Even the central bank frets about explosive dollar debt.

By Don Quijones, Spain & Mexico, editor at WOLF STREET.

In August, the bonds of Mexico’s biggest construction company, ICA, had the dubious honor of being the worst performing corporate bonds across all emerging markets. At a time when emerging economies are slowing down and the total debt exposure of EM corporations has never been higher, this was no mean feat.

Then in October, ICA reported its biggest net loss in 14 years. And things have only deteriorated since.

The Real Pain Begins

Yesterday the company’s shares plummeted 22% on news that it would use a 30-day grace period to make a $31 million interest payment that was due this week. Today its shares, which have lost more than 75% of their value since January, fell a further 8% to 3.76 pesos, their lowest point in 21 years.

To make matters worse, the builder recently hired corporate restructuring specialist Rothschild & Co. as financial adviser, fuelling speculation that it will soon seek debt relief.

“Do I think they’re going to pay within 30 days? No,” said Carlos Legaspy, a money manager at InSight Securities and holds ICA bonds due in 2017, 2021, and 2024. “The 30 days are not going to make any difference.”

If ICA does fail to pay, it would be Mexico’s biggest bond default since the tumultuous days of the Tequila Crisis 20 years ago.

Too Little, Too Late

ICA’s problems began long ago but were recently magnified by political problems at home and economic forces overseas. The revenue reported by the company, which depends on the government for a majority of its contracts, has sharply declined this year amidst infrastructure spending cutbacks, while the weaker peso has exacerbated the company’s leverage ratios.

As WOLF STREET previously reported (here and here), many Mexican corporations are acutely vulnerable to a strengthening dollar and rising U.S. interest rates. The sudden rise in central bank-engendered liquidity after the outbreak of the Global Financial Crisis enabled Mexico’s biggest companies to borrow from the international markets in much larger amounts and for much longer periods than at any other time in history. And the slide of the peso against the dollar has significantly increased the amount of leverage at some companies.

Mexico’s total corporate debt denominated in foreign currencies is now €121 billion, practically double what it was in 2008. In a report ominously titled “When the Financial Becomes Real,” the Bank of International Settlements notes that the external debt in Mexico is the fourth highest of 17 emerging economies. The three economies ahead of Mexico are Chile, Malaysia and Peru.

So serious is the problem that the Bank of Mexico just released a carefully worded alert on the potential dangers of excessive dollar-denominated corporate debt. Given that ICA’s towering dollar-denominated debt pile is already in free fall, the central bank’s intervention is a classic case of too little, too late.

That didn’t stop it from engaging in some wholly unconvincing positive thinking. The risks are “contained,” it proclaimed, despite the fact that conducting an accurate evaluation of said risks is not simple, due to the “lack of standardized information.” In other words, keep your fingers crossed and head for the hills.

Companies that have sharply increased their foreign currency-denominated debt are meanwhile advised to pay close attention to the risks they face, especially if most of their revenues are denominated in pesos.

In the case of ICA, almost all of the company’s contracts are denominated in pesos, while $1.35 billion of its debt is denominated in dollars. That’s the debt it’s now struggling to pay. According to data compiled by Bloomberg, the company’s total debt is 10.75 times its earnings before interest, taxes, depreciation and amortization.

One Last Dance?

Other companies that could be at risk of a similar predicament include Carlos Slim’s América Móvil (AMóvil), Axtel, Alfa and the beleaguered media giant TV Azteca whose shares have crumbled 50% since January. In the second quarter of 2015, the debt in dollar terms of América Móvil and Axtel exploded by 37% and 48% respectively. In the case of Alfa and TV Azteca it grew by 29% and 32%, respectively.

This explosion of dollar-denominated debt was not just the result of the strengthening dollar; many companies were also desperate to take advantage of exceptionally low interest rates by applying for more debt with favorable conditions. In a perversely ironic twist, out of fear that the Fed may be about to take away the ZIRP punch bowl, some of Mexico’s biggest corporations embarked on one last dollar-borrowing binge.

It was the Mexican equivalent of former Citigroup bossman Chuck Prince’s infamous last dance. As long as the music is playing, you’ve got to get up and dance, he said in 2007, just before leading Citigroup to the brink of the financial abyss. ICA’s creditors and investors may be about to learn that when the music stops, the dance floor can get very ugly, very quickly. By Don Quijones, Raging Bull-Shit.

And so the Hot Money flees Mexico, with consequences: Read…  Dollar-Denominated Corporate Time Bomb Set to Blow

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