- Since the pandemic-related recession began, the Latin American corporations with the lowest ratings have seen the most downgrades.
- We expect the pace of defaults to accelerate, with potentially more than 30 issuers facing default risks by the end of the year: slightly more than 10% of our rated portfolio in the region.
- The default rate could even climb beyond that if poor business conditions last longer than we anticipate.
The Weakest Latin American Companies Are Getting Weaker
As we expected, the recession has hit the weakest credits the hardest. Since late February, numerous 'BB'-rated issuers have slipped into lower categories. As Chart 2 shows, the rating distribution has skewed to lower categories, especially 'CCC+', for the lowest-rated corporations since the end of February 2020.
Since late February, nine rated Latin American companies have defaulted, and we believe the list could grow up to 36 issuers. That would mean a default rate of 10.6% of our portfolio, assuming there are no significant changes to our economic scenario and there's a slightly improved credit supply to the better credit profiles than what's been available in the past three months.
The default list has jumped since May 2020 (chart 3), and the speed may increase in the third quarter if market conditions and economies don't improve.
Investor appetite for Latin American corporate bonds has dropped in the second quarter of 2020, making it harder for issuers to roll over debt. As of the end of May, domestic bond issuances were 50% less than in the same period of 2019, and only three speculative-grade issuers were able to issue cross-border debt in the past three months (Cemex, Petrobras, and Nexa Resources). We expect domestic credit to expand gradually in the third quarter for the corporates with higher ratings, but it will be hard for companies in troubled sectors to raise new debt with the very weak business conditions.
Worst Recession In The Past 20 Years In Terms Of GDP Contraction
Under the current conditions, we expect a GDP contraction three times larger (see chart 4) than the region's GDP drop during the 2008-2009 global financial crisis. However, defaults won't be three times those of 2008-2009 mainly because we expect this recession to be shorter. Companies are also better capitalized, are less exposed to currency mismatches, and have generally stronger liquidity positions than in 2008-2009.
In our view, the current recession will most hurt transportation companies (including infrastructure assets such as airports and toll roads that have been severely affected by the mobility restrictions and distancing measures), oil & gas, retail, and real estate companies (chart 5).
The Default Rate For Corporates Could Climb To 10.6% Or Even Higher Under Harsher Conditions
Our estimated default rate is based on our assumption of very harsh industry conditions for the rest of the year. In addition, we assumed very limited access to refinancing sources for entities rated 'B-' or below.
Our default rate estimate includes potential conventional defaults and de facto restructurings. In fact, we believe many of these potential defaults would be exchange offers that we would consider to be de facto restructurings because in our opinion the bondholders won't get sufficient compensation--meaning that they receive less than the original promise.
A deeper impact could increase the default rate to 13% or 45 issuers. We believe defaults could climb above 11% of our rated portfolio if a second wave of COVID-19 extends lockdowns for longer (or reinstates them), or if the economic contraction in South America is deeper than our expectations.
Our calculations exclude project finance because they are different in nature from corporates. However, we believe project finance transactions will be more vulnerable than corporations, because their liquidity positions are generally weaker than corporate issuers (mostly limited to six-month debt service reserve accounts), they have restrictions on obtaining additional financing, and their cash flow uses are limited to what their bylaws command so they have less room to maneuver. In addition, we expect subordinated series to be weaker than senior debt tranches, because lock-up tests may be triggered under the current conditions--consequently limiting distributions to subordinated tranches.
Default Rate Depends On When Recovery Starts
We believe the starting point of the recovery will be crucial for the default rate. If the virus doesn't recede in the third quarter, and governments don't relax lockdowns and social distancing measures, the final default count may significantly climb. On the other hand, if the recovery begins in the third quarter as we assume at this point, the number of defaults could stay below 10%.
S&P Global Ratings acknowledges a high degree of uncertainty about the evolution of the coronavirus pandemic. The consensus among health experts is that the pandemic may now be at, or near, its peak in some regions but will remain a threat until a vaccine or effective treatment is widely available, which may not occur until the second half of 2021. We are using this assumption in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.
This report does not constitute a rating action.
|Primary Credit Analyst:||Diego H Ocampo, Buenos Aires (54) 114-891-2116;|
|Secondary Contact:||Candela Macchi, Buenos Aires (54)-11-4891-2110;|
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