Ecuador Debt: Vulnerable To Oil, But Safe W/China Loan Vs. Argentina, Venezuela
January 8, 2015
Ecuador’s risk of default is real, but its ability to meet bond payments appear safe despite lower oil prices.
China has infused Ecuador with cash, and it has made budget cuts, securing near-term cash flow, writes Siobhan Morden, the head of Latin America Strategy at Jefferies, in a recent note.
The debate now has to do with comparisons to Argentina. The oil-price shock resulted in underperformance in Ecuador bonds, but there has been a reversal from spread discount to spread premium versus Argentina — the two being the “serial defaulters’ of Latin America. Morden asks: should Ecuador offer a spread premium to Argentina, which faces similar macro imbalances?
“We do not expect a reversal back to 7.5% yield to maturity on Ecuador’24 but the premium to Argentina appears excessive, especially if external risk stabilizes. It is interesting to compare Argentina with Ecuador: [the] convergence trade between these two credits did happen. However Ecuador is now trading at a wider spread premium to Argentina [and] there is a different debate. Argentina is often described as the best of the worst credits among a pack of distressed credits like Venezuela and Ukraine. The Ecuador’15 and Boden’15 are trading at similar prices but there is a 150 basis point yield premium between the Ecuador’24 and the Bonar’24. The explanation for the outperformance of Ecuador, with yields widening out from 7.5% to 11.1%, is the adjustment to the oil shock.
Ecuador is clearly vulnerable. Not only does Ecuador have to compensate for the lost oil revenues of around $5 billion at current oil prices but also has to substitute the $1.8 billion in budgeted private debt as Ecuador has effectively lost market access. [The oil shock is closer to $35 billion for Venezuela, annualized for 2014/2015, Jefferies estimates.]
However … Ecuador has around $3 billion in budgetary flexibility … to adjust to lower oil prices and as such has committed to a reduction in capex of $1.42 billion promised this year. There [is] a new $5.3 billion loan from China of which $1.5 billion will be drawn down this year. The terms also are favorable with a 30-year maturity and 2% interest rate. There have also been recent official statements of larger-than-expected China financing of $7.5 billion with details pending.
Ecuador has the benefit of its small size – “too small to fail” – and explains why the country has been able to survive for so long after the 2008 default and without access to international capital markets until only recently. … The current yields do not suggest market access for Ecuador … However, the strategic funding from China provides the necessary flexibility … and access to credit lines should reassure near term cash flow and may somewhat mitigate the impact on medium-term growth potential.”
It’s tough to find an emerging market bond find with obvious holdings in Ecuador. A quick scan of several bond funds invested in emerging markets shows that the iShares JPMorgan USD Emerging Markets Bond Fund (EMB), which invests mostly in government bonds, had a 1% weighting in Argentina, as of Sept. 30, putting Argentina among its five most concentrated positions. The fund also was invested in several smaller Latin American nations’ bonds — including Peru, Uruguay and Panama – as well as Mexico and Colombia.
Latin American equities are higher today, with the iShares Latin America 40 ETF (ILF) up nearly 1.5%, slightly below the 1.7% climb in the iShares MSCI Emerging Markets ETF(EEM).