Currency Bets Backfire
One day, Controladora Comercial Mexicana SAB de CV was thriving as Mexico’s No. 3 retailer and a competitor of discount giant Wal-Mart Stores Inc. The next day, Oct. 9, the family-owned chain, known to Mexican shoppers as La Comer, had filed for bankruptcy protection, crippled by risky foreign-currency bets.
Such abrupt reversals have gotten more common these days. As global stock markets have plunged in recent months, so has the value of almost everything else, from Mexico’s peso to the price of oil. That’s left some companies that made big wagers on the direction prices were headed reeling from unexpected losses.
Throughout Latin America, companies are telling investors they have lost millions, in some cases billions, of dollars due to foreign-exchange gambles that, in some cases, had little to do with their core businesses.
Losses from bad-currency bets are ricocheting through the world’s major developing economies, including India and Korea. Officials at Citic Pacific Ltd., a Hong Kong-listed conglomerate backed in part by the Chinese government, have accused the company’s finance director of making unauthorized bets related to the Australian dollar, resulting in nearly $2 billion of foreign-exchange losses.
For now, however, such losses appear to be most widespread in Brazil and Mexico. In Brazil, the growing list of blue-chip casualties includes paper-pulp giant Aracruz Celulose SA and industrial conglomerate Grupo Votorantim. In Mexico, trading in tortilla maker Gruma’s stock was halted earlier this month after its potential losses mounted to $684 million.
The surprise disclosures have sent stock prices tumbling, and regulators in both countries are investigating whether companies adequately disclosed their trading risks to investors.
Some local reports have speculated that the damage in Brazil alone could exceed $30 billion and may affect two hundred companies.
‘We really don’t have the details yet, and it’s definitely not clear where the losses are. There are a lot of transparency issues,’ says Alexander Carpenter, senior vice president for Latin America at Moody’s Investors Service, which has issued a flurry of credit downgrades and warnings across the region.
The bad bets were made using currency derivatives — contracts tied to the value of the U.S. dollar. Companies lost badly when the dollar shot up in value starting in early September as investors cashed out of investments in emerging markets, fleeing to safer havens. And as companies raced to close out their positions they forced local currencies to tumble still further.
Latin American central banks, seeing risks to their economies, sold billions of dollars from their reserves to currency markets to prop up their currencies and cushion the blow from derivatives losses.
Mexico alone burned through about 13% of its international currency reserves. Brazil’s government is considering extending loans to affected companies.
‘The companies that bet and lost will have to face up to their responsibilities,’ Brazilian President Luiz Inacio Lula da Silva said recently as corporate losses mounted. ‘Obviously, what Brazil will always be disposed to do is create conditions so that the financial system can lend.’
In Mexico, authorities said they are investigating whether Comercial Mexicana and other companies properly disclosed the currency bets that resulted in investor losses. Under Mexican law, failure to disclose certain transactions could result in fines, and in some rare cases, criminal charges.
Among the first Latin American companies to swallow a loss was Brazilian pork and poultry processor Sadia SA, which has seen its stock slide 45% since it announced in September it had lost $360 million in currency trades.
‘We had no idea they had these kinds of contracts,’ says Marcos De Callis, who runs a $300 million Brazil fund for Schroder Investment Management and lost money when Sadia’s stock price plummeted. ‘When you buy stocks from an industrial company, you expect [them] to stick to their business.’
Since then, a dozen more Latin American companies have announced large currency losses. And investors are punishing companies they think might be in danger.
Shares in Cemex SAB, the world’s third-largest cement maker, fell nearly 56% this month as concern grew over $21 billion in derivatives on its books. Executives said in an earnings call with investors Friday that Cemex was closing out its positions and would cut its global work force by 10%.
Some bankers predict the losses will prove manageable. Marcos Lisboa, executive director of risk and internal controls at Unibanco in Brazil, said there are problems ‘but nothing like the order of magnitude people are worried about.’
He added that some companies who lost money on the dollar’s rise will make it up with more-competitive prices for their exports.
Still, the finger-pointing has started. Brazil’s Sadia fired its chief financial officer and is considering suing its bankers for pushing dangerous investments.
In other cases, risk-control experts say weak governance is to blame. The companies have said their boards and top management didn’t know about the trades.
Companies appear to have been lulled into making risky bets, perhaps without fully understanding them. Both Mexico’s peso and Brazil’s real have strengthened steadily against the dollar in recent years, thanks to high commodity prices and record foreign investment. Few thought a turnabout was likely.
Executives at Comercial Mexicana, whose stores sell digital cameras, TVs and other imported products, had protected itself against exchange-rate fluctuations by buying up dollars on futures markets. But, in recent months, with the peso’s continuing rise, that insurance proved costly.
So, starting during the summer, Comercial Mexicana’s treasury department stopped buying dollars as insurance and instead began laying bets against the U.S. currency, according to people familiar with the matter.
‘They got into a comfort zone, and tried to make money on the appreciation of the peso,’ says Nicolas Olea, an executive with KPMG in Mexico City.
The retailer, along with other companies, made the bets using currency contracts sold by big banks, including J.P. Morgan Chase & Co. and Barclays PLC, both of which declined to comment.
Under the deals, the banks offered financing and currency trades at favorable rates. But there was a hitch. If the U.S. dollar strengthened beyond a certain threshold, then the companies would have to sell dollars at a loss. In some cases, the contracts had triggers that doubled the number of dollars the companies owed.
Comercial Mexicana purchased the contracts from five different banks.At first, the deals were profit makers.
But when the company’s finance chief, Francisco Martinez de la Vega, returned from a two-week European vacation on Oct. 1, he found a situation spiraling out of control. By then, investors had panicked over the widening financial crisis had begun pulling money out of Mexico and other emerging markets. Since Aug. 1, the peso has dropped 24% against the dollar and in October careened through its biggest daily drops since a 1994 currency crisis.
Comercial Mexicana suddenly faced huge losses. Mr. de la Vega had to call in bankers from Credit Suisse over the weekend of Oct. 4 to help him analyze the situation. The total cost to close the position: $1.4 billion.
Later that week, Commercial Mexicana filed for bankruptcy, unable to pay the debt. In a note released to markets, the 76-year-old retailer said it would seek to keep its 221 stores in business.
‘Operating fundamentals are the most solid they have been in several years,’ the company said.
Antonio Regalado / John Lyons