NEW YORK - As compared to one year ago, participants were singing a different tune this spring at the tenth annual Latin American Conference hosted by Fitch Ratings, held at the Ritz Carlton in Battery Park last week. The main topics this year - what the market has learned from the Argentine crisis and what lies ahead south of the border - is a far cry from last year's hyped-up buzz about devaluation insurance.
While there was a growing concern for Argentina during the spring of 2001, the country had only just begun trotting down its long and winding tragic path. At that point, Fitch had just downgraded Argentina's sovereign rating to B+' from BB-', Moody's Investors Service had only changed the sovereign rating to B2' from B1', and Standard & Poor's had downgraded the rating to B+' from BB-'. Now that the country is in sovereign default, market participants at this year's conference felt that it was important to discuss the lessons learned from Argentina's tumultuous economic decline.
At an investor roundtable, William Hayes, a managing director at Fitch, asked a panel of investors what they have learned from Argentina, and what the market should take away from the experience. Some investors pointed to the status of their portfolios to make their point. Wilma Davis, a panelist and a senior managing director with John Hancock, noted that her company has $3 billion invested in emerging markets, two-thirds of which is in Latin America. The company has divided its corporate debt into three buckets: future flows, oil-backed deals and corporate transactions that rely on domestic cash flows.
Davis said that although some of the future flow transactions in Argentina have weakened coverages, they are performing. The Argentine oil-backed deals are also performing as a result of their dollar-denominated income. However, the corporate deals that rely on domestic cash flows have all defaulted, Davis said.
"These are early lessons because we haven't gotten through this yet," Davis said. "There's no doubt in my mind that the sovereign is in charge; it's the dominant backdrop for all cross-border deals and politics drives everything."
Looking at the domestic side, Davis added, "Currency mismatches do matter; if there's a mismatch, there's a potential problem. Politics determines what will happen; if governments can get involved corporate bonds have less liquidity in a crisis. And, creditors' rights have very little value if there isn't a good judicial system. These are things we all discuss, but they have been reinforced."
Brazil and Mexico
Brazil and Mexico are the current highlights in Latin America. At the start of the Argentine crisis most market players were concerned about the contagion effect on Brazil, in particular. Although Brazil has experienced some waves from the Argentine storm, it is still performing far better than originally expected.
Armnio Fraga Neto, governor of the Central Bank of Brazil, was the keynote speaker at the luncheon during Fitch's conference. Much to the surprise of the crowd, the Governor began speaking about Brazil in 1991 and 1992 when the country was in default.
"It's not a great thing to talk about, but I'm a straight shooter," Fraga Neto joked. He continued to speak on how the country has come a long way since that time. Hyper inflation has gone, there is a macro-economic framework in place and the country has endured deep fiscal reforms. Interest rates are currently at 8% and there is a 3% growth rate. "If the fundamentals are maintained, over a long-term period of time, it should bring the rates down, and the recovery of the U.S. will help," Fraga Neto said.
Despite the positives, market participants still have reservations about Brazil. According to sovereign analysts, the deficit remains high. With the upcoming elections there are some uncertainties. One investor at the conference said spreads in Brazil could widen to between 800 and 1000 if elections go poorly, or they could tighten by 200 if things go well. "There's a reason why interest rates are high," the investor warned.
Fitch currently has a BB-' rating with a negative outlook on Brazil's long-term foreign currency and a B+' rating on the country's long-term local currency. Fraga Neto, however, disagrees with Fitch's ratings. "I would rate the domestic debt higher than the international debt."
Nearly 80% of Brazil's debt burden is domestic debt. "Inviting others to buy that debt would be tremendous," said James Barrineau, vice president of global economic and risk research at Alliance Capital. "Armnio Fraga should be more aggressive. A freely open capital account would be real helpful."
The Governor remarked that Brazil would be at risk if the fundamentals change, although he also noted that he does not believe that will happen. "People know how bad things were and can be without [the fundamentals.]" The Governor also noted that it is important to continue reform. "If we keep going at the rate of reform as we have over the last eight years, the sky is the limit. And, I think we will," Fraga Neto added.
Mexico, now rated investment-grade by all three major rating agencies, is another country that is performing well in a region that is seemingly tainted with bad luck these days.
According to Francisco Gil Diaz, Minister of Finance in Mexico and a speaker at Fitch's conference, the economic slowdown in Mexico came in the form of financial and price stability. Gil Diaz also noted that inflation and interest rates have declined to a minimum record in decades and access to the international capital markets was not hindered. Furthermore, the Minister also said that the fiscal policy has been managed with discipline and responsibility.
In previous years, the correlation between Mexico and the United States was about 30% to 35%. The correlation has now risen to nearly 90% as a result of Mexico's involvement with the North American Free Trade Agreement (NAFTA). "We grow more when the U.S. grows," Gil Diaz said.
According to the Minister, the country is expecting a surge in the mortgage sector next year. He also noted there is something brewing in the pipeline that will lower the capitalization requirements on loans based on Instituto Nacional del Fondo para la Vivienda de los Trabajadores (INFONAVIT) and will provide a safer stream of payments and payment recovery for the banks.
The jury is still out on Mexico, however. Barrineau said, "I would like to see the policy makers a little more bold. Mexico should have a $30 billion cash reserve to pay back dollar-denominated debt." Barrineau also said the recent developments in the pension fund system in Mexico are a major positive, as it provides a window for liquidity.
However, there are some countries that investors simply avoid. According to Sarjeev Sidhu, vice president and portfolio manager of Aegon U.S.A., his company would not play in Ecuador, as it is a defaulted country. Barrineau said he would not deal with Colombia either. "The fundamentals are clearly deteriorating [in Colombia]; they can't curb a fiscal deficit and they can't even get a social security program," Barrineau said.
And, given all of the problems in Venezuela, there are many market players that are quite skeptical as a result of all of the country's recent turmoil. "2003 is crunch time for Venezuela. They need a primary surplus to generate a fiscal policy," Barrineau said.
Future flows:
The cream of the crop
There was an abundance of praise for future-flow transactions at this year's conference. And indeed, the consensus is that future flow issues were the most successful at surviving the turbulent Argenitine crisis. Violet Osterberg, assistant vice president of Pacific Life Insurance Co., outlined the deals that she prefers in order, and at the top of the list were export receivable/future flow transactions. Of these deals, Osterberg said she liked the CVRD deal out of Brazil and the Taga Airlines transaction out of El Salvador. However, she warned, "You have to be careful that you don't get stuck with one or two receivables."
Doug Doetsch, a speaker and a partner with Mayer, Brown, Rowe and Maw, also warned of two main weaknesses in these types of deals. The first is that some of these deals are not a true sale of export receivables. And, the second is that many times there are a limited number of signed acknowledgements.
One market analyst in the audience asked about a recent transaction that had notices as opposed to signed acknowledgements and Doetsch said signed acknowledgements are better since people pay more attention to things they have to sign and do not always carefully read notices that come in the mail. "Stick with the true sale structures and get signatures from most of the obligors," Doetsch advised.
Second on the list of deals that Osterberg said she prefers are structurally enhanced deals, followed by political risk insured only deals. "We have tested PRI [deals] and they have performed beautifully. It can mean different things to different deals, but it gives added enhancement," Osterberg said. Finally, a non-structured corporate transaction would be next on her list. "I would do that as opposed to a sovereign issue the sovereign has too many issues to deal with, like politics. And, you typically get offered a lot less spread for a sovereign deal."
Going forward
There was no mention of devaluation insurance at this year's Fitch conference and the market has not seen a deal of that nature since last year's Brazilian AES Tiete transaction (see ASR 4/23/01 p.13). However, some market participants still see value in devaluation insurance and would like to see more of it going forward. "We would encourage devaluation-type insurance," one analyst told ASR earlier this month.
While investors at the S&P conference earlier this month said there is still an appetite for deals in Latin America, investors at this conference said they are decreasing allocation to Latin American deals in their funds. "There has not been as much value in Latin America recently and therefore we have reduced our exposure," Davis said. "But we will still look for good opportunities."
