Investor confidence in Mexico was rattled last week after the president-elect abandoned a US$13bn airport project, raising fears that policy direction may soon take a more populist bent.
The US$6bn bonds that helped fund the project slipped multiple points after a four-day consultation that resulted in Mexicans voting in favour of refurbishing existing airports instead.
“The logical thing to do would have been for AMLO to thank the public for their valuable participation and announce that he would consider the best way forward after discussing this with the business community and the airport group,” said Roger Horn, senior EM strategist at SMBC Nikko Securities America.
Respected for fiscal discipline and sophisticated debt management, Mexico and its state-owned oil company Pemex have been favourites among international fixed-income accounts.
But fund managers who had found comfort in the moderate tone struck by AMLO post-election are now rethinking risks.
Aside from a possible renegotiation of US$6bn in airport bonds, investors fear populist members of the new president’s team are now driving policy.
“This referendum is seen by many as a make or break moment to finally get a sense of what the AMLO administration will look like,” said Alejo Czerwonko, an emerging markets economist at UBS Wealth Management.
“The majority of investors now believe that the more ideologically driven side [of the AMLO administration] is prevailing.”
The Mexico City Airport Trust (or Mexcat) 3.875% 2028s have fallen five points since last week to trade at 80.20 on Thursday, while the 5.5% 2047 has sunk more than six points over the same period to 77.25, according to MarketAxess.
Policy uncertainty has also spilled over into other asset classes ranging from an infrastructure trust issued by state-owned utility CFE to Pemex’s new 2029, which has tumbled three points since it priced last week.
“People are freaking out not necessarily because of populism but because of the unpredictability,” a senior banker told IFR.
Fitch revised its outlook on Mexico’s BBB+ rating to negative from stable on Wednesday, citing policy uncertainty.
Investors have been particularly worried about AMLO reversing energy reforms that had been designed in part to turn Pemex, rated Baa3/BBB+/BBB+, into a more independent and profitable entity.
Political appointees at Pemex and CFE had already caused nagging concerns over the summer.
“The most important thing is energy reform and the fact Pemex is a very weak company,” said Shamaila Khan, a director of emerging market debt strategy at AllianceBernstein.
Any further weakening in the credit quality of Pemex, which is a frequent borrower whose bonds are held by a wide variety of investors, could spell trouble for the market.
“Because its ratings are on the verge of investment grade, it could lead to significant distress if it is downgraded below IG,” said Khan. “That would have an impact on the entire Mexican complex.”
Aaron Gifford, an emerging market sovereign analyst at T Rowe Price, echoed such thoughts.
“It sends a signal that there are other things that AMLO has a strong opinion about that could be up for renegotiation, including energy reforms,” he said.
“Pemex has about US$100bn in outstanding debt and it is widely held, so it is a concern.”
Lawyers have also been heard approaching holders of Mexcat bonds about creating a united front in preparation for debt negotiations.
“In order to recover value, we believe investors must seek a negotiated settlement,” Citigroup analysts said in a report.
Citigroup’s best case scenario involves a quick mandatory redemption of 100% of the principal. But it thinks a partial principal payment over one or two years, and the issuance of a restructured bond with or without collateral, is more likely.
While negotiations could prove to be lengthy, bondholders can expect to receive interest – which currently comes from cashflows at the existing airport, the bank said.
At this stage, no one thinks the government would ever consider defaulting on the debt, though few believe that prices will climb back to where they were before.
“It is not that the bonds will fully recover but it shouldn’t go into distress territory either if there is a negotiation in good faith on both sides,” said Kahn.
Both Fitch and S&P put their BBB+ rating on the Mexcat notes on rating watch negative, while Moody’s downgraded them two notches to Baa3, just above junk.
Cancellation of the project could constitute an event of default and could potentially trigger an acceleration – a move that only requires agreement from 25% of holders, said Fitch.
Under that scenario, the concessionaire is entitled to payment, but the usage of those funds for debt pre-payment would require negotiated amendments, said Fitch.
“The termination of the concession could potentially be enough to trigger a default or redemption event under the bonds,” said Carlos Albarracin, a partner at Milbank, Tweed, Hadley & McCloy.
“But if the government is exercising a rescate [rescue], investors should expect to be repaid.”