Fried Chicken-Backed Bonds Not Enough for Correa: Andes Credit

Fried-chicken sales aren’t enough to back bonds in Ecuador President Rafael Correa’s local debt market.

Correa, 50, is proposing legislation that would prohibit the sales of securitized debt if the bond isn’t backed by a hard asset such as a factory, part of his effort to boost trading and reduce borrowing costs in the nation’s $3.6 billion corporate debt market. INT Food Services Corp., the operator of restaurant franchises including KFC and Cinnabon in Ecuador, sold $20 million of bonds backed by future cash flows from local restaurants in 2012, an offering that would be banned if Correa’s bill becomes law.

The new regulations would further depress a market that’s on pace for its slowest year of offerings since 2007, according to Quito-based brokerage Analytica Securities. Asset-backed deals last year accounted for about 19 percent of sales in Ecuador’s local bond market, which is about 16 times smaller than Brazil’s. That’s more than a 50 percent increase since 2008.

“What they’re doing would increase costs and impede the market’s fast and orderly growth,” Ramiro Crespo, head of Analytica Securities, said in a telephone interview from Quito. “This could hurt the sale of corporate debt.”

The press offices of Ecuador’s Communication Secretariat and the Economic Policy Ministry didn’t reply to e-mailed requests for comment on the proposed law.

‘Classic Tool’

The proposed legislation would also require the country’s two securities exchanges, where the selling and buying of bonds accounts for more than 95 percent of all trading, to convert into for-profit entities and creates a regulatory framework under which financial firms could set up investment banks and mutual funds.

“While the securities market has been seen as a classic tool of capitalism and of large economic groups, as also happens in our country, this market could be an ideal mechanism to democratize companies’ property,” Correa, a self-described socialist revolutionary, said in a letter to congress accompanying the bill on April 5. “The exchange market is a very important segment of the economy of a nation.”

Correa called bond investors “true monsters” when he defaulted in 2008.

Debt sales in Ecuador’s local markets fell 9 percent to $2.29 billion in the year through August from the same period in 2012, according to data from the Quito securities exchange. Total debt trading on the nation’s two exchanges may fall about 5 percent this year from $3.6 billion last year, according to Ismael Velez, the chief executive officer of Pichincha Casa de Valores SA, Ecuador’s biggest brokerage.

‘Practically Unviable’

If the government proposal to increase debt guarantees is approved, the cost to securitize future flows may be so expensive that companies will turn to direct bank loans instead, he said.

“Additional guarantees would increase the product and the process so much that it would become practically unviable,” Velez said in a telephone interview from Quito. “It would be cheaper to go to the bank.”

Trading on Ecuador’s two securities exchanges has suffered since 2009 as Correa, who defaulted on $3.2 billion of the country’s international bonds four years ago, tapped the government-controlled pension fund, the nation’s biggest investor, to finance public spending. The government also forced banks to divest their investment funds in 2012, leading to a loss of about $800 million from trading pools, Velez said.

Grupo KFC

Grupo KFC, as INT Food Services is known, has tapped into demand for fried chicken, Ecuadorean’s favorite fast-food dish, to fund an expansion of its chain of restaurants in the Latin American country.

The company set up a trust funded by future sales from 15 restaurants to guarantee the debt, according to the company’s bond prospectus published on the Quito securities exchange’s website. The bonds, sold in three parts, had maturities of four, five and six years and pay interest rates of 7.25 percent, 7.75 percent and 8 percent, respectively, according to the prospectus.

Grupo KFC didn’t reply to telephone and e-mailed messages seeking comment on the proposed law.

Monica Villagomez, the chairwoman of the Bolsa de Valores de Quito, said the government’s proposal to eliminate taxes on securities held longer than one year would help attract new investment while measures to make it easier for medium-size and small companies to raise financing on the exchanges would increase the number of companies trading on the bourses.

Strengthens Guarantees

“In general terms, we welcome this, but there are some areas that we’re calling ‘opportunities for improvement,’” Villagomez said in an interview broadcast on Sept. 25 by Radio Quito. “There are tax benefits that would help the market.”

Diego Lavalle, the chief executive officer of brokerage Mercapital Casa de Valores SA, said the new rules requiring additional guarantees for selling asset-backed securities are positive because they will help prevent companies from borrowing more than they are capable of repaying.

“The government is looking to lower the risk in the market,” Lavalle said in a telephone interview from Quito. “The law strengthens guarantees for investors just in case future flows don’t come.”

The average yield on corporate bonds sold in Ecuador’s local markets is 7.85 percent this year, up from 7.76 percent in 2012, according to data from the Quito securities exchange.

‘Very Optimistic’

The extra yield investors demand to own Ecuador’s dollar bonds instead of U.S. Treasuries fell one basis point, or 0.01 percentage point, to 626 basis points as of 12:16 p.m. in Quito, according to JPMorgan Chase & Co.

Correa’s Alianza Pais political party has a super majority capable of passing legislation without opposition support in the country’s congress, meaning the odds are high that he will push through his bond-market reforms, Analytica’s Crespo said.

“I’m not very optimistic,” Crespo said. “There’s too much concern to ensure that there are no defaults. They’re trying to take the risk out of the market.”

Before it's here, it's on the Bloomberg Terminal.