The Big Idea
Ecuador | Context for market entry
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For Ecuador, there are few other policy options beyond reducing the structural fiscal deficit and managing liquidity risks. Commitment to fiscal discipline should allow yields to retest former lows. Then attention should shift back to financing plans. Finance Minister Sariha Moya recently confirmed plans for partially guaranteed debt issuance. This kind of market access is a logical first step given Ecuador’s double-digit yields. New market access could also set off a virtuous cycle of lower rollover risk ahead of the sinking fund amortization payments in January. It is the backbone of the better relative value in Ecuador’s shorter maturity (2030) bonds.
The prospects for tighter yields should again refocus on the funding strategy and external market access. There have been on-and-off headlines for months about a partial multilateral guarantee for Ecuador’s debt. There are several options for either another social bond similar to the ECUASO (January 2020) or issuance similar to the first-loss Inter-American Development Bank guarantee for the Bahamas (January 2024). The motivation of these transactions is new financing. This multilateral support does not suggest a buyback transaction but rather a pure funding transaction that demonstrates market access consistent with the International Monetary Fund exceptional access criteria. These would provide funds in anticipation of revenue next year from recent tax hikes and subsidy cuts.
The multilateral relations should lower the cost of funds and broaden the investor base at a critical moment ahead of amortization payments early next year. When Ecuador launched the ECUASO’2035 bonds in January 2020, the country lowered its overall costs of funds to 7.25% (against 9.5% for ECUA’24) based on the IADB guarantee for the secured tranche. The alternative structure similar to the Bahamas (similar 40% weighted collateral) would allow for maybe even a lower cost of funds given a blended ‘BBB-‘ rating and crossover investor support. The IMF program assumes only moderate external issuance of $1 billion in 2026, $1.5 billion in 2027 and $2 billion in annual issuance thereafter. There is not the same supply overhang for Ecuador that widened out their secondary curve to accommodate the ECUASO issuance in early 2020.
The primary benefit for bondholders is the lower liquidity risks with maybe some controversy over the implied subordination of Eurobond bondholders to social bondholders (ECUASO wasn’t restructured in 2020). This would be less worrisome under the fiscal consolidation of a successful IMF program that lowers overall solvency risks. The more important near-term benefit to bondholders is the lower rollover risks for a credit that suffers from chronic liquidity risks. These transactions would likely also be less disruptive by broadening the investor base through either a weighted investment grade rating for crossover demand or significant premium on the unsecured tranche for higher hedge fund demand. This would help supply-and-demand technicals, especially ahead of the potential re-investment of the 2030 payments early next year. A successful transaction would maybe allow a virtuous circle of lower financing risks under the potential for recurrent transactions with multilateral guarantees and stronger IMF relations after another successful program review. This would suggest a downward shift in spreads on the curve with bull steepening bias.
The shortest tenors remain our top pick under this funding strategy with supply on longer tenors and reinvestment demand on the shorter tenors. The PDI 2030s may be particularly sensitive to reinvestment flows for the scarce liquidity of the smaller tranche. The shorter tenors would also benefit from the track record on willingness to pay under the Noboa administration as well as the ability to pay under broader access to external funding markets. The investment strategy should prioritize those tenors that are more closely aligned to Noboa policy risks with higher cash flow payments on the sinking fund amortization payments.
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