Capital markets: Pension funds are crucial to Mexican potential

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By:
Jason Mitchell
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Mexico has always been one of Latin America’s leading investment banking markets but the equities segment has traditionally underperformed. Jason Mitchell finds out why bankers are now predicting more activity and fees.

EQUITY CAPITAL MARKETS activity in Mexico has started to pick up this year and is likely to become much stronger in coming years as pension funds turn to variable income assets, say local experts.

Mexico remains more of a debt capital markets and M&A story than an ECM story compared with other Latin American countries, especially Brazil. However, investment bankers say this is likely to change within the next five years, as the country’s pension funds (afores, which already have $125 billion under management), continue to grow and look to diversify their range of investments. Bankers say that this is good news for their fee income, already recovering since the trough at the time of the international financial crisis, because ECM work pays better than other financial markets sectors.

For the year to October 7, total ECM activity in Mexico amounted to $3.198 billion from seven separate transactions compared with $2.4 billion from eight deals last year, $2.1 billion from seven deals in 2009 and $2.3 billion from three deals in 2008, according to Dealogic.

For the year to October 19, DCM activity totalled $28.9 billion from 63 separate deals, compared with last year’s $45.7 billion from 89 transactions. In 2009, total issuance was $23.4 billion from 63 deals and in 2008 it totalled $17.3 billion from 77 transactions.

For the year to October 7, Mexico had a total M&A volume of $16.3 billion from 133 transactions, again way below last year’s $44.2 billion from 166 deals. In 2009, total activity added up to $4 billion from 109 transactions and in 2008 it topped $8.8 billion from 179 deals.

"Mexico’s capital markets have incredible potential," says Jaime Martinez-Negrete, president of Morgan Stanley in Mexico. "Three years ago, afores could not invest in equities, today they can. This is starting to change the game. Before there was only retail demand for equities, now there is much more institutional appetite. Mexico also has a very compelling macro and financial story. I think this will encourage international investors to look at the country once appetite for risk assets returns."

Alejandro Valenzuela, chief executive at Banorte, Mexico’s third-biggest bank, says: "Today, pension funds invest 30% of their total assets in equities. Over time, I totally agree that the ECM market will become more important in the country. The family-owned companies are conservative and will only open up gradually, similar to what we saw happen in Chile. However, I think we will start to see institutional investors participate more on firms’ boards and this will encourage them to look at the ECM market."

For the year to October 7, Mexico contributed 12.1% of all ECM activity in Latin America against 4.4% last year, 7% in 2009, and 9.3% in 2008, according to Dealogic. Brazil’s share has slipped to 41.4% this year from 85% to 89% between 2008 and last year.

For the year to October 7, Mexico accounted for 30.8% of DCM activity in Latin America against 39.5% last year, 29% in 2009 and 41.3% in 2008. Brazil accounted for 46% this year against 42% last year, 37% in 2009 and 30% in 2008.

For the year to October 7, Mexico contributed 16.2% of the region’s M&A activity against 18.3% last year, 4.7% in 2009 and 8.1% in 2008. Brazil makes up 61.4% this year against 63.5% last year, 70% in 2009 and 73.7% in 2008.

Fee income

After adjusting for large transactions in terms of volume and no fees, total fee income for all investment banks in Mexico this year is estimated to be $260 million, much better than the trough year of 2008 at $140 million but still below the peak year of 2007 at $370 million, according to Dealogic. Last year income stood at $230 million and in 2009 at $215 million.

"The investment banking wallet in Mexico remains much lower than Brazil’s which is around $1 billion," says Lisandro Miguens, head of investment banking for Mexico and the Andean region at JPMorgan. "However, it’s been consistently rising since the 2008 low point, but still hasn’t reached the 2007 high point."

During the past four years, DCM deals have made up 50% of the wallet in Mexico whereas ECM transactions have accounted for 30% and M&A deals 20%. In most other countries, M&A accounts for around 30% to 35% of all investment banking fee income.

Lisandro adds that the ECM fee income in Mexico is normally highly dependent on large elephant deals, which leads to a lot of ups and downs for investment banks.

Mexico suffers from structural problems, mostly cultural, that mean that far fewer companies go public than in Brazil. Many of the country’s biggest companies remain family owned and traditionally they have been reluctant to enter the equity markets. The country also has some industrial sectors that are dominated by just one or two groups. For example, América Movíl, controlled by Carlos Slim, the world’s richest man according to Forbes, has a monopoly over the telecommunications industry in the country and private companies do not operate to any important degree in the utilities sector.

Mexico is also well known for having a highly illiquid stock market: around 130 companies are listed but most of the stocks are thinly traded and closely held.

"During the next five years, we will see a lot of change in the Mexican market," says Mark Ramsey, president of Macquarie in Mexico. "This will be driven by the pension funds, which will have greater and greater sums of assets under management. I expect them to become much more active players. The regulatory environment is becoming much more liberal. In time, this will break down the family structures and lead to many more IPOs."

Miguens adds: "The new generations running Mexican companies are much more comfortable than their parents or grandparents with the whole notion of what it means to go public. Many have been educated in the US. Since the financial crisis of 2008 we have seen Mexican companies more actively looking for opportunities abroad to become regional or global players. They understand these opportunities cannot be financed only through debt, so the equity markets will play a key role in designing a prudent capital structure to finance the acquisitions."

Marginal fees

One of the biggest issues for investment banks in Mexico is that some corporates have such clout within the economy that they are prepared to pay only marginal fees to banks or in some cases do not pay any fees at all.

The M&A market is not only down in Mexico this year but has also become more concentrated. According to Morgan Stanley, the top-five deals this year made up 74% of the market, against 80% last year and 65% in 2009.

"Investment banking activity in Mexico this year has definitely been impacted by events in global markets," says Martinez-Negrete. "The total volume of M&A deals, valued at more than $100 million, is way down this year. The IB industry in Mexico has as many players as the Brazilian one but many fewer companies that can be IB clients. There is a real concentration in specific sectors. However, I am positive about the future: on the ECM front the deal pipeline is much better than it has been in three years.

"The level of company devaluation because of falling markets has been a lot lower in Mexico than in many other markets relative to historical valuation levels. Big corporates in Mexico have taken a very defensive stance. The debt markets have been wide open to them and they would rather issue a bond than list and dilute their equity. The other big change has been the emergence of private equity in Mexico. There have been around 40 investments by PE managers in the country during the past five to seven years. In time, this will lead to exits and IPOs. We saw this phenomenon in Brazil."

This year domestic and international debt issuance is down. For the year to October 19, total domestic issuance stood at $11.4 billion from 39 deals against $21.4 billion with 54 transactions last year. For the year to October 19, total international issuance amounted to $17.58 billion from 24 deals against $24.3 billion from 24 deals last year.

Ricardo Cano, director in wholesale banking at BBVA Bancomer in Mexico

"Mexico’s capital markets have seen some volatility this year, provoked by events in the international markets"

Ricardo Cano, BBVA Bancomer

DCM issuance in Mexico tends to be dominated by the same corporate names: América Movíl and Pemex, the state-owned oil company. One of the biggest deals this year was a $2 billion issue by BBVA Bancomer, the Spanish bank that is a big player in retail banking in Mexico, in March. Its bookrunners were BBVA, Goldman Sachs and Deutsche Bank.

Mexico’s economic stability has also encouraged two Chilean companies – BCI, an investment bank, and Molibdemos y Metales (Molymet), the world’s top molybdenum producer – to issue debt there this year. On July 15, BCI placed Ps2 billion ($160 million) in three-year debt. The bank has the option to issue an additional Ps6 billion with a maturity out to five years. HSBC was the bookrunner. BCI was attracted to Mexico because of restrictions on the amount that Chilean pension funds can invest in their home country and by the longer-term maturities available in Mexico.

The debt was issued at 40 basis points above Mexico’s 28-day interbank lending rate, known as TIIE. At the time the TIIE rate was 4.77%. BCI plans to issue more bonds in Mexico next year.

In March, Molymet issued a bond for Ps1.5 billion, with Banamex (part of Citi) acting as bookrunner. In August last year, it also completed a $102 billion bond issue in the Mexican market. Mexico’s authorities expect more Latin American companies to issue there next year.

"Mexico’s capital markets have seen some volatility this year, provoked by events in the international markets," says Ricardo Cano, director in wholesale banking at BBVA Bancomer in Mexico. "There is no closed border between the country and the rest of the world; however, the DCM market is a bit more isolated because afores have a great deal of liquidity. In the local bond market, price discovery discretion is continuing to grow. Spreads moved down to very low levels in the first half this year. Since then they have spiked up with new transactions coming to the market."