Pemex CDS hint at default in the offing

Mexico’s finance ministry recently reported completing a debt refinancing deal totaling US$20.1bn by national oil company Pemex – an enormous sum that may still not be sufficient. 

Even before the refinancing was finalized, Pemex and finance minister Arturo Herrera were celebrating the issuance of US$7.5bn of new debt as a financial vote of confidence in Pemex’s turnaround. 

Debt refinancing has surged under AMLO compared with the previous government. Source: El Universal

Instead, many have moved on to treating Pemex, the world’s most heavily indebted oil company with liabilities surpassing US$102bn, as likely to fall into default in the medium term. 

“If we’re talking about refinancing,” Luis Gonzali, portfolio manager at Franklin Templeton in Mexico City, told BNamericas. “It doesn’t affect Pemex if it's [rated] junk or not. The market is already treating it as junk.” 

AWAITING A SECOND DOWNGRADE

In June, Fitch downgraded Pemex’s credit to junk, setting off alarm bells as a second such cut by one of the two other major credit rating agencies, Moody’s or S&P, would trigger forced selling of Pemex debt by institutional investors, driving Pemex’s cost of servicing its debt higher.  

Between the two, Moody’s is widely thought to be more likely to cut Pemex to junk status because, as Gonzali points out, “S&P has been very emphatic in saying that the credit rating of Pemex is highly bound to that of the sovereign.” 

Indeed, S&P has issued the same rating to Mexico’s sovereign credit and Pemex’s: BBB+. That equalized rating is based on S&P’s assessment of “extraordinary government support” should Pemex near bankruptcy. 

For now, S&P and Moody’s appear to be adopting a wait-and-see approach. 

“We’ll be looking at the way the support plays out,” Lisa Schineller, managing director for Latin America sovereigns at S&P, told BNamericas last week: “All the burden is going back on Pemex, and that’s fine if Pemex is able to deliver in terms of production.”

At an event in Mexico City in September, Moody’s analysts issued similar comments, citing such factors as a “sustained stabilization in output” as indicative of Pemex’s ability to generate the cash to pay down its debt.  

LOOKING BEYOND THE CREDIT RATING

Increasingly though, the basis for the credit ratings themselves are being questioned.  

The credit agencies typically assess corporate debt based on figures reported by the company’s themselves. 

But two months ago, Mexican daily Reforma reported that Pemex declared higher output numbers than Mexico’s hydrocarbons regulator, potentially boosting its production on paper by 21,000bpd in July.   

Moreover, as reported by the Wall Street Journal earlier this week, the credit rating agencies may be inflating their ratings to keep the credit of highly indebted companies like Pemex just above the rating where they would be deemed junk. 

“The triple-B rating has exploded in the last decade, with debt outstanding more than tripling to US$3.7tn,” the WSJ noted. “These days, about 50% of all investment-grade bonds are rated triple-B, up from 38% in September 2009,” it added.  

JP Morgan and the IMF are among those who are alarmed that corporate ratings are not giving a true read of default risks, according to the WSJ article. 

Two weeks ago, Mexico’s competition watchdog (IMCO) declared that Pemex was already in “technical default” because of a range of factors, including the low probability of a dramatic rise in oil output and the doubling of the company’s debt, in real terms, over the last decade.  

In Pemex’s case, investors are increasingly eyeing credit default swaps (CDS), insurance contracts used to hedge against the likelihood of default in the next 5-10 years. 

Source: AssetMacro

While prices on Pemex CDS fell in late September, in the wake of massive capital injections from the government, they have risen again in October.   

“I think that the market is already discounting a credit downgrade for Pemex,” Gonzali told BNamericas, “despite being rated BB+ by Fitch, the 5-year CDS is priced as if it were for an entity rated as B+.” 

The rating of B+ is considered junk, an expression of a higher risk of default.