IFR Colombia Roundtable 2019: Part 3

IFR: EPM has also been in the news for its Ituango dam, which has been delayed after the project’s structural integrity was called into question. What impact has this had on the company’s balance sheet? And what does this mean for the financing of the dam itself and your financing needs?

Jorge Tabares, EPM: We were building a US$4bn project and almost US$3bn into the project, 85% complete, we had a major issue with a tunnel blockade and a premature rising of the reservoir.

This week we reached a big milestone having regained control of the water, which was a huge issue for us as it protects the community downstream from the river that has been the major focus for us during the 10 months of the crisis. Nobody has been injured throughout the contingency plan, which has been very important.

The impact on the company from the delay in the project comes mainly from three-year lack of revenue. It is a huge project for us. It is 2.4GW project in a 3.5GW portfolio. It represents a significant increase in our generation capacity. As a result we had to find ways either to raise funding or to reduce capital needs. The company is going through what I would call a mini-4G because we are investing Ps11trn in the next four years in our infrastructure

Eighty five percent of that is in Colombia by expanding our capacity, our networks in electricity and water, improving infrastructure or serving new clients in areas we operate. Most of that is required, and we can’t delay that capital deployment. We have to find ways of funding the gap in revenue that we were counting on from the Ituango project.

We reduced the capex a little. Twenty percent was all that was possible and then we undertook a savings efficiency programme that helped us identify about US$300m over four years. We are also in the process of divesting assets.

We are selling a 10% stake in ISA, a transmission company that is listed in Colombia, and our water business in Chile, Aguas Antofagasta (ADASA). Since we acquired ADASA, Ebitda has grown by about 80% so we are pretty confident that we can sell the asset at a good price because of its growth potential and how the business is run.

IFR: How much do you hope to raise from these asset sales?

Jorge Tabares, EPM: About US$1bn. The key element of the contingency plan was to maintain the ratings. For us that is critical because we have four international debt issuances. About US$2bn is circulating in the international markets and we also have local bonds outstanding. We want to run this company as an investment-grade credit because the nature of the owner – the City of Medellin – needs reliability of income. The company represents about a quarter of the revenue of the city, which is our sole owner. We need a solid rating.

Two key elements to maintain the ratings are the asset divestment programme and the need to demonstrate access to funding. Though we are investment grade and could go to the international bond market, we didn’t want to do a long-term transaction under such weak conditions. So we approached a local bank, a Western bank and an Asian bank, thinking globally.

IFR: Which banks are those?

Jorge Tabares, EPM: We ended up signing a facility with Bancolombia (about US$500m-equivalent), and HSBC signed US$750m of loans that were very shortly afterwards syndicated with five more banks. And then we are working with an Asian bank to finalise a US$300m transaction.

It was key to act very quickly and to confirm an ability to fund to maintain the rating. And we were able to do that. The key is that this is not project finance. This is an on-balance-sheet project, and the asset base and the current portfolio of EPM is very solid. We are still putting the numbers together but this year Editda should be in the range of US$1.6bn-$1.7bn, with 8%-10% growth. That is what is allowing us to get funding and to continue our capital programme.

IFR: Beyond that will you return to the capital markets to take out that debt?

Jorge Tabares, EPM: Yes, we want longer-term (debt) because those loans have relatively short-term maturities. To obtain financing quickly, we had to secure short-term transactions, but I have to emphasise that those are unsecured loans. Because of the solid asset base we didn’t have to get into the complicated loan transactions. They were plain vanilla transactions, senior unsecured and now we want to go longer term. So at some point - depending on market conditions and the stability of the company - we will go to the capital markets.

Every time we go to the capital markets we look at local and international (markets). Because of the size of EPM, international markets are becoming much more attractive. Our debt portfolio is US$6bn-equivalent, so we prefer to do US$750m-$1bn transactions to be more efficient in the way we handle the portfolio. If you go that big in Colombia, pricing is not optimised. You have to raise perhaps US$300m to get a good price. You could get more money but increasingly you have to pay for it.

IFR: What else are the ratings agencies telling you to maintain your investment grade?

Jorge Tabares, EPM: There are two key elements that will trigger a downgrade: One is if something were to happen in the project. But we closed the water passing through the power house and nothing happened, so I think we are out of that possibility.

The second element is access to funding. We have a US$500m maturity in July for the first international bond we issued. We are considering our options. We have enough liquidity. We have about US$800m of cash on hand, so we have money to pay the bond. And it is just about when to pay. We want to be present in the international US dollar market, but we need to go a bit further in the resolution of the contingency plan to get good pricing on the bonds.

IFR: Let’s turn to our other corporate issuer at the table, GEB. Freddy, could speak about your funding needs for this year and what markets you are considering?

Freddy Ussa, GEB: We are in a period of transformation as we are trying to run each of our companies as part of a group. Next year our strategy is to grow profits, and the idea is to invest US$400m-$500m in Latin America, not only Colombia.

We will maintain our core business, transmission lines and gas pipelines, but we also want to get new projects in the renewable sector. There are some interesting opportunities in Chile, Mexico but also here in Colombia.

IFR: How will this US$400m-$500m be financed?

Freddy Ussa, GEB: We are planning to make those investments over the next two years, not only as project finance but also as financial debt.

IFR: GEB’s re-IPO last year was seen by some as a landmark transaction as it was the first international equity issue from a Colombian issuer since 2014. What were some of the challenges and do you think you will return to the equity market?

Freddy Ussa, GEB: It is not clear when we will do another. This is not the right time. The group is waiting to do another deal but I don’t think it will happen this year.

IFR:I understand there were some challenges caused by law 226, which among other things requires several stages in the so-called “democratisaton” sale process for shares from state-owned entities like GEB and sets a minimum price beforehand.

Bibiana Jaimes, White & Case: We worked on the IPO. It was an extremely interesting transaction. Nothing like this had been done out of Colombia before. Equity deals are already quite rare. On the structuring side, there is a clear path to do ADRs, but there is no path to do direct share sales, which is what they decided to do this time, and that brought complexity.

There were also structural problems. Brokerage houses in Colombia have limits on capital. They take a piece of the deal, but they are liable for up to 30% of their regulatory capital for deals in which they participate.

In this case, that would have exploded the system because of the size of the GEB deal, which was initially about US$1bn and then downsized to around US$670m. The first complex item was that the local exchange had to create a whole new process to allow brokerage houses and international investors to participate.

And because it was structured as a direct sale of shares, you had to educate investors as to how to invest in Colombia because regulations require them to open accounts with local brokerage houses. That is the only way you can invest in the local markets, which was also interesting because it had never been done before. Granted, there are other countries in the region that have similar procedures. In Brazil it is common and even in Chile, and also Peru. We had precedents to work with but it was a brand new transaction for Colombia.

Another challenge was how the pricing of the democratisation process worked because the sector solidario (associations of employees and other parties) sets your minimum price.

IFR: Is this part of law 226?

Clemente del Valle, FDN: Yes. It is not ideal but it is what we have.

Bibiana Jaimes, White & Case: That is one of the challenges. Pricing has a lot of limitations. On the GEB transaction, when they went out to international investors the price was a significant factor.

IFR: Why? Because it didn’t come at a big enough discount?

Bibiana Jaimes, White & Case: Investors were expecting about a 2% discount and they actually placed at market. It was really challenging.

IFR: Are there any efforts to change this?

Bibiana Jaimes, White & Case: I think it is unlikely. Another feature of these transactions is limitations from the so-called “ley de garantias”. Four months before the elections the company was not allowed to hire any consultants unless it did a public bid, which works in certain instances, but for this type of transactions you need comfort letters from your auditors. Only the auditors of the company can issue that document. How are you going to carry out a public bidding process for this? That is not going to happen. So we had to work around those challenges.

We proved that you can do these types of transactions. There are issues that have to be worked around. But you had international investors coming to Colombia.

IFR: How much of the final deal size was placed with foreign accounts?

Bibiana Jaimes, White & Case: About 10% were international investors.

IFR: The local markets also have their own challenges. It is still a shallow market, right?

Michel Janna, AMV: You are right. The local markets in Colombia are shallow. You can think of the capital markets in Colombia as a market with three different tiers. You have public debt that is the jewel in the crown. It is liquid, it has a good size as long as the government continues to issue debt, and you have investor confidence. We have a good arrangement of market makers locally who play that debt.

Then you have private debt of corporate bonds. There the trend in the past few years hasn’t been good. Although last year there was a big pick-up in issuance, over the last 10 years you see exactly the amount of issuance, and that is mostly from banks.

And lastly, we have seen a decrease in equities in Colombia. We haven’t had a new listing of a local company for six or seven years at least. That creates a hurdle for companies that want to fund new initiatives and growth through the capital markets.

But not everything is bad. There is some hope on one or two fronts. One is infrastructure, which should be a boost for local capital markets in the near term. When those projects migrate from the construction phase to the operational phase, we hope to see more listings and bond issuance as sponsors use local markets for refinancing.

We have also seen real estate bonds, which are slowly developing in Colombia, mostly through private equity but some are moving to be listed and that is a promising avenue for local markets.

For Colombians the most liquid and the safest assets to buy have been bricks – through homes and real estate. So if you can bring that legacy, that cultural aspect into local markets, that should boost the market.

IFR: Are you referring to real estate investment trusts (REITs)?

Michel Janna, AMV: Yes, we have a couple of REITs that have been listed. They are still small. There is a promising future for that kind of business.

IFR: Have tax breaks for funds from other Pacific Alliance countries like Chile and Peru helpe d deepen the market in Colombia?

Michel Janna, AMV: For the past four to five years, there has been a big focus to try to integrate capital markets with the Pacific Alliance countries. There has been a lot of effort on the regulatory side, on the tax side, to make it easier for institutional investors to come directly and invest in Colombian local markets.

Probably the most meaningful reform is through the passport of funds, which is a copy of what Europe has had for many years. If you are a fund that is listed in a specific country, you don’t have to go through a very expensive and cumbersome registration process in another country. That gives institutional investors in that second country better access.

Integration unfortunately has not yielded results. There are still tax issues and there are still operational barriers. FX is a big problem. If you are Chilean fund and you want to buy something in Colombia you have to go to through a dollar transaction and then swap it to pesos and then when you want to go out, you have to do the same again. There are still barriers.

The more integrated we are with Mexico, Chile and Peru, which are similar markets in terms of economic policy, the better it is because you have a broader investor base and a broader set of assets in which to invest. We will see what happens.

IFR: Is the government doing anything to improve this situation?

Michel Janna, AMV: The other promising thing is that the government has called a commission of experts to come up with a document to list the main hurdles for the Colombian capital markets. It is called “La Mision del Mercado de Capitales”. There is also some hope there will be a medium and a long-term path for the kinds of reforms needed to improve the market.

Juan Claudio Fullaondo, Scotiabank: Scotiabank is strongly committed to this. We are exploring the possibility of Mexican listed companies going to Chile and Colombia to look for specific investors. There are hurdles, but hopefully this year we will start to see such issues.

That is a perfect example of what should be done - Colombian companies listing their securities here and selling them in Mexico. There is some liquidity in the market and there are some derivatives that will have to be embedded, but there are a lot of efficiencies.

IFR: The other component of the local market is loans. Has that grown at all?

Jabar Singh, Scotiabank Colombia: Definitely Colombia is in a gradual economic recovery phase. In an environment of low inflation and historically low interest rates, that should promote growth. Last year that was not the case, being an electoral year. Commercial loan growth was 3%, so nothing astonishing.

Not only did the election delay investment decisions and capex, but local banks were still recovering from enhanced provisions for credit losses as a consequence of the named infrastructure projects that Clemente mentioned. We saw local banks being more conservative in their credit decisions than in the past.

This year we see a more promising scenario. Capital expenditure projects are being delivered and financings are being arranged and closed. There are several sectors like manufacturing – I echo Joe – it is definitely a sector that we would like to see more activity on and more revamping of capital expenditures.

Colombia also has great potential in sectors like tourism and hospitality after having come from several decades of general insecurity and the fact that Colombia is so diverse and culturally rich. And we have been receiving a lot of inbound requests from the tourism sector in general so we are slightly bullish on tourism.

IFR: What about funding costs of local loans versus local and international bonds?

Jabar Singh, Scotiabank Colombia: In terms of costs, loans compete with bonds. Here banks, because of their more long-term risk appetite or tolerance compared to international players such as ourselves, have competed with the local bond markets.

Now that banks are being a little bit more disciplined in terms of their capital deployment and loan structures I think that should promote tapping the local bond market, mainly in terms of tenor than in terms of price.

Michel Janna, AMV: As soon as Colombia moves towards more stringent and bigger capital requirements through Basel III or other types of regulations, you should see a specialisation between the banks focusing on short-term and medium-term loans and leaving the capital markets for longer-term financings.Clemente del Valle, FDN: It is the lack of investors. We have very large but very few investors. There is not enough competition in that segment. We want to see more insurance companies, more players. The more players we have the more we can do in the capital markets.

IFR: How does that come about?

Clemente del Valle, FDN: The issues have been identified for many years, but actions have not really been taken. We hope the commission will design a roadmap that the government will be willing to push forward. Hopefully that will make changes and expand the investor base a little bit.

César Arias, Ministry of Finance: The big game-changer in Colombian public debt markets is the entrance of foreign investors in the government Treasury (TES) market. The moment we moved from a foreign participation of 4%-5% to 26% today, we had a more liquid market even by Latin American standards. We have the lowest bid-to-asset spreads in Latin America. We have the highest turnover ratio, with six times the outstanding traded in TES. You cannot wait until the locals wake up. Competition and liquidity from abroad only brings great things.

IFR: How has this impacted the foreign exchange market?

César Arias, Ministry of Finance: Before if you were an EM portfolio manager and you were managing currencies in emerging markets, you only had one way to express a view on oil, which was the Russian rouble.

What we saw last year was that the rouble was contaminated by the issue of US sanctions and decoupled from oil. It was very difficult to track. But the moment you had a new government in Colombia and the political uncertainty was resolved, international investors had two ways to express a view on oil and we saw this important inflow into the Colombian FX market.

IFR: So they were expressing a view on oil through the Colombian peso?

César Arias, Ministry of Finance: Yes, globally. I am not just talking about LatAm dedicated investors. If you are investing in EM currencies, you are almost forced to have exposure in the Colombian peso. That has brought liquidity. We have to do more homework now to provide more hedging instruments but I think the way to go is competition and money from abroad.

Joe Kogan, Scotiabank: If I could make a few comments on the TES market. We have been heavily involved in this market, even before 2013, before it entered the indices and when transaction costs were extremely high. The interesting thing about the TES market is that this is the place where foreigners have increased their participation the most among EM countries. You went from 6% to 26% in about five years.

IFR: Was that because of the bigger weighting on the index?

Joe Kogan, Scotiabank: Right, and the reason for the bigger weighting on the index was some of the measures that the ministry of finance and Michel took in reducing the transaction costs.

For Colombia that experience is very new and when you talk to the central bank they are worried about what seems to them to be a large foreign presence, whereas in fact it is the opposite.

The presence in Colombia of foreigners is lower than the peer countries. In Mexico, the Mbono (local Treasury) participation of foreigners has been in the 60% range for many years now. In Peru it is around 45% now and it has gone as high as 60%. Because it is such a new experience there is this fear that foreigners could pull out as quickly as they got in. I don’t think that is true. There is a lot more room to bring foreigners into the TES market, which would be quite helpful given the various financing needs of projects that the country has.

IFR: What is the right balance César?

César Arias, Ministry of Finance: The right balance is what the market thinks is the right balance. We don’t have set numbers. In terms of the number of foreigners participating in the local Latin American markets (as a percentage of the total) Brazil is 11% and it goes up to Mexico with 60%. In my personal view, we are in the sweet spot with 26% participation, which is exactly the equivalent of the participation of local pension funds.

That helps us create a very smooth market because most of the time these two types of investors have different incentives. And that is what you have seen. We are now seeing foreigners being more cautious and we have had two months of modest outflows. But participation among locals has increased and that is what you want.

In the ministry we feel very comfortable with 26% but if we go to 30%-35%, let the market decide, or if we go back to 20% it is a market decision. You don’t impose it. Michel reduced the withholding tax from 33% to 14% and since December we cut it from 14% to 5%. So that helps but that is not the silver bullet. It is about fundamentals.

IFR: What about fears that an exogenous shock could trigger sudden outflows among foreigners?

César Arias, Ministry of Finance: It is a risk, but the international experience has demonstrated otherwise. During the taper tantrum 2013, the (Latin American) country with the largest exposure to foreign investors, Mexico, didn’t see outflows. They didn’t see inflows either, but what you saw was a re-composition in their positions along the curve. When they are bullish they go to the long end. And when they are more cautious they come to the belly or the front end. But they didn’t leave.

Mexico had other stress tests such as during the election of a US president who was against Nafta, and the perception that the new Mexican administration wasn’t market-friendly, but foreign investors are still there.

We don’t want to be complacent, but I think the way you keep foreigners is by having competitive markets, one, and two, strong fundamentals. And that is our job. Keep your ratings in check, maintain discipline in fiscal terms and hopefully you have a growth story that makes sense.

Michel Janna, AMV: It has a lot to do with the mix of investors coming to Colombia. If you have a base that is mainly composed of institutional investors, such as pension funds from other parts of the world, they are not going to do crazy things. They are not hedge funds and are usually not speculators. To have huge spikes in outflows or inflows is not something that you usually see in these types of assets. César Arias, Ministry of Finance: What Michel is saying is very important. Because when you look at the OECD world, in some of those cases, it was actually one investor (that caused outflows), so you have a huge concentration in one decision-making process. I think that is risky.

In Colombia, we have the usual suspects, but I am starting to see in the data a lot of diversification. For example, we have sovereign wealth funds, which are very good investors in our view, and some central banks from developed countries. And when we did this change in the tax and we gained membership to the OECD suddenly we were eligible for pension funds from the US and Europe. The more the merrier. It makes it more stable.

IFR: Are you covered for the rest of the year for financing after your latest bond deal? Would you look at a possible euro deal now that you are a member of the OECD, which broadens your appeal among investors there?

César Arias, Ministry of Finance: Our traditional approach in Colombia, especially in years of a lot of uncertainty like this one, is to pre-fund yourself. That is what we did. We went in October and pre-funded US$1bn and we went in January and pre-funded US$2bn.

IFR: So you have enough for the year on the external funding side?

César Arias, Ministry of Finance: Yes, on financing needs. However we are also very proactive in the second half of the year when the market permits and usually pre-fund. We think the euro is a good option, especially after what the European Central Bank has been saying that (monetary tightening) will be a very slow process. Interest rates are still very low, but what we don’t like sometimes is that the duration is a maximum 10 years. But it is an option that is on the table. We tapped the euro market a few years ago.

We are also thinking about Green bonds. We think we have a good story to tell there, and I wouldn’t be surprised if the next exercise would be a Green bond.

IFR: Thank-you all for your contributions.