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Independent corporate lawyers noted that all of the defaults happened with issues listed by the Guayaquil bourse. (Guayaquil photo by Alfredo Molina)
Wednesday, March 25, 2015

Ecuador: A Seed of a Problem

Local corporate defaults raise eyebrows in Ecuador.


QUITO --  In the 15 years since the US dollar became Ecuador's currency, it has helped to transform the investment climate in the country. Previously, with the currency, the sucre, subject to constant political manipulation, potential investors had a huge disincentive to buy local fixed-income securities, given that holding long-term value wasn't a characteristic of the currency system. The introduction of the dollar changed that, generating a solid basis for demand and supply for corporate bond issuance. More than 800 securities sold in the market since then, with only 11 bonds suffering from defaults. But with 10 of these occurring only in recent months, worries about increasing risks have emerged.

Among the defaults, the noisiest has been that of companies part of Guayaquil's Ortega Trujillo conglomerate. Companies that missed payments included an automotive retailer and a health insurer, leading the corporate regulator, the Superintendencia de Compañías, to intervene last month, taking control over 82 companies in the group and of the assets of 30 individuals, thanks to a friendly judge.

The regulator argued that this would help ensure the companies meet their obligations, while independent corporate lawyers questioned the legality of the entire procedure. Some have noted that all of the defaults happened with issues listed by the Guayaquil bourse, and all were reviewed by the same credit ratings agency, Sociedad Calificadora de Riesgo Latinoamericana, according to business review Líderes.

Analysts note that Web pages with ratings of defaulted bonds have been mysteriously deleted, eliminating the ability to easily review the paper trail. No allegations of manipulation have emerged however, and the overwhelming majority of issues placed in Guayaquil have experienced no problems, nor have any on the other stock exchange in Ecuador, in Quito (securities listed on one exchange are automatically traded on both). The combined amounts of the defaults total less than half of a percent of all outstanding fixed-income securities.

But while the system remains solid, the recent problems do highlight some underlying issues that hamper further development of the capital market in Ecuador. The administration has wavered between its rival claims to be running a socialist revolution and to be technocratically modernizing Ecuador, resulting in contradictions and dithering regarding the capital markets law, which took half a decade to write, and slowness in issuing approvals and regulations.

Private-sector financial market participants have noted some genuine willingness by regulators to help develop the market, but this has been tempered by lack of training in some instances, and a tendency to prefer opaqueness – such as in the case of the disappearing Web sites – rather than risk unsettling the market. This has led to an all-too slow transmission of information when defaults have in fact occurred, leading thus to greater market jitters than perhaps warranted.

Another aspect that has generated some uncertainty is that, ironically, virtually all issues are rated investment-grade. This reflects several characteristics of the local market. Issuing junk bonds is practically impossible as regulators balk at permitting any issuance below investment grade. Investor skepticism also diminishes appetite for risk, particularly given the near inexistence of a liquid secondary market. This generally limits the ability of companies to issue bonds to those who are indeed very solid. But it excludes others who might have strong growth potential from tapping the market.

The top-heaviness of the ratings also suggest to some that credit ratings agencies might be failing to do their job, as they were revealed to have done in the run-up to the US 2008 credit crisis. Officials at the ratings companies deny this charge, pointing also to the far more conservative composition of the Ecuadorian securities market compared with that of the US. The overwhelming amount of investment-grade ratings also points to another Ecuadorian anomaly: the state-run social security institute, which for obvious reasons can only buy very low-risk issuance, is by far the dominant investor.

Coupled with a cooling economy and state intervention in imports and through tax regulations, the outlook for the exchanges has become cloudier. Meanwhile, with red tape slowing companies wanting to tap the bond market and rates rising, many have instead begun to find bank loans a competitive alternative, thus slowing the development of the bond market further.

This commentary originally appeared in Ecuador Weekly Report published by Analytica. Republished with permission.

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