The rapid increase in Latin American corporate debt has raised eyebrows for some investors, who wonder if the collective burden is sustainable for the region’s companies. Yet many investors believe such risks shouldn’t deter them from seeking out multiple opportunities.
Latin American businesses issued $178 billion worth of debt last year, up from $165 billion in 2013, according to Dealogic, marking the sixth straight annual increase. The majority — $109 billion — was denominated in U.S. dollars, with $47 billion in local currencies. The lion’s share of the issuance came from companies in Brazil ($56 billion) and Mexico ($60 billion), which had lost the mantle of Latin America’s biggest corporate debt issuer to Brazil in 2009, only to regain it in 2013.
Some analysts worry about the ability of companies to service so much dollar debt given the weakness of Latin currencies, which have been hurt by anticipation of U.S. monetary tightening and by the continued unwinding of the price boom in commodities. “One of the biggest vulnerabilities is depreciation,” says Siddharth Dahiya, London-based head of emerging-markets corporate debt at $504 billion Aberdeen Asset Management. “A number of companies have been able to borrow through external debt, but they don’t have any external income.”
Dahiya points to Mexican homebuilders that constructed low-cost properties in their native country, funding themselves largely through dollar loans that have become hard to repay following the decline of the Mexican peso to a rate of about 15 to the dollar, from 13, over the past year.
Soummo Mukherjee, a Santiago-based debt analyst at Itaú BBA, the investment banking arm of Brazilian bank Itaú Unibanco, cites the plight of Automotores Gildemeister. The Chilean car importer buys vehicles in dollars and sells them in local currency; its business has been hit by a 9 percent decline in the Chilean peso, to 605 to the dollar in late April from about 550 in May 2014. In April the company asked investors to take losses of as much as 50 percent on its $700 million in dollar-denominated bonds as part of a debt restructuring; investors have rejected the proposal, leaving Gildemeister struggling to shoulder the existing burden. “Our view is that the company will find it very difficult to meet its ongoing debt service payments,” Mukherjee contends.
Gildemeister also suffers from a problem that has afflicted many other Latin American corporate debt issuers: a slowdown in the domestic economy, largely because of commodity price drops. The importer was wrong-footed by an 11 percent contraction in Chile’s auto sales last year, Mukherjee says.
A further vulnerability in some countries is politics. This is most apparent in Brazil, where a corruption scandal involving state-owned energy giant Petróleo Brasileiro and its web of contractors has heightened political uncertainty, aggravated the country’s recession and caused international investors to shy away from new and old debt. Between the start of the year and April 2, only two Brazilian companies issued dollar-denominated paper, Dealogic reports.
Fears about Brazil’s politics and economy have sent yields rising, though they have fallen back a little since the beginning of the year. The average spread on Brazilian corporate debt is 4.89 percentage points above U.S. Treasuries, for a yield of 6.85 percent, according to London-based BlueBay Asset Management; that’s up from 3.81 points above Treasuries, or 5.51 percent, in April 2013. Spreads for Latin America as a whole have also widened, but much less so, to 3.67 points over Treasuries from 3.26 points two years ago. BlueBay cites data from JPMorgan’s Corporate Emerging Market Bond Index Diversified family.
The pummeling of Brazilian corporate debt by nervous international investors spells opportunity, managers at $59 billion BlueBay contend. “There are times when there is a general risk-off sentiment in Brazil, and you see spreads on all sectors widening out,” says Anthony Kettle, a portfolio manager with BlueBay’s emerging-markets credit team in London. “That presents opportunities when you see companies that should benefit from the trends in the Brazilian currency.” The real declined to nearly 3.30 to the dollar in March from 2.25 in September 2014 but recovered some to trade at about 2.93 in late April.
Kettle sees promise in Latin American agricultural exporters, for example. They haven’t suffered the price busts experienced by energy and mining companies, so they can keep earning strong dollar revenue. The rise in the dollar makes it easier for agricultural exporters to sustain their business costs, which are in the declining local currency. This is a case where, far from being a vulnerability, local currency depreciation can work to the advantage of a company with dollar debt. Some of these agricultural businesses are big issuers: Cosan, the Brazilian conglomerate with a large interest in agriculture, issued $500 million in ten-year debt and 500 million reais ($170 million) in five-year paper in March 2013.
Aberdeen’s Dahiya also sees the bright side of currency depreciation. Take Brazil’s Vale, the world’s biggest iron ore producer: Much of the company’s production is in Brazil, where the fall in the real has reduced costs in dollar terms. Dahiya also sees an upside to the commodity price slide. Although he acknowledges that the price of iron ore has plummeted, Vale is a “very low-cost producer, so even in this environment these guys make money.” The yield on Vale’s seven-year triple-B bond has eased to 4.4 percent from a high of close to 6 percent in December, at the height of the Brazilian political crisis.
Exporters pricing their goods and commodities in dollars could be in an even stronger position if the U.S. Federal Reserve Board’s first rate hike in many years, which many analysts are forecasting for later in 2015, boosts the greenback further. But Latin American corporate debt specialists tend to play down the positive or negative fallout from a move that financial markets have expected for many months.
Dahiya says there could be awkward side effects of a U.S. rate hike, including a temporary loss of emerging-markets liquidity as dollar investors return home. “If markets shut down, some companies with imminent maturities could face pressure,” he explains. “However, the bigger ones should be fine because they will have good access to local banking markets.”
In theory, Latin American corporate debt could be harder to sustain than during previous times of falling global liquidity because it is so plentiful. But Dahiya is not concerned. “Sometimes people look at the debt numbers and think that the growth of overall dollar debt looks quite scary,” he says. “But people need to look at it in the context of these economies. Total external corporate debt as a percentage of GDP has not increased that much, because GDP itself has been growing a lot.”
Notwithstanding the economic weakness of the past year or so, Latin American gross domestic product is much higher than a decade ago, and foreign currency debt remains below 10 percent of output, Dahiya notes. As a result, he adds, the debt does not pose a systemic risk.
In short, long-standing investors in Latin American debt see reasons to be wary but reasons to be greedy too.
