When the wave of the coronavirus pandemic reached Latin America, the region’s capital markets slammed shut. Corporates of all sizes rushed for liquidity, pulling down revolving facilities and seeking fresh short-term debt from banks, acting on a history that suggests risk appetite would be slow to return.
And yet in early May, Brazil saw an IPO come to market. Estapar, a parking lot company, raised R$300 million ($52.7 million), beating an increasingly confident pipeline of follow-on transactions.
Via Varejo has hired Bradesco BBI, Bank of America, Banco do Brasil and XP Investimentos to manage its capital raising, while fellow retail company Centauro has mandated BTG Pactual, Bradesco BBI, Itaú BBA and Banco Santander.
Other IPOs are also in the works, with construction company Aura likely to be next to issue, using first-quarter numbers and being led by Itaú BBA, XP and Credit Suisse. Corporate debentures have also been issued.
A deeper and prolonged contraction of activity increases the risk of scarring effects… which could delay and undermine the recovery once the viral outbreaks are brought under control- Alberto Ramos, Goldman Sachs
Elsewhere in Latin America, the capital markets reopened in a slightly more orthodox manner: sovereigns reopened the international bond market to Latin American credits and the stronger corporates followed.
From the Panama sovereign trade, which raised $2.5 billion in late March, to the blow-outs for Peru and Chile, investors scrambled for new sovereign debt from the region.
The Chile transaction in particular – a $2 billion dual currency trade – drew huge books that enabled it to price without a new-issue premium.
Peru also closed its lowest-ever dollar funding – an incredible achievement given market volatility and the country being part of a $26 billion fiscal relief programme.
The quasi-sovereigns and the high-grade corporates navigated the conditions with ease, too.
Deals from Colombia’s Grupo Energía Bogotá and Chile’s government-owned copper miner, Coldelco, were able to tighten the pricing on their April deals.
In Mexico, Santander and América Móvil also attracted plenty of investor demand.
However, all isn’t necessarily as it seems. Estapar was brought by BTG Pactual, whose partner and ex-chief executive, André Esteves, bought 46% of the shares in what was a capital raising to fund a specific acquisition.
“We don’t consider it as capital markets transaction,” one ECM banker tells Euromoney sniffily. “But while there were idiosyncratic reasons not to use this deal as a broad ‘risk-on’ signal, it did create grounds for optimism.”
Those local debt transactions also aren’t quite as good as they look either.
Many local banks structure bank loans as debentures and ‘store’ them in their asset management businesses to ensure better capital treatment for the credit.
There’s little transparency about whether these deals are fully or partially distributed in the local market, but sources suggest the early deals were not sold widely.
Daniel Bassan, head of global banking in Brazil for UBS, says international investors are taking a differentiated view of issuers’ business sectors.
“TMT [technology, media and telecom] are doing well,” he says. “I wouldn’t say they are growing at the same pace as in the past, but they are performing very well in the crisis – along with others such as healthcare and banks. We are more optimistic about transactions coming for companies in those sectors in the short term.”
Bassan adds that his conversations with sector-dedicated investors are good, but Latin American companies will face strong competition from other companies in regions that are not being as badly affected by coronavirus.
We have been encouraging clients to look ahead – our general view is that we are going through a relatively benign window of opportunity in which to issue to extend maturities and eventually to raise equity- Eduardo Miras, Citi
Weaker credits – those that rely on emerging-market and Latam-specific accounts – haven’t seen the same surge to get deals over the line. And the fact that the only Latin American company without a single-A rating to have issued since the crisis – Ecopetrol, which still enjoys the status as a quasi-sovereign – had to pay a large new-issue premium (between 60 and 90 basis points) for its $2 billion, 10-year paper took the wind out of the sails of those not in the top tier of Latin American issuers.
“Companies don’t want to print at these levels,” says one banker. “They’re waiting for levels to move back to more familiar territory.”
But there is no certainty that waiting will lead to improved conditions.
Latin America was the last region to be hit by the Covid-19 pandemic, but it could well end up suffering the most. Banks, including Goldman Sachs in a recent report, have revised their predictions about the length and severity of the downturn.
Weak health systems and political confusion mean that the lockdowns and social distancing, in place in many regions since the second half of March, will be extended for a couple of months.
This could lead to a 7.6% contraction across the seven biggest regional economies in 2020, with the largest expected to be hit particularly hard: Argentina (-8.5%), Brazil (-7.4%) and Mexico (-8.5%).
“This extension will generate a deeper and longer-lasting effect on real activity,” says the Goldman Sachs report’s lead author Alberto Ramos. “Furthermore, a deeper and prolonged contraction of activity increases the risk of scarring effects… which could delay and undermine the recovery once the viral outbreaks are brought under control.”
This deteriorating outlook is particularly true for Brazil – and so far there has been deafening silence from Brazilian issuers of any kind in the international market.
Speaking on May 18, Alessandro Zema, Brazil country head and head of investment banking in Brazil at Morgan Stanley, says: “The vast majority of the frequent issuers – the blue-chip names – came into this crisis having already conducted liability management exercises, and their capital structures were in good shape.
“In a sense they have the luxury to wait for what they think is the optimal timing, and I think most will be opportunistic,” he adds. “But I do think we will see the first international debt capital markets transaction coming from Brazil in the next few weeks.”
Zema doesn’t believe that these issuers are waiting for the sovereign to come to open the markets – he points to the fact that Mexican and Chilean corporates issued ahead of their public finance ministries.
Bruno Fontana, Brazil investment banking head at Credit Suisse, disagrees.
“I am 100% sure of it,” he says, when asked if Brazilian corporates are waiting to follow the sovereign back to the international capital markets.
And, as Fontana notes, that could be a problem: “There is a discussion about Brazil’s sovereign rating – how that is going to look. There are a few questions there.”
Out of control
If Brazil’s sovereign team is even a little sensitive to its pricing levels – which it is – then recent developments are not going to help investors pile into a new issuance in the same way as other large Latin American countries.
The country is becoming the new global epicentre for the disease; the government’s response has gone from ineffectual to counter-productive.
President Jair Bolsonaro has seen his rejection of the consensus on science and public health policy lead to the resignation of two health ministers within a month. The pandemic is in danger of spiralling out of control and the economic ramifications are going to be a heavy weight. With the rate of daily deaths still growing in late May, the prospect for reopening the economy seems far away.
On May 15, Bank of America revised down its 2020 GDP growth forecast for Brazil to -7.7% and the region to -6.8%.
In a client note Capital Economics estimates that the markets are charging an additional 50bp of political premium in the spreads of Brazilian sovereign dollar bonds, complicating the decision to issue new debt.
There is little prospect that this risk premium will get better as the political and economic situation deteriorates further. Investors express their view through constant capital outflows, while the currency is the worst performing among all large economies this year – down 46% year to date.
There are other specific weaknesses to the region’s economy, such as high levels of labour informality, which means extending the lockdown weighs particularly heavily on the poor, as well as institutional weakness in delivering a coherent policy response to health and economic emergencies.
This is particularly true of Brazil. The country came into the crisis with bad fiscal dynamics and it will exit with debt of about 90% of GDP and a primary fiscal deficit approaching 5%.
The country’s political dysfunction won’t give investors confidence that there will be a consensus to address the resultant fiscal emergency.
Many investment bankers fear that the current benign environment for capital raising may turn out to be a brief window for Latin American corporates to raise much needed cash rather than the beginning of any enduring recovery.
If they are right, then the companies who are reticent to enter the markets now may regret it as they could be left with just banks for funding – and although that source is still liquid, it isn’t limitless.
Eduardo Miras, managing director of investment banking for Citi in Brazil, says: “We have been encouraging clients to look ahead – our general view is that we are going through a relatively benign window of opportunity in which to issue to extend maturities and eventually to raise equity.
“But we don’t know how long this is going to last,” he adds. “The economic impacts are going to be very significant, and at some point markets might completely shut. [If that happens], companies will need to rely on banks – and banks are getting to their limits.”
Minas says that many of his clients are struggling to formulate strategy. On the one hand, the large companies that are in non-distressed industries responded quickly to the crisis in March by increasing liquidity.
“They have the cushion to endure,” he notes.
On the other hand, management is beginning to realize that the ‘V-shaped’ recovery touted so much early on isn’t the most likely scenario.
“We could have aftershocks, an ‘L-shaped recovery’ where the economy takes much longer to come back,” says Miras. “The liquidity [that companies raised] was very short term. They raised it in March and we are coming up to June, so we have nine months to figure out how to pay the debt or refinance, and if so by accessing what markets? And which markets: the equity, convertible or debt markets?”
Bankers around the region are having similar conversations.
Brazilian companies are notoriously cost conscious. They eschew statement trades – one Brazilian banker marvelled at the trade by Exxon earlier this year, issuing when the oil price was below $20 and $30 a barrel just to show that it could.
But Brazilian companies’ focus on cost goes beyond aversion to such chutzpah. In many cases, they seem averse to any additional financing cost that companies in other regions regularly pay for – namely tenor extension and investor diversification for debt and selling equity away from market peaks to de-lever balance sheets.
There is a predisposition from investors to provide capital to the region’s brand names and those companies that are perceived to be the long-term winners. But I think there is a fair bit of risk around from additional waves of contagion- Eduardo Mendez, Morgan Stanley
“We are in a window of availability,” says Eduardo Mendez, head of equity capital markets and sales distribution for Latin America at Morgan Stanley. “There is a predisposition from investors to provide capital to the region’s brand names and those companies that are perceived to be the long-term winners.
“But I think there is a fair bit of risk around from additional waves of contagion as states and countries begin the process of reopening.”
Mendez says new lockdowns could “impact risk appetite from investors to provide capital down the line, and so it behoves corporates to strike while the iron is hot – to ensure that they can take liquidity now.”
He notes that there is “significant” cash on the sidelines, but “I wouldn’t say that there is an infinite amount available, so if there is a long delay in coming to the markets, money may or may not be available at that stage.”
Mendez adds that his reply to those cost conscious CFOs who note that debt and equity prices still have room to recover to pre-crisis levels is to lock in now.
“Cost is less relative right now,” Mendez says. “Let’s make sure that the funding is available. If in months or years down the line, we reach the conclusion that the situation wasn’t as drastic as we had anticipated – and companies have excess capital – there are a series of measures that can be taken down the line, from share buybacks to returning capital in different fashions that can be done to optimize returns.”
Bruno Amaral, partner at BTG Pactual, says the strength of demand for equities “is the result of more than one factor – investors have been used to interest rates that were interesting for them on a risk-free real return, but now those returns are zero or close to zero – that’s not an environment that an investor is used to seeing. But that factor needs to be looked at in the context of the financial deepening that is happening in the country.
“It’s a sign of an improved maturity, and investors see an opportunity to enter the market at these levels,” Amaral adds. “So we think the markets should remain open in the second half of the year and expect ECM deals to come – though at much lower levels that we had expected at the beginning of the year.”
One banker away from the Estapar deal says the fact that retail investors made up 20% of the book – and there was a lot of institutional volume too – is encouraging for future issuance as it shows that both types of investors remain engaged.
It also supports the surprisingly bullish local performance of local retail equity investors – there were no widespread redemptions from the asset class despite drawdowns of 35% to 45%.
On the contrary, there were numerous cases of equity raising amid collapsing equity prices. Well-known Brazilian equity managers raised billions in hours (for example, Dynamo attracted R$1 billion ($176 million) for its Cougar fund within a working day).
Local bankers say the follow-on pipeline could return strongly, but as a result of companies needing capital to de-lever rather than the growth-orientated stories that promised to dominate 2020 before the pandemic.
(There is a consensus among investment bankers that, without the pandemic, Brazil would have enjoyed a record year in terms of fresh equity issuance in 2020.)
This cautious optimism seems grounded when looking at the relatively good recovery of the markets to this point. However, if the crisis extends or deepens across Latin America, then investors will return to maximizing cash positions, while the markets for fresh debt and equity will snap shut.
Investment bankers will always urge their clients to go to market – it is how they get paid. But many Latin American companies that didn’t follow their investment bankers’ entreaties to strengthen their balance sheet during this window may not survive to regret that decision.