Sunday, 22 July 2018

Adjusting to reality

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While LatAm bond issuance has ground to a halt, the region's loan market has proven surprisingly resilient. Relationships are pushing deals forward, but economics are increasingly a deciding factor for banks taking a more defensive posture. Capital is scarce but so far has been available for good names willing to pay the price, as Paul Kilby reveals.

The landscape for the Latin American loan market remains relatively benign and is one of the few seeing any real activity this year. Yet volumes have declined considerably as the subprime crisis has taken its toll on banks' balance sheets, and the situation could get worse before it gets better.

Back of the envelop calculations put volumes during the first quarter at around US$6.4bn, including some larger blue chip and commodity based transactions – such as Votorantim's US$1.3bn three-year, a US$1.2bn senior credit facility from Usiminas, a US$1.22bn extension for Venezuelan oil company PDVSA and a US$1bn plus loan for Argentina's YPF.

It is not enough to see the region catch up with last year's US$60.55bn figure, let alone the spectacular heights reached in 2006 when Brazilian mining company Vale broke records with its US$18bn package to fund its acquisition of Inco. That year, LatAm saw volumes close to US$70bn.

This year the region's loan markets are likely to be driven by circumstances forcing borrowers into the market: M&A activity; infrastructure needs; refinancing of bonds; or the need to establish credit lines in anticipation of deepening credit problems.

Latin American banks themselves are also eying the syndicated loan market as their traditional watering holes – bi-laterals – require more frequent rollovers, potentially uncomfortable in this environment.

So far, Brazilian companies have been at the fore, but the hopes pinned on another mega acquisition financing package from Vale were waning fast in March amid news its bid to buy Xstrata for US$90bn may collapse. The US$50bn package to support the acquisition would have provided some momentum, though its potential presence was heard impacting other deals.

Chile and Peru are expected to see activity on the back of project finance deals, and rumblings are being heard from Mexico, where corporates have been conspicuously absent.

Still, margins are likely to be wider across the board, even for blue chips. After sitting on the sidelines since last year, Mexico's Federal Electricity Commission finally emerged in early March with a US$2bn three-year revolver that was expected to be a benchmark transaction. But margins were heard to be at Libor plus 40bp, a far cry from the aggressive 28bp over it achieved when it upsized loan to US$800m in early 2006. Even blue-chip Pemex, which is also expected to tap this year, won't to get away with the last minute downward flexes of the past.

While spreads may be widening, Libor rates have dropped considerably, keeping all-in costs relatively interesting, at least earlier this year. "There is a new pricing level across the board (but) the decline in rates for the higher rated companies makes up for an increase in spread," said one banker.

Falling Libor rates may be good for borrowers, but questions remain about banks’ willingness to lend. Merrill Lynch caused a stir earlier this year when it walked away from the Vale financing and the potentially juicy fees involved in its acquisition of Xstrata, raising speculation that write-downs had taken their toll on the investment bank.

Other banks have also been retreating amid rising funding costs, making loans to blue-chips unfeasible. Costs have risen to between Libor plus 30 and 60bp, depending on their ability to access commercial paper markets. For some local banks they are up to 100bp, said one banker in early March.

This has kept local banks out of some blue-chip syndications, with local, lower-tier names, offering higher margins, proving more attractive. "They are more comfortable with local risk and are willing to do this," said one banker.

Some borrowers have focused on a core group of relationship banks, which can help avoid the execution risk of wide syndications, and may keeps margin down for borrowers who have such leverage.

Relationships remain crucial. Take Brazilian conglomerate Votorantim, which launched a US$1.3bn loan at what many considered extremely aggressive pricing given the volatile backdrop: the company approached the market with a three-year working capital facility at Libor plus 55bp and five and seven-year trade related tranches with margins of 72.5bp and 82.5bp respectively.

That came above Vale's last mega financing for the acquisition of Canada's Inco, which was completed near the height of the liquidity wave that washed over the financial markets earlier this decade. Its US$5bn five year priced at Libor plus 62.5bp and the US$1bn seven-year came at 75bp over.

However, Votorantim's loan was considerably tighter than Brazilian steel maker Gerdau, which had successfully navigated the first bout of sub-prime volatility, with a US$2.75bn package consisting of a US$1.25bn five-year at Libor plus 100bp and a US$1bn six-year at Libor plus 125bp.

At those levels, Votorantim was thought to have got past the finish line, largely with the help of relationship banks. But Votorantim is the exception, not the rule.

"Despite tight pricing, Votorantim got done. Today relationships remain important but economics are also very important," said one LatAm loan banker. "Before we could often get by on just relationships. Voto struggled a bit because the economics were not attractive."

The fact Votorantim had less of a need and could walk away surely helped. On the other hand, the Usiminas trade, which was used to fund its acquisition of J Mendes, was widely seen as reflective of the market and considered well priced in the circumstances.

Usiminas' deal comprised five and seven-year pre-export facilities, totalling US$500m, as well as a US$700m two-year revolver. Margins were tied to a leverage grid and paid Libor plus 110bp on the five-year, going up to 160bp if ratings move below BBB– and down to 90bp if the borrower achieves A– or above. The seven-year piece pays Libor plus 135bp, and can move between 185bp and 115bp within the same ratings range.

This period of price discovery hasn't all been plain sailing, especially in high beta countries such as Argentina and Venezuela. Oil company PDVSA's US$1.226bn loan extension in February got done, but came at a steeper price after fees jumped by about 25bp across the board and the final margin came at a higher Libor plus 150bp.

The two-year credit line was essentially a rollover from the original one which carried an option to extend for another year as long as 75% of the banks from the first deal stayed on board. The original deal was initially offered at Libor plus 125bp, but was tightened to 100bp after an upgrade.

A US$2bn financing package backing Grupo Petersen's purchase of about 25% of YPF, the Argentine subsidiary of Spanish oil and gas company Repsol YPF, was also heard to be a difficult sell. In the end the package comprised a US$1.05bn vendor's loan and 3.5 year syndicated loan.

The deal caused quite a stir at launch in December, involving an interesting structure that paid banks a spread over Argentine three-year CDS, but in the end few were heard joining the final syndicate.

"The YPF deal was a struggle," said one banker away from the deal. "At the end of the day the structure was Argentina risk, which doesn't have the best appetite around."

Others have simply had to flex up to lure attention, even better names. Chilean retailer Cencosud bumped up pricing on its US$480m senior unsecured loan in response to poorer market conditions. Launched in early December, the loan was delayed in January to give banks time to assess the unexpected US$500m acquisition of Peruvian retailer Wong.

The five-year loan was initially marketed at Libor plus 35bp in year one, plus 40bp in year two, plus 45bp in year three and plus 60bp in years four and five. However, with sentiment deteriorating, the price was flexed upward, with the borrower finally offering Libor plus 50bp in year one, plus 55bp in year two, plus 60bp in year three and plus 65bp in years four and five.

Peruvian bank BCP had a similar experience, flexing its US$300m three-year amortiser by about 20bp to pay Libor plus 70bp in year one, 75bp in year two and 85bp in year three. "Underwriting capacity is scarcer and thus more expensive," said one banker.

Meanwhile, infrastructure improvements are likely to help momentum in places like Mexico, where the government has created a new fund dedicated to investing in a variety of projects, as it looks to boost growth and support social projects.

Project finance is also expected to be active in countries like Peru, Brazil and Chile. The latter may see several large loans as it looks to wean itself from its reliance on Argentine energy. Spreads and fees in investment grade Chile may be less alluring, but they are solid assets to have the books in times such as these, though some bankers have been heard banking away in this market.

While project finance deals have longer tenors, they are considered attractive due to competitive pricing, solid structures and, typically, strong local government support. This potentially opens the door to European banks – especially French and Spanish – as well as Japanese financial institutions, which are traditionally strong in this area.

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