Corporate Debt Strategy México Mexican Corporates against COVID July 22, 2020 Special Note www.banorte.com ▪ Companies are facing significant operational and financial challenges @analisis_fundam coming from the economic impact of the Coronavirus pandemic, triggering concerns about a possible deterioration of their credit profiles ▪ Financial flexibility is deteriorating as a result of limited cash flow Manuel Jiménez Director of Market Strategy generation, coupled with a quick use of liquidity [email protected] ▪ Main challenges for Mexican corporates: (1) operation disruptions; (2) Tania Abdul Massih drop in revenues; (3) liquidity erosion; (4) funding sources limitations; Director of Corporate Debt and (5) rating reviews [email protected] ▪ During 1H20, the corporate debt market presented a low level of Hugo Gómez issuances, limiting the issuers funding. Nevertheless, in recent weeks Senior Analyst, Corporate Debt various placements were made with spreads considerably higher than the [email protected] comparable curve Gerardo Valle ▪ During 2H20 we expect a few downgrades to be carried out, considering Analyst, Corporate Debt the revisions and outlook changes to ‘Negative’ as a consequence of the [email protected] 2Q20 quarterly results The impact of an unprecedented crisis. The global health crisis is deteriorating the financial flexibility of many Mexican corporates as a result of limited cash generation capacity, coupled with a quick use of their liquid resources. According to Fitch Ratings, in the last five years the historical analysis shows that most Latin American companies step in the crisis with a weak financial position, considering cash generation and capital expenditure (Capex). Specifically, in Mexico we have Document for distribution among public observed that the lockdown has brought important financial consequences for corporates: (1) operation disruptions; (2) drop in revenues; (3) liquidity erosion; (4) funding sources limitations; and (5) rating reviews, among others. In the first stage, the sectors considered to be the most vulnerable were those with the highest exposure to the people lockdown such as airlines, hotels and entertainment. However, the consequences are beginning to be seen more clearly across different sectors, although at this point it is very complex to estimate the cumulative economic and social effects that this crisis will trigger. Below, we show a heat map based on perceived risk assessment by sector. COVID-19 Risk Assessment – Heat map by sectors Food Construction Automotive Airlines Beverages Financial Services Airports Entertainment (Leasing & Microfinance Retail stores Companies) Infrastructure / Toll roads REITs Health / Pharmaceutical Transportation Departament stores Restaurants Companies Source: Banorte with information from S&P Global Ratings, Fitch Ratings and Moody’s Investors Service. 1 A global review… all corporates in the spotlight. Given the global health crisis and its economic effects, rating agencies revised the credit quality of corporates. Particularly, Fitch Ratings has published regional statistics related with rating actions taken for the companies in its portfolio. In its most recent document on Latin America (June 2020), the agency stablished that coronavirus-driven rating actions accelerated the cumulative net downgrade/upgrade trend across Latin America since 2013, with 41 rating downgrades since the pandemic hit the region from March to June 2020. Moreover, Latin American non-financial corporate issuers with Negative Outlooks and Rating Watch Negatives increased to 36% as of May 12, 2020, compared with 15% as of January 1st, 2020 (see charts below). According to Fitch Ratings, a significant portion of the changes in the outlook to Negative were in line with sovereign ratings. It is worth noting that inside its document, Fitch Ratings affirms that historically, 50-60% of Negative Outlooks and Rating Watch Negative on corporates have been followed by a negative action within 12 months. In this context, the rapid change to the Outlook mix in the past months suggests that there will be further downgrades in the near term. Corporate Outlook / Watches – as of January 1st, 2020 Corporate Outlook / Watches – as of May 12, 2020 % % Negative 13% Positive 6% Negative 30% Rating Watch - 2% Positive Rating Watch Stable 4% + 60% 1% Rating Watch Stable - 78% 6% Source: Fitch Ratings Source: Fitch Ratings. Main challenges for corporates. As previously mentioned, companies are facing significant operational and financial challenges coming from the economic impact of the Coronavirus pandemic, triggering concerns about a possible deterioration of their credit profiles: (1) operation disruptions; (2) drop in revenues; (3) liquidity erosion; (4) funding sources limitations; and (5) rating reviews, among others. Regarding funding sources limitations, we have observed that several companies has disposed their revolving credit facilities in order to face their financial obligations, anticipating a complex liquidity scenario. Some of these companies are: Grupo Televisa, Grupo Bimbo, Ienova, Fibra Uno, Crédito Real, Gap, BBVA Leasing México, Fibra Shop, Vinte, among others. 2 Limited funding sources, few refinances in the market. After the low number of issuances registered during 1S20, during last weeks we have observed a moderate reactivation of the market. Nevertheless, as a result of the credit risk implicit in the corporate bond market, spreads have experienced an important pressure as we describe it in our recent document “Evolución de Spreads”. The movement that most clearly reflects what is happening in the market is that of the sample ‘Unsecured AAA 28-day TIIE’, with an upward shift of the curve of 10- 15bp, explained by recent issuances of GAP 20-2, FEFA 20 and 20V at spreads higher than its comparable curve, as well as through the revaluation of other issuances. Rating actions coming from the economic impact of the Coronavirus pandemic. About the fifth challenge, downgrades / ratings reviews, in recent weeks, rating agencies have undertaken a great number of actions coming from the economic impact of the Coronavirus pandemic. In the following part of the document we describe the most relevant rating actions. Sovereigns and State-owned companies summary. During March and April 2020, Mexico’s credit rating was cut by three international agencies: Moody’s Investors Service (April 17th), Fitch Ratings (April 15th) and S&P Global (March 26th) acknowledging that the Coronavirus pandemic, combined with the plunge in crude oil prices have resulted in relevant headwinds for the Mexican economy and fiscal accounts. It is worth mentioning that Mexico’s sovereign profile is holding its ‘Investment Grade’ status (IG), after this round of reductions (see table below). The rating for Petroleos Mexicanos (Pemex) and Comision Federal de Electricidad, were also cut, following sovereign downgrade. Particularly, further downgrades for Pemex were triggered by the company's higher liquidity and business risk. As it was widely expected, Moody's Investors Service downgraded Pemex’s senior unsecured ratings from ‘Baa3’ to ‘Ba2’, lowering it to a high- yield level. For details related with rating actions see table below. Mexico’s sovereign and Pemex credit rating Bold level indicates current level Source: Banorte with data from S&P Global, Fitch Ratings and Moody’s Investors Service 3 Airlines sector summary. Given the economic challenges coming from the economic impact of the Coronavirus pandemic, in recent weeks issuer ratings of Mexican airlines, Aeroméxico, Volaris and Viva Aerobus (current market participants) have been cut or review (unsecured and structured ABS). The main reasons for the downgrades are the fact that airlines, according to agencies reports, will face a sharp decrease in passenger traffic in 2020 and 2021, as well as in revenues, coupled with high lease payments, which will pressure their leverage metrics. As a result, agencies expect a drop in EBITDA and profitability, while the potential recovery will involve additional debt to make up for the liquidity deficit. Timeline of rating actions – Airlines Notches Issuer Date Agency Previous Current 17-mar Moody’s B1 (G) B2 (G) (UR-) 20-mar S&P BB- (G) B+ (G) (UR-) 8-apr HR Ratings HR2 (ST) HR3 (CP) (UR-) 30- apr Verum 1/M (ST) 3/M (ST) (UR-) 21-may S&P B+ (G) (UR-) B- (G) (Neg.) Aeroméxico 2-jun Moody’s B2 (G) (UR-) Caa1 (G) (Neg.) 1-jul S&P B- (G) (Neg.) D (G) 1-jul HR Ratings HR3 (ST) (UR-) HR5 (ST) (UR-) 1-jul Verum 3/M (ST) (UR-) D/M (ST) 2-jul Moody’s Caa1 (G) (Neg.) Ca (G) 3-jul HR Ratings HR5 (ST) (UR-) HRD (ST) (UR) 8-apr HR Ratings HR AA+ (Neg.) HR A+ (UR-) 30- apr Verum AA+/M A+/M (UR-) AERMXCB 17 / 19 (ABS) 1-jul HR Ratings HR A+ (UR-) HR BB- (UR) 1- jul Verum A+/M (UR-) BB/M (UR-) 8-apr HR Ratings HR3 (ST) HR3 (ST) (UR-) Viva Aerobus 29-apr Verum 2/M (ST) 3/M (ST) 6-jul Verum 3/M (ST) 4/M (ST) 8-apr HR Ratings HR AA HR AA- (UR-) VIVAACB 19 (ABS) 29-apr Verum AA/M AA-/M (Neg.) 6-jul Verum AA-/M (Neg.) A/M (UR-) Volaris 30-apr Verum AA+/M AA+/M (Neg.) VOLARCB 19 (ABS) 8-may HR Ratings HR AA+ HR AA (UR-) Source: Banorte with information from rating agencies. (Neg.) Negative Outlook, (Pos.) Positive y (St.) Stable; (UR) Under Review; (UR-) Under Negative Review; (G) Global; (ST) Short Term Airport sector summary. The current issuers in this sector are GAP and OMA. The impacts on their ratings have resulted from both sovereign rating movements and the health crisis. The changes have been more limited than the actions for airlines for different reasons that have allowed them to remain solid against COVID-19. Some of these reasons are the strong liquidity and recent measures taken to improve it, as well as Capex and expenses reductions due to less traffic and low leverage. Timeline of rating actions – Airport Notches Issuer Date Agency Previous Current GAP 21-apr Moody’s A3 (G) Baa1 (G) (Neg.) OMA 24-apr Fitch AA+(mex) (Pos.) AA+(mex) (St.) Source: Banorte with information from rating agencies.