Monday, 22 October 2018

Latin American Loans Roundtable 2007: Part 3

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IFR: What about retail banks' participation in the region. I understand some didn't renew during the recent Pemex amendment. Is retail pulling back from the region and if so how important is that?

Rubio: Well maybe with the any new repricing, they will come back and be more active now.

Gracia: Many of the retail banks walked away from the region probably last year, or slightly before that, when prices started to get extremely tight. The tendency of price tightening continued into probably the beginning of the second quarter of this year. And as Ricardo mentioned, I think they’ll probably look at the region again, if pricing gets to a level where they feel comfortable with their return models.

IFR: We have seen a couple of deals flexed up over the last months or so. Will we see more of this or were these deals peripheral ones and didn't represent what is really happening in the market?

Bouazza: I would be careful implying that prices are going to go up, because I think there are certain deals that were challenging even before the market took a turn. If you were talking about the top two or three credits in each country, there's a huge resistance to go up in price, and there’s still pressure on the banks to lower the price on whatever outstanding issues are there.

So I do not expect prices to easily go up. There's maybe now a valid resistance level for them not to go down. But I wouldn’t rush [to that conclusion]. America Movil's pricing is staying the same, even though they're doing a revolver today versus a term loan. And so that’s not going to change.

What is going to change is you’re going to have maybe more muscle power in, say, acquisition finance. Or in the case of an issuer that isn't one of the country's top borrowers, you may see pricing adjusting some. And obviously, the second-tier borrowers, you’ll be able to get more out of there. But let's just be careful. I don’t think Codelco, Pemex or America Movil expect their prices to change.

Wilds: But I think you need to be very careful, because they're not really coming to market. Pemex's timing was impeccable. They were in and out of the market before this really hit, and American Movil is not talking about raising new money; its deals is just an amendment. It’s really almost a technical amendment.

None of the banks in this room funds themselves today at Libor plus an eighth. And so it’s very difficult to understand how you’re going to commit to lend for five years at Libor plus an eighth.

Lopez: That’s the thing. It's liquidity, which is an issue. Holds become more important. But I agree. Obviously, these top names want to keep getting the same price they've always gotten, because nothing has happened to them.

Wilds: But they won't come to market.

Gracia: And many of these banks are loaded with a lot of paper from these top names. So you will go back again to the liquidity issue. And in addition you have no retail for many of these top names and that’s going to raise the pricing.

Lopez: I don't disagree with what Katia said. But in the face of your borrower, it's a very difficult slog to get that through to them. So one of the ways that you can maybe get away with it is with higher final holds. And, as was discussed earlier, some of these other structural enhancements like market flex, which you haven't seen in Chile for six or seven years. If that's back on the table, I think there are people in this room that are willing to take that gamble and see how it goes.

Gracia: I think the market flex is very tricky because. My theory is you should price to where it clears the market, not price to apply the market flex if the deal fails. And probably that’s a bad perception that many banks might have when applying the market flex, or when having a market flex on a term sheet. You might price and have the market flex as a get out, but I think you should price to clear the market and have the market flex in case something worse occurs that you were not anticipating.

Molina: That’s very important. I think we have never flexed up a transaction for a top-tier borrower in Latin America or somewhere else. So talking about using the flex up as a tool to get the deals done is misleading. I guess the flex up will be used for the second-tier and leverage financing, where it is more commonly used. The transactions that have been flexed up are those kinds of deals. But flexing-up Pemex? I don't see it.

Bouazza: We won’t be flexing down, maybe. That’s the better way to put it.

Donovan: Yes flexing down is a term we are less likely to use.

Radzyminski: Right, I think there has been a change, because before they wouldn't accept a market flex in a proposal. And the top-tier names today have the luxury to decide not to come to this market, and see what happens. So you don’t see a change in pricing because they're not going to issue.

Vorona: They are not going to come to market. Exactly.

Radzyminski: So on the second-tier leverage deal, what happened with Javer is exactly what was going on in the market. Banks were willing to do ridiculous things for acquisition finance and put in no flex, and they got stuck with a big deal when the market changed. That has changed, and definitely, it's going to continue changing.

Before, when I sent a proposal for an acquisition financing, I was competing with five banks, and you talked to a client and they were saying: "This bank is willing to do a no flex, or a cap of 25bp on leverage”. That doesn’t happen anymore. Now you are competing with just two or three banks. A lot of people are much more cautious.

I think on the second-tier/leverage issue, I agree with Rodrigo. Nobody's sending a proposal with the intention of flexing, because you’re hurting your relationship. But now, credit committees are saying: “If you need to sell it, you'll flex it”. It's no longer the case that they are saying: "We’re friends, and that’s it."

Wilmer: Recognising that when dealing with borrowers – especially where we are coming from – it's a tough transition. But there are plenty of facts out there to show that the market has changed. If you just look at their bonds, and how they're trading, it's a perfect example. Of course they don't want to accept it, but the reality is the market has changed. So it's about how badly they need to raise the funds.

Jakob: I think you raise a good point. There is also more pressure from the credit committees who simply say: "It’s all nice and good for the relationship but we can’t afford to be long too many positions”. And if that involves flexing the deal, I think it’s going to be a very a fine balancing act between relationships and long positions.

But I think when people look at portfolios and commitments globally – and that is [at least] the feedback we have been getting – there is more pressure to move paper, and move it at what is deemed to be a market price.

Because it's not only what's happening in Latin America, but if you look at somebody who looks at a bank's portfolio, and if you are long certain leverage positions that you went into maybe pre-crisis, all of a sudden every dollar that you can move off your balance sheet counts.

So I think there will be much more pressure to flex and price at what I would call the new equilibrium level. It is not always an easy discussion with the clients, but if there are people out there who are prepared to do it without that, I wish them good luck.

Rubio: Especially on the LBO-type financing, at least in North America, it's kind of common to go to market and flex it if you want to get it done. And it’s not as big a deal as it is for us [in Latin America].

IFR: Is that because the relationships between banks and issuers in Latin America is different from what happens in the US?

Rubio: At least from my experience, when you see LBO-type of deals in the region, you have sponsors that are used to these types of structures, and you flex and they say, "Okay, fine."

Radzyminski: In LBOs sometimes they are not so sensitive on the pricing, but on getting the assurance that they'll get the money when they buy. But with top-tier credit, it's a different ballgame.

Gracia: But I think the idea of flexing a deal to a top-tier name is seen as projecting something negative about the company in the market. And basically that's a perception the top names have, and they resist applying the market flex for that reason.

IFR: What about the loan credit default swap (LCDS) market in Latin America? How significant is this market in the region and has it developed. If not, why not?

Rubio: You see a couple of traders doing CDSs in the most liquid names. You will find CDSs for Pemex. But those are based on the ones that have nothing to do with the loans. A year ago, some people were talking about doing the CDS for loans, or incorporating loans into the baskets of the CDSs, but [that hasn't happened].

IFR: Why hasn't this market developed then?

Rubio: There is just no liquidity. I mean you don’t trade the loans in our region. Everything is buy and hold. It's about relationships. Some issuers feel offended if you sell a loan.

IFR: Why aren't those attitudes changing, though, as the market develops?

Rubio: There are banks that are always sellers and you try to unwind your positions in that way. Your CDS is that, selling cash. But again you need an active secondary market to have an active CDS, in my opinion. One does not go without the other.

Jakob: It comes back to the point that we go over every year, namely that this is a bank market. It's a buy and hold market; and there is not really the institutional market out there. It is a function of the size of the market. I mean it is minuscule compared to anything going on in other parts of the world, particularly the US.

So as long as that doesn’t change – and I don’t expect will, and there is nothing out there to indicate it will change – we won't see very much activity in the loan credit defaults market.

Radzyminski: In some second-tier names, you saw some hedge funds interested in looking at these, or buying. And that is no longer there at all. There was a trend that was slowly developing. Hedge funds were interested but now they don't even bother.

IFR: What are some of your major concerns going forward? What should we be looking for in terms of warning signs that the market may be taking a turn for the worse?

Bouazza: I think as long as we bring sensible deals, they get done and we keep the positive momentum going, I think people will continue to sleep well.

The minute we have a very visible benchmark transaction that struggles, that's when alarm bells will go off. I'm not talking about the couple deals that were challenging to start off with, but a visible benchmark transaction where it does not get done even within reasonable parameters.

And I don't expect us to get there, as long as we are coming up with reasonable structures and the pricing and the names make sense. As long as that remains in check, we shouldn't get there. The panic and the real credit crunch should not hit our market. But obviously, the cost of funding of banks and things on the global scale, over time, can affect even the strongest of countries and regions. So we’ll keep an eye on that.

Donovan: We've all been asking over the last two months when will this global liquidity crisis hit Latin America? And I don't think there's been a deal that we can say has really been affected by it. Maybe you see a fewer number of banks participating, but these deals get done, and they all get done pretty well at these levels.

And again, going back to what we were talking about, structures are tightening up. The spreads will probably not go down any farther. They may widen out a little bit in places with the better names in Chile and Mexico. They may widen a little bit, but not by much. In Brazil we've seen some widening there, which is warranted.

But no, in general, as Katia's saying, if you offer well-structured deals priced properly, it still is a bank market, and you’ll have the relationship banks in there.

Wilmer: The truth is though that even if the cost of funding for issuers were to go up, say, 20%, on a historical basis that is still an attractive cost of funds. So a small adjustment is not necessarily going to disrupt the market significantly.

Wilds: What's interesting, though, is that the short-end of Libor is extremely expensive right now. It's 5.80%. And with 10-year Treasuries where they are, investment-grade issuers that have access to the bond market might be better off actually paying the new issue premium they would need to pay to access the bond market, rather than go short Libor plus what looks to be a tighter spread but a higher all-in cost. That’s probably a very unique set of circumstances in the market right now.

Bouazza: I agree and I think that some will take advantage of it. At the moment, it's not just a matter of just paying the new premium to get a deal done. I think nobody wants to be the first one to be in the bond market to test the waters, because it is not clear what the premium is. So I think this will start happening once somebody opens the door a little. Maybe it will be a sovereign.

And after that, I think people are going to realise that, as Eugenia said, an all-in under 6% is quite good, compared to taking the Libor.

Wilds: But when your Libor shows up on the screens at 5.20%, I don’t think, if you wanted to lock it in, that you could.

Bouazza: Yeah. Not at this level.

Donovan: No, there’s a premium to it. I don’t recall last time I talked about Libor plus a premium.

Wilds: That’s a very interesting rate environment, right now.

Donovan: Again, liquidity. It concerns all our home offices.

Wilds: And that’s why banks' funding costs are so high.

IFR: What about volumes this year? Will we see a drop in volumes this year, especially considering that this year we are unlikely to see a trade as large CVRD's?

Donovan: last year we had CVRD, which was a US$19bn acquisition financing. I haven't seen the numbers yet, but I think in generally we are on track for a pretty good year. It is different from when it was US$28bn–$29bn.

Rubio: Last year was about US$60bn, and this year we are predicting, say, US$40bn.

Bouazza: I don't think anyone looks at volumes anymore because it depends on just one or two trades.

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