Libor-SOFR Switch Angst; LatAm Energy View

with him in a bit. Please to join you. But before we do, let's talk libor transition, by which we mean the switch to a new price benchmark for the trillions of dollars in assets that need to happen over the next few months. But by all accounts, it's not going very well, so let's get straight to it. Paula, what's the latest you're hearing on this. I am glad you asked, because I love talking about libor. So essentially we have to first take this context of the whole

libor transition. So a lot of asset classes have been doing fine, but specifically in the one point for trillion US leverage loan market, we're down to the wire. It goes away in the middle of this year, but there are still controversies as companies switch their existing loans from libor to SOFA, the secured overnight financing rate the preferred

replacement in the United States. So we've been covering a lot of stories about how there have been some cases where lenders are upset essentially about the credit spread adjustment.

This is a special extra little bit of basis points that you add in to the coupon on the loan in order to compensate for how LIBOR typically prints above where SOFUR does, and so there have been cases where lenders have been trying to organize to vote against it, and this time we've recently done a story about cases where lenders don't get a chance to vote at all

when these things are changed. So specifically, what we're looking at is essentially, if you look at the universe of existing leverage loans, they all have this special, essentially legal documentation built into them that will allow for an easier switch from libor to SOFUR, And for roughly thirty percent of the market they have this way where you can vote,

and there's been some controversy there. You can see our prayer coverage, but a recent story is about twelve percent, where essentially you don't have to vote if you're the company. What happens is essentially, if you switch from libor to sofur and you're the company and your bank that's been helping you with this, agrees to the rate and the credit spread adjustment, you're good and you don't have to ask for a vote as long as you're doing what's

considered the market standard. But what's been happening is there's been bickering over what exactly is the market standard. So what we've seen is some companies have used a ten basis point credit spread adjustment during this transition instead of using a staggered credit spread adjustment that was essentially recommended by a regulatory body, where they recommend eleven basis points or twenty six basis points if you're borrowing on a

one or three month basis. So essentially, I like lenders, These asset managers have been getting these notifications that say, hey, by the way, your libel loan is now a sofa loan and it used a ten basis point credit spread adjustment, and they go, wait, hang on a minute, I wanted to vote on this. This isn't the market standard, but the company's perspective as they did pick the market standard because there have been other loans that have flipped this way,

and so it's messy, it's complicated. Honestly, I can see both sides of it, depending on how you think about the market. And so we've been really trying to reflect in our coverage how this is very much still a price discovery and there's still a lot of arguing between

lenders and borrowers as this unfolds. That's great, but in simple terms, we're talking about risky companies borrowing from banks in what we call the leverage loan market, and the basis on which their price is changing, and somebody's losing out here, yes, exactly. So that's all about that credit spread adjustment. So on one hand, you have the company and they've borrowed sometimes billions of dollars from large groups of institutional asset managers in this market called the leverage

loan market. And so if the thing is the difference between libor and sofur, because both them are floating rate, right like, both of those are benchmarks that change over time,

so the difference between them also changes over time. So there's a special group that's endorsed by regulators called the Alternative Reference Rates Committee, and so they tried to solve this problem, and in March of twenty twenty one, they picked essentially the five year historical median of the difference between these two rates to set their own recommendations, and that's where that eleven basis points for one month and

twenty six basis points for three months comes from. So in theory it should reflect the fact that this changes all the time. But right now, overall the difference between the rates is smaller than where the arc that regulatory group set these recommendations, and so it's just arguing over basically pricing. Essentially, you know, if the borrowers lock in a lower rate, they essentially save interest expense, but then that's at the expense of the lenders who length them

the money in the first place. This is especially tricky for what are called clos or collateralized loan obligations, because they pull a bunch of loans and then structure it in the special type of structured financial product and then sell that in bonds, and those bonds will have certain ways that they flip as well. So they could actually lose a lot in the difference if it's not the

type of credits preadadjustment that they want. So much of finance, so much of lending is based on libel consumer loans, car loans, credit cards. Why is the leverage loan market such a legod in all this, It's because it's very bespoke. If you talk to people in the market, they kind of brag about the fact that it's a very opaque market. There's not a lot of electronic trading each loan is. It's not out of security. It's very customized and specific.

And to even participate you have to be a very large institutional asset manager like normal people like me and you, we can't buy this kind of debt, right, And so the actual structure of the loan market is almost kept like purposely opaque and complex because companies want it to be customized and very private. And so usually that's quite frankly fine. It you know, goes along quite well. There's massive volumes every year of new deals. Things are refinanced,

leveraged buyouts are financed. There, it's not a problem. But when you take that you know, customized market, you know, a very opaque market and apply it to something as complex as the lieboard transition. That's why you start to see these very interesting situations come up. What's the deadline to switch over to the new benchmark the end of June of this year, and that is already an extension of the original deadline. So do we face some kind

of catastrophe when we hit that deadline? That is unlikely. Most loans have some kind of fallback language that will essentially default them to the spread adjustments recommended by the ARC. But there are certain chunks of loans, the thirty percent of negative consent, the twelve percent of no lender consent, and those are the ones where we're going to see

some weird variability. The worst case scenario for some companies is that if they absolutely cannot get their stuff together and they flip to nothing come July first, they will fall back to what's called the prime rate, and that is roughly seven point seven five percent now, so the risk is if their companies would fall through the cracks, they will suddenly see their interest expense spike significantly by roughly three percent percentage points. Great, okay, very interesting. What's

the next thing to watch here? What are we looking at in terms of short term the developments in this story. We're just waiting to see how fast the market transitions. So roughly twenty five percent of the leverage loan market has transition to sofur and we're now just basically waiting to see how fast or how long it takes for

the remaining seventy five percent to make the switch. And how is all this drama affecting the broader credit markets In a lot of ways, it's not doing that much Like this is just sort of going along in the background. You know. We have, separately from that, we've seen sort of this rally and credit markets in January, and that rally has begun to pull back in leverage LANs that we've been talking about. Leverage lanes have actually held up pretty well and we still have a lot of issuance there.

But in high old bonds, which are a very related asset class, we've seen yields go up and we've seen issuance of new debt really slow down in recent days. Thank you, Paula Selexon. We look forward to reading your scoops and listeners can can read all of your news and analysis of leverage finance and other credit markets, and our global team by by Paula and our global team of credit reporters on the Bloomberg terminal or at Bloomberg dot com switching gears here a bit. As I mentioned earlier,

we have very lucky to have Jamie Patel from Bloomberg Intelligence. Now, I mean, you look at the energy sector in Latin America, which is always exciting. Um I was, you know, I've been covering that that region and that particular sector for quite a long time. We've got Pemex in Mexico, We've got Petrobras in Brazil, Echo Petrel in Colombia. The region is full of huge state owned energy companies, you know,

some of the biggest in the world. I've spent time at Pemex City in Mexico City, which, as it suggests, truly is a city within a city. These companies are massive, really, and they're also huge borrowers in the dollar markets, and so international investors are very exposed. But I just wanted to start jam And by asking you what's the general state of this industry is it? Is it in good shape? I think I think generally it's in better shape than

it was a year ago. Certainly old prices, having rallied the way they did, even though they've come down quite a bit, have enabled these companies to significally repair the boundaries at Petro Brass sit yet by almost fifty percent UM.

If you know, you've got Whitepf and Champaigner here in uh In in Argentina UM, which are you know, much smaller companies, but UM just as interesting UM and and and just as much in the minds of investors, high yield energy investors as perhaps some of the others UM that have really managed to bring their leverage down now not to the extent that you've seen with the oil majors, but but quite significantly been able to repair their balance sheet.

They haven't always been known for their efficiency though, how how good are they are doing what they do compared to the oil majors. What you know, what's the cost of production for for a barrel of oil? Well, you know, interestingly, if you look at their ebidax margins UM, they are very competitive. They're significantly higher than the oil majors. And you know, here I'm talking about not just the big one like Echo Control and Petro Bron, but also Whitepf, uh,

not so much, panics. Um, And there's there's a perhaps a different story, Um. But the reason is not necessarily because they are more efficient. They do have you know, quite competitive lifting costs, but because their focuses so much on crude oil than it is on natural gas. When we saw the rally in crude oil prices, um, before we saw the rally in natural gas prices, their margins

obviously will end up significantly more. Now when we see the twenty twenty two earnings results come in, Um, you know, part of that edge may have may have dissipated, but now on natural gas prices have come down very significantly, both European and US natural gas prices. So to the extent that that affects their their pricing, Um, you'll see them, i think, regain regain the margin edge that we had seen them enjoy it before. But how exposed are they

to the drop in oil prices. You know, we're heading potentially into recession in the US, which isn't good for oil demand, and you know that's going to be lower prices. Are they edged at all? Well? Again, it really depends from a country to country. UM. I think you know you've heard of the Hacienda edge in in Mexico. UM. Now that's that's the government hedge. But all of these companies will have hedge to a certain extent. Clearly, Lord uh crew all prices will have hurt their bound sheets

in their earnings to some extent. But again, as I said, it really depends on which company you're talking to. If you look at the pemics, for instance, UM which has a significant shortfall of refining capacity and will do so until it completed it just podcast massive boast refinery in Tabasco, UM they will continue to UM have to continue will continue to have to import significant amounts of expensive UM

finished products, including gasoline and diesel. UM. So you may have natural, you may have crew pro or prices coming down that impacts the revenues from crude, but you also have this offset from lower prices, significantly lower prices or the fuel. So yes, there will be a learning impact, certainly for Pemics, not so much for Petrol Brown which which has significantly refining capacity, and for Ecodrow. But again, as I said, it really depends on the company you're

looking at. Okay, that's interesting. One thing I've noticed Jayman on the on the bond side. Um, the debt is pricing much wider than the sovereigns, you know, at least compared to I remember in previous years. You know that that is, it costs these companies much more to borrow in the dollar markets than it costs the countries they are in, even though they are stay owned and looked like, you know, the same level of risk at least to me, why is that what's going on there? Well, yeah, that's

a that's a really interesting situation. And again, even though we're talking about one region, each country is an enterviewer onto itself. So what you just said certainly applies very much to to PEMICS in Mexico. Um. But when when you consider that MX is really the only one percent owned by the government company that's owned by the government. Um, yes, certainly, when when you look at the others, there is significant government influence and ownership, but Pemex is the only one

that's one hundred percent owned by the government. Investments investment grade rating indeed is based on the likelihood of what they referred to as extraory support from the government. UM. So to me, yes, you know, your PEMICS is certainly the most leverage of all these companies and perhaps you know the most leverage uh uh company and energy company in the world, certainly the most indebted. Um that that

price gap can be quite surprising. Um, you know, it's a lot of a lot of that movements between the sovereign and the corporate yields has really depended to a significant extent upon the rhetoric that we hear coming from the Mexican government. Um, whenever they announced that they will be supporting all plans to supports the company specifically, that is, they are BULLI for X amount in terms of equity or they're going to use their taxes by y amount. You see that spread narrow. So it's a kind of

a temporary thing. It's not really a long term phenomenal or a trade that people should be jumping into. Well I think, I think um, if if Mexico steps forward with something specific in terms of an equity infusion, um, you will see you should see that spread narrow significantly. But again, as I said, uh, you know, getting back to to to the pretext of your questions, UM, it not all of not all of these companies have a wide gap between the sovereign and the and the corporate.

In fact, in Argentina's case, the s in trade significantly wider than the corporate, primarily because if the corporates are big export earners. Interesting, okay, so they have hard currency coming in. On the funding side, do we expect Latin American oil and gas to be big issuers of debt this year? I think if you do see significant issuance,

it may be from Eco Control. With the with the changing government under the Petro administration and the move to transition the company to clean your energy, all of that rule spending is going to have to be funded somehow, so I think you may see more from ECCO Control perhaps than you will from Petro Brack. In Petro Bro's case. Again, we're not quite sure how the Lula administration wants to

play with the refining situation. But if they do decide to construct refineries or increase the refining spacity, you may see from there, um you are not good to see. I don't think much out of Argentina only because there is such a limited access to the market. Okay, interesting, So just switching slightly to another related topic, esg um. You know it's such a big deal for all markets and credit in particular. But how are these companies transitioning

away from fossil fuels into green and clean fuels. Well, I think I think Eco patrol is probably the one that comes first to mind. Um. Just given as I mentioned the transition um to cleaner edgy that the new administration wants to push through, we haven't seen as much. Perhaps we've seen something from from Brazil, but not so

much from Mexico or Argentina. Um. But at the other end the spectrum, you know, I think I think we should really talk about Eddi vessa Um, which you know has heaviest oil um again to what we see in the oil fans, but all so the diarliest fuel so um. If if sanctions are lifted or eased for Peti Vester and we see their production moving up, I think that may become a central point for ESG in Latin America.

Interesting on sanctions, I mean you kind of raise the issue of political risk, which is so key to a lot of these companies. I mean, I remember the Petrobras car wash scandal, which brought down several presidents and other executives um and really slammed the price of all the securities and tipped that company into distress. What's what's the regional outlook? We are we are much more in a much more stable that in America than previously or is it still as rocky as ever? Well, I certainly we've

seen a degree with earlier. We just saw two changes of administration, one in Brazil UM and one in Columbia UM. Their policies UM will will perhaps affect the earliest capability of these companies, but I don't think you're going back as far as you know to anything like the car

scanels occurring UM. If anything, there might be some positive movements when we look at Venezuela and Pedavesto, even though you may not have a regime change, greater corporation UM and and and dialogue with the US may open open that region up UM. Where Argentine is concerned, it's much more an economic case. They have very strict capital controls

UM and. Even though these companies white DF and companies here are very profitable, the concern we have there is their ability to repay debt as it comes to you, particularly for white white DF in twenty twenty three, and their access to dollars to do that, which interestingly UM you know, makes the Argentinean government's recent buy back of dollars debt very interesting because they could use those funds

perhaps to be some power controls. Do we think generally that um political risk is it's priced into Latin American markets on the on the credit side, I think so. I think so because you know, really depends upon the spread that you see between the sovereign and the corporate and you know, earnings and inefficiency and death maturities aside which you see primary x UM. I think it's pretty pretty well priced for ECCO control in Colombia and Brazil

and fraud. Okay, let's hope you're right. We'll definitely read your analysis with great interests as we go through this. Uh, it's always it's always an interesting time for for Latam. Thanks very much, Jamon Patel from Bloomberg Intelligence. You can read all of his analysis on the Bloomberg Terminal, and thanks also to Paula Selexon from Bloomberg News. Read all her scoops on the terminal and at Bloomberg dot Com.

I'm James Crumbie. It's been a pleasure having you. See you next week on the credit edge