Wed 01/11/2023 16:13 PM
As the global economic outlook remains uncertain but gloomy at the beginning of 2023, Latin American corporates and sovereigns are facing some specific challenges, including rising interest rates, political risk and currency exposure, that could create opportunities for distressed investors. Restructuring experts are watching specific industries for signs of distress, including financial institutions, power generation, aviation, mining, petrochemicals, construction and construction materials.
With about $113 billion of non-investment-grade corporate bonds coming due across the region between now and 2026, according to an estimate by Stifel, this year could be an active one for distress and restructuring. Although many of the distress situations depend on specific issues faced by debtors, restructuring professionals interviewed by Reorg pointed to certain macro trends that could make companies more likely to need restructuring.
“Given the anticipated impact of inflation and rising interest rates in 2023, together with the significant amount of debt that is scheduled to mature over the course of 2023, 2024, 2025, particularly in Latin America, we could see a larger volume of restructurings than we are accustomed to seeing, historically, in Latin America,” said Tyson Lomazow, a restructuring partner at Milbank.
Other sources also pointed to rising interest rates as the main factor that will contribute to a rise in corporate distress and defaults.
“I think this is all going to be about the impact of rising interest rates testing the resilience of balance sheets of public and private companies in ’23, ’24 and ’25,” said Timothy Karcher, a restructuring partner at Proskauer Rose.
Central banks across Latin America began raising interest rates in 2022, and in some cases, the rate hikes were even more aggressive than in the United States. Mexico’s rate began 2022 at 5.5% and ended the year at 10.5%; for Brazil, those numbers were 9.25% and 13.75%; Chile, 4% and 11.25%; Peru, 3% and 7.25%; Colombia, 3% and 12%; and Argentina, 38% and 75%.
Even though 2022 was a year when the U.S. dollar was historically strong, the high rates contributed to many Latin American currencies gaining value against the dollar throughout the year, including the Mexican peso, Brazilian real, Peruvian sol and Uruguayan peso. However, the risk that those currencies could lose value next year looms.
While in the past few years, much of the restructuring activity in Latin America was “one-off, Covid- or sector-related,” higher interest rates and concerns over an impending slowdown could cause distress across industries, according to Brock Edgar, senior managing director within the corporate finance and restructuring segment at FTI Consulting.
“I think the economy of every country is going to have problems doing the refinancings that normally would occur,” Edgar said. “I think the number of new [corporate debt] issuances will go down, and exchange offers will be difficult, because no one will want to extend for the same interest rates.”
The dynamics causing distress in U.S. debt markets can have even bigger effects south of the border, Ari Lefkovits, managing director at Lazard, said.
“In general, we’ve seen situations being magnified in Latin America,” he said.
One of the issues that began driving up capital costs in Latin America in 2022 has been the increase in high-yield investing opportunities in the United States, which means that Latin American issuers have needed to offer comparatively higher yields to entice investors into their deals.
Edgar pointed to that issue as one factor that drove up yields for Latin American bankruptcy exit financings last year, adding that he expects the trend to continue this year.
Other experts say they are not necessarily predicting an acceleration in restructuring activity this year but expect the pace of restructuring seen in 2022 to continue.
Brent Herlihy, partner in the restructuring and special situations group at PJT Partners, is expecting “an active year” for restructuring in Latin America, as in the United States, but not a “crisis” or a “massive wave.”
“In the U.S. market, and also Latin America, there have been more and more phone calls in the last quarter or two,” he said.
Herlihy noted that an uptick in distress could be deeper in Latin America than in the United States.
Carlos E. Martinez, head of the Latin America Practice Group at Proskauer Rose, said that the restructuring outlook for the region this year is a “mixed bag,” as the impact of the pandemic wanes.
“The impact of the pandemic is less relevant now than it was before in terms of restructurings,” he said. “What we see now is interest rates.”
Martinez said he expects that in 2023, rising interest rates will cause more trouble for companies with variable-rate bank debt than for those with bond debt, unless those bonds are maturing in 2023 or 2024.
In the case of Brazil, the region’s largest economy, some experts expect a more stable 2023, but that will depend on many factors, most importantly the performance of the U.S. economy and the economic policy of Brazil’s new government.
Brazil, along with Peru, are the countries where experts have expressed the most concern about political risk. In Brazil, the region’s largest economy, a contentious presidential succession process and uncertainty about the new administration’s fiscal policy has caused market fluctuations in the first few weeks of the year. Whether the new government pursues an expansionist fiscal policy will condition the outlook for distress this year, said Otávio Guazzelli, managing director at Moelis in São Paulo.
Guazzelli said that an expansionist fiscal policy could be beneficial for certain industries, especially construction but could cause complications for the wider economy.
In Peru, the impeachment and jailing of former President Pedro Castillo in December 2022 and the subsequent destabilizing protests led by his supporters have led to a virtual pause of investment and financial activity in the country, according to sources.
In Mexico, the region’s second-largest economy, sources pointed to the acceleration of nearshoring as a trend that might mitigate against a wave of corporate distress, as well as to the fiscal policies that kept the Mexican peso relatively strong throughout 2022. However, currency exposure in 2023 remains a risk.
Certain industries that experienced distress in 2022 are expected to continue to face problems this year, including the nonbank financial sector (largely in Mexico), airlines and power generation (largely in Chile).
Nonbank Financial Institutions
For Mexican nonbank financial institutions, or NBFIs, one of the most distressed sectors in the region, their troubles that came to a head in 2022 are expected to continue this year, sources said.
After the default of AlphaCredit in August 2021 and Crédito Real in January 2022, investor confidence in the sector collapsed, and many peer companies experienced drops in their bond prices and found themselves struggling to access funding. Management of the surviving companies have insisted that the issues behind the collapses of AlphaCredit and Crédito Real were specific to those two firms, and that the credit market has unfairly judged the entire sector based on the behavior of a few.
In August, Unifin, the largest NBFI in Mexico, suspended payments on its debt, bringing the sector’s total defaulted international bonds to almost $4 billion. The three remaining nonbanks who have international bond financing (GF Mega, Mexarrend and Financiera Independencia) have a total of about $900 million of outstanding notes trading at stressed or distressed levels.
The nonbank lending sector’s troubles are related to a lack of access to financing, one of the causes of which has been the “reputational” harm brought on by the defaults of AlphaCredit and Crédito Real, said Enrique Presburger, president of ASOFOM, an association of nonbank lenders in Mexico that are incorporated as SOFOMes, or multipurpose financial societies.
“Everything that happened with AlphaCredit and Crédito Real, even though those are isolated cases, has had an effect on the prestige of the sector when it comes to issuing debt,” he said.
However, he noted that even in those two cases, the defaults were principally the result of liquidity problems and not a decline in the quality of loan portfolios, although “administrative issues” may have played a role.
“It’s an issue of liquidity, not a decline in fundamentals,” he said.
Presburger added that the sector plays a vital role in the Mexican economy and that he expects it to survive.
According to Presburger, nonbank lenders were the only financial sector that grew in assets during the pandemic, and that the approximately 2,000 SOFOMes have combined loan portfolios of about 1 trillion Mexican pesos ($51.5 billion) representing 20% of all outstanding loans in Mexico. In addition, 65% of new small and medium-sized enterprises, or SMEs, get their first financing from a nonbank.
Other sources have expressed concerns about the quality of the loan portfolios, including noting the risk of “default contagion,” or that the slowdown in origination for SME loans will make it harder for SME debtors to refinance, causing more defaults. Presburger said that ASOFOM has not detected those problems.
For PJT’s Herlihy, from the perspective of investors, the burden of proof is on the companies to open their books and prove that their low bond prices are the result of a “reputational” problem.
“With each particular company, it’s hard to tell whether it’s a good business without going under the hood,” said Herlihy. “And if you’re not under the hood, it’s hard to convince an investment committee that this is a good investment.”
Power Generation
Herlihy also highlighted power generation as a sector that faced distress in 2022 and is expected to continue to suffer this year.
“There has been significant energy reform across Latin America driven by more liberal governments coming into control that has made it more difficult for traditional fossil fuel generators to operate,” Herlihy said. “Combine that with high energy costs, Covid-19-related construction delays [and] infrastructure not keeping up with the amount of renewables that are coming online - all of those variables have led to a lot of volatility in the cash flows of power producers in the region.”
Some of the problems affecting both conventional and renewable energy projects have been especially acute in Chile.
In 2019, then-President Sebastián Piñera announced a plan to phase out coal plants by 2040 and make the country carbon neutral by 2050. The announcement predictably caused distress for conventional power generators, especially coal plants. Subsequent announcements that the decarbonization timeline will be accelerated, and confusion over its implementation, has caused further uncertainty over the future of the conventional power generation industry.
Renewable power generation projects are also facing distress, partly because of the inadequacy of distribution infrastructure and the decoupling of injection and withdrawal energy prices between the power-rich North and densely populated Central regions of the country.
Energy prices are set at the level of nodes, where electricity is injected or withdrawn from the national power grid. Power generators that are subject to power purchase agreements, or PPAs, are responsible for supplying certain amounts of energy at withdrawal node prices. If the price is higher at the withdrawal node than at the injection node, the generator is responsible for that difference.
The inadequacy of distribution networks is a “fundamental flaw” in the Chilean energy market, according to FTI Consulting’s Edgar.
“If you’re a producer, you sell your energy on an effective basis at the top of the country, and then you have to buy it from somebody else in the middle of the country; and that price, right now, is higher than what you’re selling it for,” he said.
The decoupling of injection and withdrawal prices has always been a risk, and power generators have made financial plans with “worst-case scenarios” in mind, according to Roland Estevez, a partner at Milbank. But in the middle of 2022, the high supply of renewable energy in the north of the country has depressed prices at injection nodes, while high coal and gas prices have pushed up the price at withdrawal nodes in central Chile, driving decoupling to a devastating extreme.
“What’s happened in the last few months, particularly over our summer, is that it’s spun out well beyond the most sensitive model projections that anybody ran,” Estevez said. “It just went multiples beyond what anybody thought.”
The extreme decoupling seen in the middle of 2022 was the result of a “perfect storm” of government support for renewable energy projects and rising conventional energy input costs, Edgar said.
In the last few months of the year, the decoupling of prices declined, but the problem is expected to return in the Northern Hemisphere summer months. If energy prices remain high, the sector can expect to face continued troubles.
Aviation
The aviation industry is expected to continue to experience distress related to the pandemic. Airlines that did not restructure in the past two years and still have stressed capital structures may expect to restructure next year, according to PJT’s Herlihy.
“If you didn’t get a bailout (and almost no one in Latin America did), and you didn’t restructure, you had to continue financing somehow,” he said. “A lot of companies got deferrals on their leases, or got new financing, so we can expect continued stress, especially in the major Brazilian carriers.”
Herlihy added that the airlines will continue to face challenges such as changing currency valuations and high fuel costs, although so far the industry has done a good job handling high fuel costs.
Two major airlines that distressed professionals are watching are Gol and Azul, both Brazilian carriers.
The emergence from bankruptcy of LATAM Airlines, the region’s largest carrier, is also expected to put competitive pressure on other airlines, including Gol and Azul, according to Moelis’ Guazzelli.
--Simon Schatzberg