Fallen angel? Pemex's wings clipped by the bond market

MEXICO CITY/NEW YORK (Reuters) - Mexico’s state oil producer Pemex is on the brink of making history as the global bond market’s largest “fallen angel” ever, but in the eyes of the fixed-income world the debt-laden company has already lost its wings.

FILE PHOTO: A view of the headquarters of state owned oil company Pemex in Mexico City, Mexico March 5, 2019. REUTERS/Daniel Becerril

Earlier this month, Fitch Ratings downgraded Pemex’s roughly $80 billion of bonds to speculative grade - or “junk” status. A second downgrade seen coming soon from Moody’s Investors Service would formally confirm Pemex as a junk credit or fallen angel as bond issuers stripped of their investment grade ratings are known.

Pemex bonds are already trading like junk, however, having been pummeled since the Fitch downgrade.

“It is trading more like a low BB or high B sovereign,” Pemex bondholder Tim Jagger, head of emerging market debt at asset manager Columbia Threadneedle, said in reference to the ratings scale.

“Pemex’s financial structure is not sustainable in its current form,” he added.

Pemex Chief Financial Officer Alberto Velazquez told Reuters in an interview on Thursday that the ratings agencies had been overly harsh in their assessments of Pemex bonds.

“We believe that in the short term we will achieve the metrics required to improve our creditworthiness,” Velazquez said, without giving details. “The most important thing is: we are convinced that what we are doing is right.”

Yield spreads on Pemex bonds - indicative of the premium investors demand for holding them rather than safer U.S. Treasuries - have mushroomed in the last month amid investor doubts about Mexican President Andres Manuel Lopez Obrador’s plans to save what was once the symbol of Mexico’s self-reliance.

Among the most heavily traded Pemex bonds on June 20 was its 6.5% issue worth $1.98 billion coming due in January 2029, according to MarketAxess data.

Earlier this week, the bond’s benchmark spread hit 525 basis points according to Refinitiv’s Eikon, a record since its issuance six months ago. It has climbed more than 100 basis points since early May.

Some bond managers see opportunity in the weakness.

Omotunde Lawal, head of the emerging markets corporate debt group at asset manager Barings, said her team had been adding Pemex bonds to both its high yield only and investment grade portfolios. “We used the volatility last week to top up existing positions,” she said.

JPMorgan estimated earlier this year that two downgrades to junk status would trigger as much as $16 billion of forced selling by investors whose mandates stipulate they must hold bonds of investment grade quality.

Lopez Obrador took office in December vowing to revive Pemex. But ratings agencies have repeatedly criticized the president’s plans, which include building an $8 billion refinery in his home state Tabasco. Detractors argue the refinery would divert funds away from the more profitable production and exploration business.

A Moody’s downgrade could cripple the president’s bold energy agenda, along with his plans to use new oil revenue to help finance social welfare programs.

The downgrade would make Pemex the largest fallen angel ever by a factor of two, overtaking Brazil’s scandal-plagued Petrobras. It could also imperil Mexico’s sovereign creditworthiness and make it much more expensive for both Pemex and Mexico to borrow.

Mexico itself is investment grade in the eyes of the three major ratings agencies investors rely on for guidance.

Lopez Obrador has called credit ratings agencies “not objective” and blamed policies under his predecessor, former President Enrique Pena Nieto, for Pemex’s troubles. The company’s financial debt increased by 75% to $106 billion under Pena Nieto, according to a Reuters analysis of Pemex accounts.

Max Wolman, an emerging market debt investment director at Aberdeen Standard, said he sold some of his Pemex bonds several months ago because he was not convinced of Lopez Obrador’s plans for the company.

“Pemex is currently priced as a high yield bond anyway,” he said, adding that a second downgrade from Moody’s would trigger billions of dollars of forced selling that would push Pemex bond prices down even further.

GRAPHIC-Pemex’s massive debt, click

Reporting by Stefanie Eschenbacher in Mexico City, Kate Duguid in New York and Ana Isabel Martinez in Leon, Guanajuato.; Editing by Dan Burns, Tom Brown and Lisa Shumaker