EMTA Corporate Bond Forum (NYC) - Sept. 10

New York Corporate Bond Forum Speakers React to Brazil’s Sovereign Downgrade

EMTA’s first post-summer event was its Corporate Bond Forum, held on Thursday, September 10, 2015 in New York City.  BNP Paribas sponsored the event, which was held in midtown and attracted a crowd of 150 attendees.

Mark Howard (BNP Paribas) opened the session by pointing out that, after a month of China focus, the market had spent the prior 23 hours digesting the downgrade of Brazil’s sovereign credit rating by Standard & Poor’s.  Howard invited speakers to give their reactions.

“No one was surprised by the downgrade, but the timing and the agency’s maintaining a negative outlook on the rating were unexpected,” noted Anne Milne (Bank of America Merrill Lynch).  Milne estimated that nearly $80 billion of Brazilian corporates were about to lose investment grade status with S&P as a result.  If other agencies take similar actions, then 60% of EM corporates could now be high yield credits, reversing the currently dominant investment grade status.  There remained the concern that crossovers would leave the asset class, although Milne observed that selling appeared to be controlled and not panicky – at least so far.

Barclays’ Sarah Leshner Carvalho concurred, and said her firm expected Fitch would downgrade Brazil by year-end, with Moody’s following in Q1 2016.  For now, Brazil remains in investment grade indices, although this was precarious; the loss of either remaining investment grade rating would result in Brazil being cut from such benchmarks, triggering further sales. 

Jonathan Prin (Greylock Capital Management) argued that the Brazil downgrade was justified, although agreeing that the market had been surprised by the timing.  Finally, TIAA-CREF’s Katherine Renfrew stated that Brazil’s economic decline, lack of job creation, “abysmal” growth, rising unemployment and lack of leadership made the ratings action appropriate.  “Where we go from here is unknown; it is a very challenging environment—will power be transferred in an orderly way, or will it be messy?  Credibility needs to be restored for investors.”  For those who believe that the Rousseff administration can restore some level of investor confidence, debt prices might be cheap, she argued.

Howard then turned to China.  Milne noted that lower onshore rates in China appear to be enticing Chinese corporates to raise more funding in the domestic market.  The increased opening of bank offices not only in the traditional financial centers of Hong Kong and Singapore but also in mainland China offers anecdotal evidence of increased investor interest for on-the-ground investment intelligence given the large size of the Asia market in general and China in particular.

On EM currency movements, weakened EM FX affects companies differently, Renfrew highlighted.  Some EM exporters would benefit (including those who could be hurt by a lowered sovereign ceiling), although perhaps not commodity exporters.  For her firm, part of credit analysis work included whether a corporate issuer hedged FX exposure.

As for corporate maturity concerns, “the risk of increased EM corporate defaults is clearly an issue for investors,” acknowledged Leshner Carvalho.  However, many firms took advantage of conditions in past years to refinance and pre-finance debt, so maturities were manageable at least until 2017.  “Valuations may be overdone, as our base case is that there will not be a massive amount of defaults,” she concluded. 

The potential for a cross-over exodus from EM was not an academic discussion, and could have significant impacts, in Prin’s view.  Internal re-allocations of funds can occur without appearing in outflow statistics, impacting EM pricing, while leaving market participants scratching their heads as to the cause.  On the other hand, dedicated investors don’t easily walk away from EM even after a bad year, Milne stated, and emphasized that EM corporate returns were still in positive territory ytd, performing better than many categories, including equities and US high yield.  “So performance is not that bad in comparison,” she underscored. 

Panelists saw no urgency to add to Russian corporate exposure.  Milne observed that the removal of international sanctions against Russia was a prerequisite for most institutional investors, which she did not envision happening over the next 12 months.  Prin maintained a neutral stance, noting the strong technical backdrop for Russian corporates that existed in the past was no longer the case.  Renfrew acknowledged exposure to Russian corporates, “but they are not a top 5 overweight for us.”

The panel ended with speaker recommendations.  Short-end Petrobras paper at 500 bps over the sovereign was “interesting” for Leshner Carvalho.  Mexican HY corporates (ex REITS) were overvalued, in Prin’s opinion, and investors would one day wake up.  In contrast, Renfrew liked Mexican banks, but expressed concern over decreasing liquidity.  Short- to mid-term Russian oils could offer opportunities to some investors, stated Milne.