LatAm bonds on the rebound but Fed to dictate recovery

Twelve months ago, when GlobalCapital surveyed Latin America’s DCM heads about their expectations for 2022, there was broad acknowledgment that the previous two years of bumper volumes had been exceptional.

A vast majority predicted lower issuance, reflecting expectations of higher spreads, increased rates volatility and the awareness that sovereigns had leaned on bond markets heavily to fund pandemic-fuelled spending that was now being reined in.

No one could have foreseen quite how precipitous the fall in volumes would be. Without a surprise flourish in December, new issuance of international bonds from Latin American and Caribbean issuers is likely to have fallen by almost 60% in 2022 compared with 2021. As of November 28, there had been just $57.5bn of new issuance, down from $141.6bn.

At the end of 2022 all but one LatAm DCM head is predicting a year-on-year increase in issuance of more than 25% for 2023. Yet it would be hard to frame this as optimism. After all, 2022 has been — by some distance — the quietest year for LatAm bond issuance since 2008.

Although almost 65% of LatAm DCM heads are predicting issuance will rise by a margin of between 25% and 50%, only 23% expect it to rise by more than 50%. For context, even a 50% increase in issuance from 2022 would put 2023 volumes at only $86.25bn — versus average annual issuance of $124bn in the 10 years ending 2021.

“In terms of volumes we are still not going to be anywhere close to what we were used to,” says Lisandro Miguens, head of Latin America DCM at JP Morgan, adding that high interest rates will continue to incentivise borrowers to go to other markets, such as loans and local currencies.

“Investors will continue to be very selective as to where they put their money and we will find ourselves returning to the mindset that we used to have in EM, when the bond market was largely dominated by sovereigns and big corporates,” Miguens says.

Sovereigns start, corporates uncertain

To some extent, this has already happened. Indeed, the fall in SSA issuance from Latin America in 2022 was far less pronounced than the collapse in corporate and FIG volumes. Adrian Guzzoni, head of LatAm DCM at Citi, says sovereign financing needs are “clearer”. He senses sovereigns will be the “first Latin American issuers to venture out in 2023”.

This smaller slump means, however, that sovereigns have limited capacity to lift LatAm volumes. Just one DCM head picked “increased external sovereign funding needs” in their top three potential upsides for issuance volumes.

On the other hand, corporate and FIG issuance tumbled so far — from more than $70bn in each of the previous three years to just $24bn year-to-date by the end of November 2022 — that LatAm DCM heads participating in GlobalCapital’s survey were mostly expecting a bigger relative jump in corporate issuance than in sovereigns.

But they may have to wait some months for corporates to come to the party.

“I do not expect to see a lot of corporate issuance in the first quarter, as balance sheets are pretty healthy,” says Guzzoni. “However, because we are coming from such a low base [of corporate issuance] it will be easier to see a pick-up in activity.”

It’s not clear that Latin American companies are in a rush to come back. Moody’s said in an October report that the difficult market environment, coupled with “moderate” refinancing needs, will continue to weigh on corporate issuance through 2023 at least.

“The Latin American corporates that have used the capital market as a frequent source of funding are in a good position,” says Andre Silva, head of LatAm DCM at BNP Paribas. “Most companies have done well in terming out their maturities and preserving liquidity.”

After all the refinancing that took place amid low rates in 2020 and 2021, the “next big year” for maturities is 2025, says Miguens at JP Morgan. The question, he says, is when will corporates decide to address those maturities.

“If 2023 is not a good year, then some companies will start to get more nervous in 2024,” he says.

Evolving options

Just three DCM heads picked more pressing corporate refinancing needs among their top three reasons to expect an upside in LatAm international bond issuance in 2023. Apart from anything else, these days many LatAm companies have better options — one of the key reasons 2022 volumes dropped more sharply in Latin America than in other EM regions.

Strong domestic bond markets across LatAm, but to an exceptional degree in Brazil, meant it rarely made sense for corporates to turn to dollar markets in 2022. And local bond markets may continue to pinch business from New York syndicate desks. When asked what the most significant drag on volumes would be, four DCM heads picked the strength of domestic bond markets as their first choice, while a further four had this option in their top three choices.

Yet another source of liquidity that provided competition to international bond markets in 2022 may not be quite as robust in 2023. Bank markets stepped up in a big way when bond markets began to fail LatAm issuers in 2022, suddenly appearing attractive as lenders were not as quick in adjusting pricing upwards. This led some issuers to move away from bonds and towards loans, notes Silva at BNPP. But the loan market is not likely to provide quite the same level of competition to the bond market in 2023 as it did in 2022.

“We are starting to see lending banks becoming more restricted in how they lend in Latin America — both in terms of the pricing they can offer and their level of appetite for certain transactions,” Silva says.

Braver or better?

In any case, Latin American companies have largely been unwilling to validate the higher funding costs implied by secondary markets in the wake of 2022’s rates sell-off — and without an improvement here Silva says he doesn’t “see an avalanche of corporate issuance”.

“Corporates will naturally look at coupons and continue to be somewhat reluctant to issue,” he says.

Can this improve? Although the survey responses show a slight bias towards expecting LatAm credit spreads to tighten, there is no consensus.

Where there is near unanimity is on what could improve appetite for LatAm bonds: a potential “pivot” in Fed policy, away from monetary tightening. Of course, this can work both ways.

“Our expectation is that, at some point in the next few months, market volatility will start subsiding as Fed tightening eases, and that means volumes will pick up,” Guzzoni says. “But the fear is that the opposite happens — if inflation stays sticky, Q1 doesn’t prove to be the top of the rates cycle, and volatility continues.”

The focus on the Fed explains the caveat that several DCM bankers have: conditions will improve, but not until later in the year. What’s more, for a decent chunk of respondents, optimism around market conditions is largely based on the fact that they can “hardly get worse”. These bankers agreed that “conditions will remain treacherous”.

LatAm DCM bankers certainly appear under no illusions about the challenges ahead. But in any case, volumes should increase.

Even if conditions remain tricky, several DCM bankers say the most compelling reason to expect greater issuance is that borrowers would simply become braver in the face of volatility.

“We came into 2022 with buffers that issuers had built up in 2020 and 2021,” says Chris Gilfond, chairman of LatAm DCM at Citi. “There is strong reason to believe that these buffers have been largely consumed, and we may find ourselves in a situation where — simply due to the passage of time — today’s levels become more natural.

“With each new deal that prints, the shock [of higher funding costs] wears off a little bit.”

Moreover, the more time goes by with minimal issuance, the harder EM investors have to work to deploy cash that they receive back from issuers. As Miguens of JP Morgan highlights, the $85bn or so of outflows from EM in 2023 rather pale in comparison with the roughly $280bn of inflows from coupon, amortisation and maturity payments.

“There is still a lot of liquidity out there,” Miguens says. “In November, for example, there was an encouraging CPI reading and investors were suddenly desperately trying to put their money to work. And because nobody wanted to sell, prices were sometimes jumping up four or five points.

“Investors have been on the sidelines because of their worries about rates, but the minute there is visibility on that front, they will put their cash to work.” GC