Speaker 1: Hello, and welcome to The Credit Edge, a weekly markets podcast.
Speaker 1: My name is James Crumbie. I'm a senior editor at Bloomberg.
Speaker 1: Today's guests are Paula Seligson, who covers leveraged finance at
Speaker 1: Bloomberg News. We're delighted to have you on the show.
Speaker 1: Thanks for having me. We're also very happy to welcome
Speaker 1: jam And Patel, who looks at utilities and energy companies
Speaker 1: for Bloomberg Intelligence. We'll be discussing Latin American oil producers
Speaker 1: with him in a bit. Please to join you. But
Speaker 1: before we do, let's talk libor transition, by which we
Speaker 1: mean the switch to a new price benchmark for the
Speaker 1: trillions of dollars in assets that need to happen over
Speaker 1: the next few months. But by all accounts, it's not
Speaker 1: going very well, so let's get straight to it. Paula,
Speaker 1: what's the latest you're hearing on this. I am glad
Speaker 1: you asked, because I love talking about libor. So essentially
Speaker 1: we have to first take this context of the whole
Speaker 1: libor transition. So a lot of asset classes have been
Speaker 1: doing fine, but specifically in the one point for trillion
Speaker 1: US leverage loan market, we're down to the wire. It
Speaker 1: goes away in the middle of this year, but there
Speaker 1: are still controversies as companies switch their existing loans from
Speaker 1: libor to SOFA, the secured overnight financing rate the preferred
Speaker 1: replacement in the United States. So we've been covering a
Speaker 1: lot of stories about how there have been some cases
Speaker 1: where lenders are upset essentially about the credit spread adjustment.
Speaker 1: This is a special extra little bit of basis points
Speaker 1: that you add in to the coupon on the loan
Speaker 1: in order to compensate for how LIBOR typically prints above
Speaker 1: where SOFUR does, and so there have been cases where
Speaker 1: lenders have been trying to organize to vote against it,
Speaker 1: and this time we've recently done a story about cases
Speaker 1: where lenders don't get a chance to vote at all
Speaker 1: when these things are changed. So specifically, what we're looking
Speaker 1: at is essentially, if you look at the universe of
Speaker 1: existing leverage loans, they all have this special, essentially legal
Speaker 1: documentation built into them that will allow for an easier
Speaker 1: switch from libor to SOFUR, And for roughly thirty percent
Speaker 1: of the market they have this way where you can vote,
Speaker 1: and there's been some controversy there. You can see our
Speaker 1: prayer coverage, but a recent story is about twelve percent,
Speaker 1: where essentially you don't have to vote if you're the company.
Speaker 1: What happens is essentially, if you switch from libor to
Speaker 1: sofur and you're the company and your bank that's been
Speaker 1: helping you with this, agrees to the rate and the
Speaker 1: credit spread adjustment, you're good and you don't have to
Speaker 1: ask for a vote as long as you're doing what's
Speaker 1: considered the market standard. But what's been happening is there's
Speaker 1: been bickering over what exactly is the market standard. So
Speaker 1: what we've seen is some companies have used a ten
Speaker 1: basis point credit spread adjustment during this transition instead of
Speaker 1: using a staggered credit spread adjustment that was essentially recommended
Speaker 1: by a regulatory body, where they recommend eleven basis points
Speaker 1: or twenty six basis points if you're borrowing on a
Speaker 1: one or three month basis. So essentially, I like lenders,
Speaker 1: These asset managers have been getting these notifications that say, hey,
Speaker 1: by the way, your libel loan is now a sofa
Speaker 1: loan and it used a ten basis point credit spread adjustment,
Speaker 1: and they go, wait, hang on a minute, I wanted
Speaker 1: to vote on this. This isn't the market standard, but
Speaker 1: the company's perspective as they did pick the market standard
Speaker 1: because there have been other loans that have flipped this way,
Speaker 1: and so it's messy, it's complicated. Honestly, I can see
Speaker 1: both sides of it, depending on how you think about
Speaker 1: the market. And so we've been really trying to reflect
Speaker 1: in our coverage how this is very much still a
Speaker 1: price discovery and there's still a lot of arguing between
Speaker 1: lenders and borrowers as this unfolds. That's great, but in
Speaker 1: simple terms, we're talking about risky companies borrowing from banks
Speaker 1: in what we call the leverage loan market, and the
Speaker 1: basis on which their price is changing, and somebody's losing
Speaker 1: out here, yes, exactly. So that's all about that credit
Speaker 1: spread adjustment. So on one hand, you have the company
Speaker 1: and they've borrowed sometimes billions of dollars from large groups
Speaker 1: of institutional asset managers in this market called the leverage
Speaker 1: loan market. And so if the thing is the difference
Speaker 1: between libor and sofur, because both them are floating rate,
Speaker 1: right like, both of those are benchmarks that change over time,
Speaker 1: so the difference between them also changes over time. So
Speaker 1: there's a special group that's endorsed by regulators called the
Speaker 1: Alternative Reference Rates Committee, and so they tried to solve
Speaker 1: this problem, and in March of twenty twenty one, they
Speaker 1: picked essentially the five year historical median of the difference
Speaker 1: between these two rates to set their own recommendations, and
Speaker 1: that's where that eleven basis points for one month and
Speaker 1: twenty six basis points for three months comes from. So
Speaker 1: in theory it should reflect the fact that this changes
Speaker 1: all the time. But right now, overall the difference between
Speaker 1: the rates is smaller than where the arc that regulatory
Speaker 1: group set these recommendations, and so it's just arguing over
Speaker 1: basically pricing. Essentially, you know, if the borrowers lock in
Speaker 1: a lower rate, they essentially save interest expense, but then
Speaker 1: that's at the expense of the lenders who length them
Speaker 1: the money in the first place. This is especially tricky
Speaker 1: for what are called clos or collateralized loan obligations, because
Speaker 1: they pull a bunch of loans and then structure it
Speaker 1: in the special type of structured financial product and then
Speaker 1: sell that in bonds, and those bonds will have certain
Speaker 1: ways that they flip as well. So they could actually
Speaker 1: lose a lot in the difference if it's not the
Speaker 1: type of credits preadadjustment that they want. So much of finance,
Speaker 1: so much of lending is based on libel consumer loans,
Speaker 1: car loans, credit cards. Why is the leverage loan market
Speaker 1: such a legod in all this, It's because it's very bespoke.
Speaker 1: If you talk to people in the market, they kind
Speaker 1: of brag about the fact that it's a very opaque market.
Speaker 1: There's not a lot of electronic trading each loan is.
Speaker 1: It's not out of security. It's very customized and specific.
Speaker 1: And to even participate you have to be a very
Speaker 1: large institutional asset manager like normal people like me and you,
Speaker 1: we can't buy this kind of debt, right, And so
Speaker 1: the actual structure of the loan market is almost kept
Speaker 1: like purposely opaque and complex because companies want it to
Speaker 1: be customized and very private. And so usually that's quite
Speaker 1: frankly fine. It you know, goes along quite well. There's
Speaker 1: massive volumes every year of new deals. Things are refinanced,
Speaker 1: leveraged buyouts are financed. There, it's not a problem. But
Speaker 1: when you take that you know, customized market, you know,
Speaker 1: a very opaque market and apply it to something as
Speaker 1: complex as the lieboard transition. That's why you start to
Speaker 1: see these very interesting situations come up. What's the deadline
Speaker 1: to switch over to the new benchmark the end of
Speaker 1: June of this year, and that is already an extension
Speaker 1: of the original deadline. So do we face some kind
Speaker 1: of catastrophe when we hit that deadline? That is unlikely.
Speaker 1: Most loans have some kind of fallback language that will
Speaker 1: essentially default them to the spread adjustments recommended by the ARC.
Speaker 1: But there are certain chunks of loans, the thirty percent
Speaker 1: of negative consent, the twelve percent of no lender consent,
Speaker 1: and those are the ones where we're going to see
Speaker 1: some weird variability. The worst case scenario for some companies
Speaker 1: is that if they absolutely cannot get their stuff together
Speaker 1: and they flip to nothing come July first, they will
Speaker 1: fall back to what's called the prime rate, and that
Speaker 1: is roughly seven point seven five percent now, so the
Speaker 1: risk is if their companies would fall through the cracks,
Speaker 1: they will suddenly see their interest expense spike significantly by
Speaker 1: roughly three percent percentage points. Great, okay, very interesting. What's
Speaker 1: the next thing to watch here? What are we looking
Speaker 1: at in terms of short term the developments in this story.
Speaker 1: We're just waiting to see how fast the market transitions.
Speaker 1: So roughly twenty five percent of the leverage loan market
Speaker 1: has transition to sofur and we're now just basically waiting
Speaker 1: to see how fast or how long it takes for
Speaker 1: the remaining seventy five percent to make the switch. And
Speaker 1: how is all this drama affecting the broader credit markets
Speaker 1: In a lot of ways, it's not doing that much
Speaker 1: Like this is just sort of going along in the background.
Speaker 1: You know. We have, separately from that, we've seen sort
Speaker 1: of this rally and credit markets in January, and that
Speaker 1: rally has begun to pull back in leverage LANs that
Speaker 1: we've been talking about. Leverage lanes have actually held up
Speaker 1: pretty well and we still have a lot of issuance there.
Speaker 1: But in high old bonds, which are a very related
Speaker 1: asset class, we've seen yields go up and we've seen
Speaker 1: issuance of new debt really slow down in recent days.
Speaker 1: Thank you, Paula Selexon. We look forward to reading your
Speaker 1: scoops and listeners can can read all of your news
Speaker 1: and analysis of leverage finance and other credit markets, and
Speaker 1: our global team by by Paula and our global team
Speaker 1: of credit reporters on the Bloomberg terminal or at Bloomberg
Speaker 1: dot com switching gears here a bit. As I mentioned earlier,
Speaker 1: we have very lucky to have Jamie Patel from Bloomberg Intelligence. Now,
Speaker 1: I mean, you look at the energy sector in Latin America,
Speaker 1: which is always exciting. Um I was, you know, I've
Speaker 1: been covering that that region and that particular sector for
Speaker 1: quite a long time. We've got Pemex in Mexico, We've
Speaker 1: got Petrobras in Brazil, Echo Petrel in Colombia. The region
Speaker 1: is full of huge state owned energy companies, you know,
Speaker 1: some of the biggest in the world. I've spent time
Speaker 1: at Pemex City in Mexico City, which, as it suggests,
Speaker 1: truly is a city within a city. These companies are massive, really,
Speaker 1: and they're also huge borrowers in the dollar markets, and
Speaker 1: so international investors are very exposed. But I just wanted
Speaker 1: to start jam And by asking you what's the general
Speaker 1: state of this industry is it? Is it in good shape?
Speaker 1: I think I think generally it's in better shape than
Speaker 1: it was a year ago. Certainly old prices, having rallied
Speaker 1: the way they did, even though they've come down quite
Speaker 1: a bit, have enabled these companies to significally repair the
Speaker 1: boundaries at Petro Brass sit yet by almost fifty percent UM.
Speaker 1: If you know, you've got Whitepf and Champaigner here in
Speaker 1: uh In in Argentina UM, which are you know, much
Speaker 1: smaller companies, but UM just as interesting UM and and
Speaker 1: and just as much in the minds of investors, high
Speaker 1: yield energy investors as perhaps some of the others UM
Speaker 1: that have really managed to bring their leverage down now
Speaker 1: not to the extent that you've seen with the oil majors,
Speaker 1: but but quite significantly been able to repair their balance sheet.
Speaker 1: They haven't always been known for their efficiency though, how
Speaker 1: how good are they are doing what they do compared
Speaker 1: to the oil majors. What you know, what's the cost
Speaker 1: of production for for a barrel of oil? Well, you know, interestingly,
Speaker 1: if you look at their ebidax margins UM, they are
Speaker 1: very competitive. They're significantly higher than the oil majors. And
Speaker 1: you know, here I'm talking about not just the big
Speaker 1: one like Echo Control and Petro Bron, but also Whitepf, uh,
Speaker 1: not so much, panics. Um, And there's there's a perhaps
Speaker 1: a different story, Um. But the reason is not necessarily
Speaker 1: because they are more efficient. They do have you know,
Speaker 1: quite competitive lifting costs, but because their focuses so much
Speaker 1: on crude oil than it is on natural gas. When
Speaker 1: we saw the rally in crude oil prices, um, before
Speaker 1: we saw the rally in natural gas prices, their margins
Speaker 1: obviously will end up significantly more. Now when we see
Speaker 1: the twenty twenty two earnings results come in, Um, you know,
Speaker 1: part of that edge may have may have dissipated, but
Speaker 1: now on natural gas prices have come down very significantly,
Speaker 1: both European and US natural gas prices. So to the
Speaker 1: extent that that affects their their pricing, Um, you'll see them,
Speaker 1: i think, regain regain the margin edge that we had
Speaker 1: seen them enjoy it before. But how exposed are they
Speaker 1: to the drop in oil prices. You know, we're heading
Speaker 1: potentially into recession in the US, which isn't good for
Speaker 1: oil demand, and you know that's going to be lower prices.
Speaker 1: Are they edged at all? Well? Again, it really depends
Speaker 1: from a country to country. UM. I think you know
Speaker 1: you've heard of the Hacienda edge in in Mexico. UM.
Speaker 1: Now that's that's the government hedge. But all of these
Speaker 1: companies will have hedge to a certain extent. Clearly, Lord
Speaker 1: uh crew all prices will have hurt their bound sheets
Speaker 1: in their earnings to some extent. But again, as I said,
Speaker 1: it really depends on which company you're talking to. If
Speaker 1: you look at the pemics, for instance, UM which has
Speaker 1: a significant shortfall of refining capacity and will do so
Speaker 1: until it completed it just podcast massive boast refinery in Tabasco,
Speaker 1: UM they will continue to UM have to continue will
Speaker 1: continue to have to import significant amounts of expensive UM
Speaker 1: finished products, including gasoline and diesel. UM. So you may
Speaker 1: have natural, you may have crew pro or prices coming
Speaker 1: down that impacts the revenues from crude, but you also
Speaker 1: have this offset from lower prices, significantly lower prices or
Speaker 1: the fuel. So yes, there will be a learning impact,
Speaker 1: certainly for Pemics, not so much for Petrol Brown which
Speaker 1: which has significantly refining capacity, and for Ecodrow. But again,
Speaker 1: as I said, it really depends on the company you're
Speaker 1: looking at. Okay, that's interesting. One thing I've noticed Jayman
Speaker 1: on the on the bond side. Um, the debt is
Speaker 1: pricing much wider than the sovereigns, you know, at least
Speaker 1: compared to I remember in previous years. You know that
Speaker 1: that is, it costs these companies much more to borrow
Speaker 1: in the dollar markets than it costs the countries they
Speaker 1: are in, even though they are stay owned and looked like,
Speaker 1: you know, the same level of risk at least to me,
Speaker 1: why is that what's going on there? Well, yeah, that's
Speaker 1: a that's a really interesting situation. And again, even though
Speaker 1: we're talking about one region, each country is an enterviewer
Speaker 1: onto itself. So what you just said certainly applies very
Speaker 1: much to to PEMICS in Mexico. Um. But when when
Speaker 1: you consider that MX is really the only one percent
Speaker 1: owned by the government company that's owned by the government. Um, yes, certainly,
Speaker 1: when when you look at the others, there is significant
Speaker 1: government influence and ownership, but Pemex is the only one
Speaker 1: that's one hundred percent owned by the government. Investments investment
Speaker 1: grade rating indeed is based on the likelihood of what
Speaker 1: they referred to as extraory support from the government. UM.
Speaker 1: So to me, yes, you know, your PEMICS is certainly
Speaker 1: the most leverage of all these companies and perhaps you
Speaker 1: know the most leverage uh uh company and energy company
Speaker 1: in the world, certainly the most indebted. Um that that
Speaker 1: price gap can be quite surprising. Um, you know, it's
Speaker 1: a lot of a lot of that movements between the
Speaker 1: sovereign and the corporate yields has really depended to a
Speaker 1: significant extent upon the rhetoric that we hear coming from
Speaker 1: the Mexican government. Um, whenever they announced that they will
Speaker 1: be supporting all plans to supports the company specifically, that is,
Speaker 1: they are BULLI for X amount in terms of equity
Speaker 1: or they're going to use their taxes by y amount.
Speaker 1: You see that spread narrow. So it's a kind of
Speaker 1: a temporary thing. It's not really a long term phenomenal
Speaker 1: or a trade that people should be jumping into. Well
Speaker 1: I think, I think um, if if Mexico steps forward
Speaker 1: with something specific in terms of an equity infusion, um,
Speaker 1: you will see you should see that spread narrow significantly.
Speaker 1: But again, as I said, uh, you know, getting back
Speaker 1: to to to the pretext of your questions, UM, it
Speaker 1: not all of not all of these companies have a
Speaker 1: wide gap between the sovereign and the and the corporate.
Speaker 1: In fact, in Argentina's case, the s in trade significantly
Speaker 1: wider than the corporate, primarily because if the corporates are
Speaker 1: big export earners. Interesting, okay, so they have hard currency
Speaker 1: coming in. On the funding side, do we expect Latin
Speaker 1: American oil and gas to be big issuers of debt
Speaker 1: this year? I think if you do see significant issuance,
Speaker 1: it may be from Eco Control. With the with the
Speaker 1: changing government under the Petro administration and the move to
Speaker 1: transition the company to clean your energy, all of that
Speaker 1: rule spending is going to have to be funded somehow,
Speaker 1: so I think you may see more from ECCO Control
Speaker 1: perhaps than you will from Petro Brack. In Petro Bro's case. Again,
Speaker 1: we're not quite sure how the Lula administration wants to
Speaker 1: play with the refining situation. But if they do decide
Speaker 1: to construct refineries or increase the refining spacity, you may
Speaker 1: see from there, um you are not good to see.
Speaker 1: I don't think much out of Argentina only because there
Speaker 1: is such a limited access to the market. Okay, interesting,
Speaker 1: So just switching slightly to another related topic, esg um.
Speaker 1: You know it's such a big deal for all markets
Speaker 1: and credit in particular. But how are these companies transitioning
Speaker 1: away from fossil fuels into green and clean fuels. Well,
Speaker 1: I think I think Eco patrol is probably the one
Speaker 1: that comes first to mind. Um. Just given as I
Speaker 1: mentioned the transition um to cleaner edgy that the new
Speaker 1: administration wants to push through, we haven't seen as much.
Speaker 1: Perhaps we've seen something from from Brazil, but not so
Speaker 1: much from Mexico or Argentina. Um. But at the other
Speaker 1: end the spectrum, you know, I think I think we
Speaker 1: should really talk about Eddi vessa Um, which you know
Speaker 1: has heaviest oil um again to what we see in
Speaker 1: the oil fans, but all so the diarliest fuel so um.
Speaker 1: If if sanctions are lifted or eased for Peti Vester
Speaker 1: and we see their production moving up, I think that
Speaker 1: may become a central point for ESG in Latin America.
Speaker 1: Interesting on sanctions, I mean you kind of raise the
Speaker 1: issue of political risk, which is so key to a
Speaker 1: lot of these companies. I mean, I remember the Petrobras
Speaker 1: car wash scandal, which brought down several presidents and other
Speaker 1: executives um and really slammed the price of all the
Speaker 1: securities and tipped that company into distress. What's what's the
Speaker 1: regional outlook? We are we are much more in a
Speaker 1: much more stable that in America than previously or is
Speaker 1: it still as rocky as ever? Well, I certainly we've
Speaker 1: seen a degree with earlier. We just saw two changes
Speaker 1: of administration, one in Brazil UM and one in Columbia UM.
Speaker 1: Their policies UM will will perhaps affect the earliest capability
Speaker 1: of these companies, but I don't think you're going back
Speaker 1: as far as you know to anything like the car
Speaker 1: scanels occurring UM. If anything, there might be some positive
Speaker 1: movements when we look at Venezuela and Pedavesto, even though
Speaker 1: you may not have a regime change, greater corporation UM
Speaker 1: and and and dialogue with the US may open open
Speaker 1: that region up UM. Where Argentine is concerned, it's much
Speaker 1: more an economic case. They have very strict capital controls
Speaker 1: UM and. Even though these companies white DF and companies
Speaker 1: here are very profitable, the concern we have there is
Speaker 1: their ability to repay debt as it comes to you,
Speaker 1: particularly for white white DF in twenty twenty three, and
Speaker 1: their access to dollars to do that, which interestingly UM
Speaker 1: you know, makes the Argentinean government's recent buy back of
Speaker 1: dollars debt very interesting because they could use those funds
Speaker 1: perhaps to be some power controls. Do we think generally
Speaker 1: that um political risk is it's priced into Latin American
Speaker 1: markets on the on the credit side, I think so.
Speaker 1: I think so because you know, really depends upon the
Speaker 1: spread that you see between the sovereign and the corporate
Speaker 1: and you know, earnings and inefficiency and death maturities aside
Speaker 1: which you see primary x UM. I think it's pretty
Speaker 1: pretty well priced for ECCO control in Colombia and Brazil
Speaker 1: and fraud. Okay, let's hope you're right. We'll definitely read
Speaker 1: your analysis with great interests as we go through this. Uh,
Speaker 1: it's always it's always an interesting time for for Latam.
Speaker 1: Thanks very much, Jamon Patel from Bloomberg Intelligence. You can
Speaker 1: read all of his analysis on the Bloomberg Terminal, and
Speaker 1: thanks also to Paula Selexon from Bloomberg News. Read all
Speaker 1: her scoops on the terminal and at Bloomberg dot Com.
Speaker 1: I'm James Crumbie. It's been a pleasure having you. See
Speaker 1: you next week on the credit edge