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Speaker 1: Hello, and welcome to The Credit Edge, a weekly markets podcast.

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Speaker 1: My name is James Crumbie. I'm a senior editor at Bloomberg.

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Speaker 1: Today's guests are Paula Seligson, who covers leveraged finance at

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Speaker 1: Bloomberg News. We're delighted to have you on the show.

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Speaker 1: Thanks for having me. We're also very happy to welcome

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Speaker 1: jam And Patel, who looks at utilities and energy companies

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Speaker 1: for Bloomberg Intelligence. We'll be discussing Latin American oil producers

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Speaker 1: with him in a bit. Please to join you. But

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Speaker 1: before we do, let's talk libor transition, by which we

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Speaker 1: mean the switch to a new price benchmark for the

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Speaker 1: trillions of dollars in assets that need to happen over

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Speaker 1: the next few months. But by all accounts, it's not

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Speaker 1: going very well, so let's get straight to it. Paula,

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Speaker 1: what's the latest you're hearing on this. I am glad

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Speaker 1: you asked, because I love talking about libor. So essentially

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Speaker 1: we have to first take this context of the whole

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Speaker 1: libor transition. So a lot of asset classes have been

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Speaker 1: doing fine, but specifically in the one point for trillion

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Speaker 1: US leverage loan market, we're down to the wire. It

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Speaker 1: goes away in the middle of this year, but there

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Speaker 1: are still controversies as companies switch their existing loans from

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Speaker 1: libor to SOFA, the secured overnight financing rate the preferred

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Speaker 1: replacement in the United States. So we've been covering a

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Speaker 1: lot of stories about how there have been some cases

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Speaker 1: where lenders are upset essentially about the credit spread adjustment.

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Speaker 1: This is a special extra little bit of basis points

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Speaker 1: that you add in to the coupon on the loan

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Speaker 1: in order to compensate for how LIBOR typically prints above

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Speaker 1: where SOFUR does, and so there have been cases where

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Speaker 1: lenders have been trying to organize to vote against it,

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Speaker 1: and this time we've recently done a story about cases

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Speaker 1: where lenders don't get a chance to vote at all

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Speaker 1: when these things are changed. So specifically, what we're looking

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Speaker 1: at is essentially, if you look at the universe of

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Speaker 1: existing leverage loans, they all have this special, essentially legal

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Speaker 1: documentation built into them that will allow for an easier

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Speaker 1: switch from libor to SOFUR, And for roughly thirty percent

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Speaker 1: of the market they have this way where you can vote,

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Speaker 1: and there's been some controversy there. You can see our

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Speaker 1: prayer coverage, but a recent story is about twelve percent,

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Speaker 1: where essentially you don't have to vote if you're the company.

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Speaker 1: What happens is essentially, if you switch from libor to

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Speaker 1: sofur and you're the company and your bank that's been

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Speaker 1: helping you with this, agrees to the rate and the

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Speaker 1: credit spread adjustment, you're good and you don't have to

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Speaker 1: ask for a vote as long as you're doing what's

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Speaker 1: considered the market standard. But what's been happening is there's

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Speaker 1: been bickering over what exactly is the market standard. So

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Speaker 1: what we've seen is some companies have used a ten

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Speaker 1: basis point credit spread adjustment during this transition instead of

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Speaker 1: using a staggered credit spread adjustment that was essentially recommended

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Speaker 1: by a regulatory body, where they recommend eleven basis points

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Speaker 1: or twenty six basis points if you're borrowing on a

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Speaker 1: one or three month basis. So essentially, I like lenders,

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Speaker 1: These asset managers have been getting these notifications that say, hey,

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Speaker 1: by the way, your libel loan is now a sofa

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Speaker 1: loan and it used a ten basis point credit spread adjustment,

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Speaker 1: and they go, wait, hang on a minute, I wanted

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Speaker 1: to vote on this. This isn't the market standard, but

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Speaker 1: the company's perspective as they did pick the market standard

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Speaker 1: because there have been other loans that have flipped this way,

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Speaker 1: and so it's messy, it's complicated. Honestly, I can see

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Speaker 1: both sides of it, depending on how you think about

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Speaker 1: the market. And so we've been really trying to reflect

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Speaker 1: in our coverage how this is very much still a

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Speaker 1: price discovery and there's still a lot of arguing between

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Speaker 1: lenders and borrowers as this unfolds. That's great, but in

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Speaker 1: simple terms, we're talking about risky companies borrowing from banks

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Speaker 1: in what we call the leverage loan market, and the

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Speaker 1: basis on which their price is changing, and somebody's losing

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Speaker 1: out here, yes, exactly. So that's all about that credit

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Speaker 1: spread adjustment. So on one hand, you have the company

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Speaker 1: and they've borrowed sometimes billions of dollars from large groups

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Speaker 1: of institutional asset managers in this market called the leverage

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Speaker 1: loan market. And so if the thing is the difference

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Speaker 1: between libor and sofur, because both them are floating rate,

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Speaker 1: right like, both of those are benchmarks that change over time,

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Speaker 1: so the difference between them also changes over time. So

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Speaker 1: there's a special group that's endorsed by regulators called the

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Speaker 1: Alternative Reference Rates Committee, and so they tried to solve

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Speaker 1: this problem, and in March of twenty twenty one, they

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Speaker 1: picked essentially the five year historical median of the difference

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Speaker 1: between these two rates to set their own recommendations, and

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Speaker 1: that's where that eleven basis points for one month and

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Speaker 1: twenty six basis points for three months comes from. So

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Speaker 1: in theory it should reflect the fact that this changes

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Speaker 1: all the time. But right now, overall the difference between

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Speaker 1: the rates is smaller than where the arc that regulatory

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Speaker 1: group set these recommendations, and so it's just arguing over

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Speaker 1: basically pricing. Essentially, you know, if the borrowers lock in

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Speaker 1: a lower rate, they essentially save interest expense, but then

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Speaker 1: that's at the expense of the lenders who length them

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Speaker 1: the money in the first place. This is especially tricky

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Speaker 1: for what are called clos or collateralized loan obligations, because

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Speaker 1: they pull a bunch of loans and then structure it

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Speaker 1: in the special type of structured financial product and then

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Speaker 1: sell that in bonds, and those bonds will have certain

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Speaker 1: ways that they flip as well. So they could actually

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Speaker 1: lose a lot in the difference if it's not the

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Speaker 1: type of credits preadadjustment that they want. So much of finance,

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Speaker 1: so much of lending is based on libel consumer loans,

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Speaker 1: car loans, credit cards. Why is the leverage loan market

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Speaker 1: such a legod in all this, It's because it's very bespoke.

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Speaker 1: If you talk to people in the market, they kind

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Speaker 1: of brag about the fact that it's a very opaque market.

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Speaker 1: There's not a lot of electronic trading each loan is.

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Speaker 1: It's not out of security. It's very customized and specific.

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Speaker 1: And to even participate you have to be a very

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Speaker 1: large institutional asset manager like normal people like me and you,

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Speaker 1: we can't buy this kind of debt, right, And so

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Speaker 1: the actual structure of the loan market is almost kept

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Speaker 1: like purposely opaque and complex because companies want it to

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Speaker 1: be customized and very private. And so usually that's quite

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Speaker 1: frankly fine. It you know, goes along quite well. There's

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Speaker 1: massive volumes every year of new deals. Things are refinanced,

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Speaker 1: leveraged buyouts are financed. There, it's not a problem. But

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Speaker 1: when you take that you know, customized market, you know,

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Speaker 1: a very opaque market and apply it to something as

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Speaker 1: complex as the lieboard transition. That's why you start to

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Speaker 1: see these very interesting situations come up. What's the deadline

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Speaker 1: to switch over to the new benchmark the end of

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Speaker 1: June of this year, and that is already an extension

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Speaker 1: of the original deadline. So do we face some kind

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Speaker 1: of catastrophe when we hit that deadline? That is unlikely.

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Speaker 1: Most loans have some kind of fallback language that will

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Speaker 1: essentially default them to the spread adjustments recommended by the ARC.

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Speaker 1: But there are certain chunks of loans, the thirty percent

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Speaker 1: of negative consent, the twelve percent of no lender consent,

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Speaker 1: and those are the ones where we're going to see

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Speaker 1: some weird variability. The worst case scenario for some companies

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Speaker 1: is that if they absolutely cannot get their stuff together

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Speaker 1: and they flip to nothing come July first, they will

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Speaker 1: fall back to what's called the prime rate, and that

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Speaker 1: is roughly seven point seven five percent now, so the

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Speaker 1: risk is if their companies would fall through the cracks,

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Speaker 1: they will suddenly see their interest expense spike significantly by

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Speaker 1: roughly three percent percentage points. Great, okay, very interesting. What's

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Speaker 1: the next thing to watch here? What are we looking

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Speaker 1: at in terms of short term the developments in this story.

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Speaker 1: We're just waiting to see how fast the market transitions.

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Speaker 1: So roughly twenty five percent of the leverage loan market

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Speaker 1: has transition to sofur and we're now just basically waiting

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Speaker 1: to see how fast or how long it takes for

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Speaker 1: the remaining seventy five percent to make the switch. And

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Speaker 1: how is all this drama affecting the broader credit markets

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Speaker 1: In a lot of ways, it's not doing that much

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Speaker 1: Like this is just sort of going along in the background.

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Speaker 1: You know. We have, separately from that, we've seen sort

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Speaker 1: of this rally and credit markets in January, and that

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Speaker 1: rally has begun to pull back in leverage LANs that

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Speaker 1: we've been talking about. Leverage lanes have actually held up

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Speaker 1: pretty well and we still have a lot of issuance there.

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Speaker 1: But in high old bonds, which are a very related

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Speaker 1: asset class, we've seen yields go up and we've seen

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Speaker 1: issuance of new debt really slow down in recent days.

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Speaker 1: Thank you, Paula Selexon. We look forward to reading your

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Speaker 1: scoops and listeners can can read all of your news

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Speaker 1: and analysis of leverage finance and other credit markets, and

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Speaker 1: our global team by by Paula and our global team

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Speaker 1: of credit reporters on the Bloomberg terminal or at Bloomberg

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Speaker 1: dot com switching gears here a bit. As I mentioned earlier,

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Speaker 1: we have very lucky to have Jamie Patel from Bloomberg Intelligence. Now,

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Speaker 1: I mean, you look at the energy sector in Latin America,

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Speaker 1: which is always exciting. Um I was, you know, I've

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Speaker 1: been covering that that region and that particular sector for

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Speaker 1: quite a long time. We've got Pemex in Mexico, We've

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Speaker 1: got Petrobras in Brazil, Echo Petrel in Colombia. The region

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Speaker 1: is full of huge state owned energy companies, you know,

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Speaker 1: some of the biggest in the world. I've spent time

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Speaker 1: at Pemex City in Mexico City, which, as it suggests,

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Speaker 1: truly is a city within a city. These companies are massive, really,

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Speaker 1: and they're also huge borrowers in the dollar markets, and

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Speaker 1: so international investors are very exposed. But I just wanted

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Speaker 1: to start jam And by asking you what's the general

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Speaker 1: state of this industry is it? Is it in good shape?

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Speaker 1: I think I think generally it's in better shape than

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Speaker 1: it was a year ago. Certainly old prices, having rallied

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Speaker 1: the way they did, even though they've come down quite

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Speaker 1: a bit, have enabled these companies to significally repair the

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Speaker 1: boundaries at Petro Brass sit yet by almost fifty percent UM.

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Speaker 1: If you know, you've got Whitepf and Champaigner here in

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Speaker 1: uh In in Argentina UM, which are you know, much

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Speaker 1: smaller companies, but UM just as interesting UM and and

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Speaker 1: and just as much in the minds of investors, high

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Speaker 1: yield energy investors as perhaps some of the others UM

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Speaker 1: that have really managed to bring their leverage down now

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Speaker 1: not to the extent that you've seen with the oil majors,

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Speaker 1: but but quite significantly been able to repair their balance sheet.

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Speaker 1: They haven't always been known for their efficiency though, how

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Speaker 1: how good are they are doing what they do compared

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Speaker 1: to the oil majors. What you know, what's the cost

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Speaker 1: of production for for a barrel of oil? Well, you know, interestingly,

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Speaker 1: if you look at their ebidax margins UM, they are

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Speaker 1: very competitive. They're significantly higher than the oil majors. And

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Speaker 1: you know, here I'm talking about not just the big

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Speaker 1: one like Echo Control and Petro Bron, but also Whitepf, uh,

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Speaker 1: not so much, panics. Um, And there's there's a perhaps

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Speaker 1: a different story, Um. But the reason is not necessarily

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Speaker 1: because they are more efficient. They do have you know,

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Speaker 1: quite competitive lifting costs, but because their focuses so much

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Speaker 1: on crude oil than it is on natural gas. When

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Speaker 1: we saw the rally in crude oil prices, um, before

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Speaker 1: we saw the rally in natural gas prices, their margins

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Speaker 1: obviously will end up significantly more. Now when we see

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Speaker 1: the twenty twenty two earnings results come in, Um, you know,

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Speaker 1: part of that edge may have may have dissipated, but

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Speaker 1: now on natural gas prices have come down very significantly,

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Speaker 1: both European and US natural gas prices. So to the

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Speaker 1: extent that that affects their their pricing, Um, you'll see them,

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Speaker 1: i think, regain regain the margin edge that we had

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Speaker 1: seen them enjoy it before. But how exposed are they

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Speaker 1: to the drop in oil prices. You know, we're heading

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Speaker 1: potentially into recession in the US, which isn't good for

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Speaker 1: oil demand, and you know that's going to be lower prices.

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Speaker 1: Are they edged at all? Well? Again, it really depends

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Speaker 1: from a country to country. UM. I think you know

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Speaker 1: you've heard of the Hacienda edge in in Mexico. UM.

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Speaker 1: Now that's that's the government hedge. But all of these

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Speaker 1: companies will have hedge to a certain extent. Clearly, Lord

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Speaker 1: uh crew all prices will have hurt their bound sheets

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Speaker 1: in their earnings to some extent. But again, as I said,

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Speaker 1: it really depends on which company you're talking to. If

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Speaker 1: you look at the pemics, for instance, UM which has

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Speaker 1: a significant shortfall of refining capacity and will do so

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Speaker 1: until it completed it just podcast massive boast refinery in Tabasco,

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Speaker 1: UM they will continue to UM have to continue will

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Speaker 1: continue to have to import significant amounts of expensive UM

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Speaker 1: finished products, including gasoline and diesel. UM. So you may

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Speaker 1: have natural, you may have crew pro or prices coming

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Speaker 1: down that impacts the revenues from crude, but you also

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Speaker 1: have this offset from lower prices, significantly lower prices or

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Speaker 1: the fuel. So yes, there will be a learning impact,

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Speaker 1: certainly for Pemics, not so much for Petrol Brown which

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Speaker 1: which has significantly refining capacity, and for Ecodrow. But again,

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Speaker 1: as I said, it really depends on the company you're

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Speaker 1: looking at. Okay, that's interesting. One thing I've noticed Jayman

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Speaker 1: on the on the bond side. Um, the debt is

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Speaker 1: pricing much wider than the sovereigns, you know, at least

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Speaker 1: compared to I remember in previous years. You know that

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Speaker 1: that is, it costs these companies much more to borrow

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Speaker 1: in the dollar markets than it costs the countries they

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Speaker 1: are in, even though they are stay owned and looked like,

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Speaker 1: you know, the same level of risk at least to me,

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Speaker 1: why is that what's going on there? Well, yeah, that's

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Speaker 1: a that's a really interesting situation. And again, even though

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Speaker 1: we're talking about one region, each country is an enterviewer

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Speaker 1: onto itself. So what you just said certainly applies very

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Speaker 1: much to to PEMICS in Mexico. Um. But when when

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Speaker 1: you consider that MX is really the only one percent

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Speaker 1: owned by the government company that's owned by the government. Um, yes, certainly,

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Speaker 1: when when you look at the others, there is significant

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Speaker 1: government influence and ownership, but Pemex is the only one

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Speaker 1: that's one hundred percent owned by the government. Investments investment

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Speaker 1: grade rating indeed is based on the likelihood of what

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Speaker 1: they referred to as extraory support from the government. UM.

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Speaker 1: So to me, yes, you know, your PEMICS is certainly

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Speaker 1: the most leverage of all these companies and perhaps you

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Speaker 1: know the most leverage uh uh company and energy company

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Speaker 1: in the world, certainly the most indebted. Um that that

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Speaker 1: price gap can be quite surprising. Um, you know, it's

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Speaker 1: a lot of a lot of that movements between the

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Speaker 1: sovereign and the corporate yields has really depended to a

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Speaker 1: significant extent upon the rhetoric that we hear coming from

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Speaker 1: the Mexican government. Um, whenever they announced that they will

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Speaker 1: be supporting all plans to supports the company specifically, that is,

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Speaker 1: they are BULLI for X amount in terms of equity

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Speaker 1: or they're going to use their taxes by y amount.

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Speaker 1: You see that spread narrow. So it's a kind of

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Speaker 1: a temporary thing. It's not really a long term phenomenal

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Speaker 1: or a trade that people should be jumping into. Well

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Speaker 1: I think, I think um, if if Mexico steps forward

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Speaker 1: with something specific in terms of an equity infusion, um,

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Speaker 1: you will see you should see that spread narrow significantly.

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Speaker 1: But again, as I said, uh, you know, getting back

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Speaker 1: to to to the pretext of your questions, UM, it

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Speaker 1: not all of not all of these companies have a

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Speaker 1: wide gap between the sovereign and the and the corporate.

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Speaker 1: In fact, in Argentina's case, the s in trade significantly

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Speaker 1: wider than the corporate, primarily because if the corporates are

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Speaker 1: big export earners. Interesting, okay, so they have hard currency

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Speaker 1: coming in. On the funding side, do we expect Latin

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Speaker 1: American oil and gas to be big issuers of debt

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Speaker 1: this year? I think if you do see significant issuance,

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Speaker 1: it may be from Eco Control. With the with the

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Speaker 1: changing government under the Petro administration and the move to

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Speaker 1: transition the company to clean your energy, all of that

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Speaker 1: rule spending is going to have to be funded somehow,

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Speaker 1: so I think you may see more from ECCO Control

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Speaker 1: perhaps than you will from Petro Brack. In Petro Bro's case. Again,

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Speaker 1: we're not quite sure how the Lula administration wants to

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Speaker 1: play with the refining situation. But if they do decide

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Speaker 1: to construct refineries or increase the refining spacity, you may

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Speaker 1: see from there, um you are not good to see.

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Speaker 1: I don't think much out of Argentina only because there

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Speaker 1: is such a limited access to the market. Okay, interesting,

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Speaker 1: So just switching slightly to another related topic, esg um.

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Speaker 1: You know it's such a big deal for all markets

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Speaker 1: and credit in particular. But how are these companies transitioning

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Speaker 1: away from fossil fuels into green and clean fuels. Well,

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Speaker 1: I think I think Eco patrol is probably the one

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Speaker 1: that comes first to mind. Um. Just given as I

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Speaker 1: mentioned the transition um to cleaner edgy that the new

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Speaker 1: administration wants to push through, we haven't seen as much.

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Speaker 1: Perhaps we've seen something from from Brazil, but not so

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Speaker 1: much from Mexico or Argentina. Um. But at the other

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Speaker 1: end the spectrum, you know, I think I think we

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Speaker 1: should really talk about Eddi vessa Um, which you know

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Speaker 1: has heaviest oil um again to what we see in

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Speaker 1: the oil fans, but all so the diarliest fuel so um.

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Speaker 1: If if sanctions are lifted or eased for Peti Vester

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Speaker 1: and we see their production moving up, I think that

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Speaker 1: may become a central point for ESG in Latin America.

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Speaker 1: Interesting on sanctions, I mean you kind of raise the

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Speaker 1: issue of political risk, which is so key to a

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Speaker 1: lot of these companies. I mean, I remember the Petrobras

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Speaker 1: car wash scandal, which brought down several presidents and other

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Speaker 1: executives um and really slammed the price of all the

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Speaker 1: securities and tipped that company into distress. What's what's the

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Speaker 1: regional outlook? We are we are much more in a

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Speaker 1: much more stable that in America than previously or is

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Speaker 1: it still as rocky as ever? Well, I certainly we've

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Speaker 1: seen a degree with earlier. We just saw two changes

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Speaker 1: of administration, one in Brazil UM and one in Columbia UM.

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Speaker 1: Their policies UM will will perhaps affect the earliest capability

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Speaker 1: of these companies, but I don't think you're going back

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Speaker 1: as far as you know to anything like the car

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Speaker 1: scanels occurring UM. If anything, there might be some positive

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Speaker 1: movements when we look at Venezuela and Pedavesto, even though

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Speaker 1: you may not have a regime change, greater corporation UM

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Speaker 1: and and and dialogue with the US may open open

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Speaker 1: that region up UM. Where Argentine is concerned, it's much

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Speaker 1: more an economic case. They have very strict capital controls

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Speaker 1: UM and. Even though these companies white DF and companies

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Speaker 1: here are very profitable, the concern we have there is

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Speaker 1: their ability to repay debt as it comes to you,

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Speaker 1: particularly for white white DF in twenty twenty three, and

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Speaker 1: their access to dollars to do that, which interestingly UM

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Speaker 1: you know, makes the Argentinean government's recent buy back of

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Speaker 1: dollars debt very interesting because they could use those funds

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Speaker 1: perhaps to be some power controls. Do we think generally

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Speaker 1: that um political risk is it's priced into Latin American

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Speaker 1: markets on the on the credit side, I think so.

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Speaker 1: I think so because you know, really depends upon the

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Speaker 1: spread that you see between the sovereign and the corporate

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Speaker 1: and you know, earnings and inefficiency and death maturities aside

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Speaker 1: which you see primary x UM. I think it's pretty

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Speaker 1: pretty well priced for ECCO control in Colombia and Brazil

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Speaker 1: and fraud. Okay, let's hope you're right. We'll definitely read

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Speaker 1: your analysis with great interests as we go through this. Uh,

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Speaker 1: it's always it's always an interesting time for for Latam.

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Speaker 1: Thanks very much, Jamon Patel from Bloomberg Intelligence. You can

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Speaker 1: read all of his analysis on the Bloomberg Terminal, and

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Speaker 1: thanks also to Paula Selexon from Bloomberg News. Read all

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Speaker 1: her scoops on the terminal and at Bloomberg dot Com.

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Speaker 1: I'm James Crumbie. It's been a pleasure having you. See

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Speaker 1: you next week on the credit edge