout post-downgrade, then there is less motivation to adopt tough measures like tax reform or the re-opening of the mine. The mine re-opening has been rejected by all candidates.
The Fitch downgrade was a clear vote of no confidence citing the political obstacles of the economic growth slowdown, social pressures, political fragmentation, and low political capital of the next administration. It’s also worrisome that polls show an anti-establishment backlash with majority support for independent candidates that could further obstruct a coalition-building process. The hurdles are quite high for the next administration to not only raise awareness but also reach consensus to quickly reduce a structural fiscal deficit of 4% of GDP towards 2% of GDP necessary to stabilize debt ratio within the investment grade category.
Why would politicians reduce the fiscal deficit when they can finance the fiscal deficit? There is not much time to react with the litmus test on the 2025 budget. The next administration will have to quickly adopt credible tax reform for inclusion within the 2025 budget. If there is no fiscal pragmatism post-elections, then de-indexation is most threatening for their already low ‘Baa3’ rating (stable outlook) from Moody’s and the ‘BBB’ rating (negative outlook) from S&P. The 12-month review for both outlooks coincide in the fourth quarter of 2024 with a concentration for event risk on negative action. The typical process would suggest first a negative outlook from Moody’s with a rating downgrade maybe in the first half of 2025. This would suggest a de-indexation event maybe within 12 months under a scenario of policy inaction. This seems the most logical outcome.
The valuations do not yet fully capture these downgrade risks, especially on relative metrics to Colombia. The supply/demand risks are also arguably much worse on the chronic Eurobond issuance and divestment from crossover investment grade investors. This should warrant a higher “liquidity penalty” versus other liquid ‘BB’ credits. It’s not just the one-off $2 billion to $4 billion divestment from crossover investors but also the $4 billion in annual Eurobond issuance as the highest sovereign issuer within LatAm despite the medium-sized economy. The next administration may be forced to come back to Eurobond markets in the second half of 2024 if fiscal deficits near 4% of GDP. It’s also important to remember the unique concentration of liquidity risk with Eurobonds 75% of the debt stock that is increasingly vulnerable to any shocks on the lower ‘BB’ credit ratings. This makes it more difficult for rating agencies to not respond to policy inaction post elections. Inaction = downgrade. The long end may offer an ideal combination of low cash prices and still relatively high around 7% current yield but they also are vulnerable to the highest positioning risk from crossover investors. The increasingly liquidity premium should increase the market beta and demand a more proactive trading strategy. This suggests higher risk of underperformance into the inaction post-elections with a shift back to underweight for higher secondary risks and primary supply risks.
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.
Important disclaimers for clients in the EU and UK
This publication has been prepared by Trading Desk Strategists within the Sales and Trading functions of Santander US Capital Markets LLC (“SanCap”), the US registered broker-dealer of Santander Corporate & Investment Banking. This communication is distributed in the EEA by Banco Santander S.A., a credit institution registered in Spain and authorised and regulated by the Bank of Spain and the CNMV. Any EEA recipient of this communication that would like to affect any transaction in any security or issuer discussed herein should do so with Banco Santander S.A. or any of its affiliates (together “Santander”). This communication has been distributed in the UK by Banco Santander, S.A.’s London branch, authorised by the Bank of Spain and subject to regulatory oversight on certain matters by the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA).
The publication is intended for exclusive use for Professional Clients and Eligible Counterparties as defined by MiFID II and is not intended for use by retail customers or for any persons or entities in any jurisdictions or country where such distribution or use would be contrary to local law or regulation.
This material is not a product of Santander´s Research Team and does not constitute independent investment research. This is a marketing communication and may contain ¨investment recommendations¨ as defined by the Market Abuse Regulation 596/2014 ("MAR"). This publication has not been prepared in accordance with legal requirements designed to promote the independence of research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. The author, date and time of the production of this publication are as indicated herein.
This publication does not constitute investment advice and may not be relied upon to form an investment decision, nor should it be construed as any offer to sell or issue or invitation to purchase, acquire or subscribe for any instruments referred herein. The publication has been prepared in good faith and based on information Santander considers reliable as of the date of publication, but Santander does not guarantee or represent, express or implied, that such information is accurate or complete. All estimates, forecasts and opinions are current as at the date of this publication and are subject to change without notice. Unless otherwise indicated, Santander does not intend to update this publication. The views and commentary in this publication may not be objective or independent of the interests of the Trading and Sales functions of Santander, who may be active participants in the markets, investments or strategies referred to herein and/or may receive compensation from investment banking and non-investment banking services from entities mentioned herein. Santander may trade as principal, make a market or hold positions in instruments (or related derivatives) and/or hold financial interest in entities discussed herein. Santander may provide market commentary or trading strategies to other clients or engage in transactions which may differ from views expressed herein. Santander may have acted upon the contents of this publication prior to you having received it.
This publication is intended for the exclusive use of the recipient and must not be reproduced, redistributed or transmitted, in whole or in part, without Santander’s consent. The recipient agrees to keep confidential at all times information contained herein.
