Republic of Costa Rica: Summary Bond Terms Costa Rica Bonds 6.548%, 2014 9.995%, 2020 4.25%, 2023 Issuer Republic of Costa Rica Currency USD Issue Date January 12, 2004 July 20, 2000 November 16, 2012 Tenor at Issue 10 Years 20 Years 10 Years Time Remaining Till Maturity 0.87 Years 7.25 Years 9.73 Years Duration 0.83 5.41 8.28 Maturity Date March 20, 2014 August 1, 2020 January 26, 2023 Maturity Type Bullet Bullet Bullet Coupon 6.548% p.a. semi-annual (March 20 & 9.995% p.a. semi-annual (February 1 4.25% p.a. semi-annual (January 26 & September 20) & August 1) July 26) Day Count Basis 30/360 30/360 30/360 Bond Rating Baa3 (Moodys; April 2013), BB (S&P; Baa3 (Moodys; April 2013), BB (S&P; Baa3 (Moodys; April 2013), BB (S&P; April 2013), BB+ (Fitch; April 2013) April 2013), BB+ (Fitch; April 2013) April 2013), BB+ (Fitch; April 2013) Use of Proceeds Repay/Refinance Debt Repay/Refinance Debt Repay / Refinance Debt Governing Law New York Price/ Yield (Ask) Data 1 Price: $103.947 Yield to Maturity: 1.24% Price: $137.543 Yield to Maturity: 3.956% Price: $102.232 Yield to Maturity: 3.962% Recommendation HOLD HOLD HOLD 1 As at May 13, 2013 Page 1 of 10
Republic of Costa Rica: Summary Bond Terms Costa Rica Bonds 4.375%, 2025 5.625%, 2043 Issuer Republic of Costa Rica Currency USD Issue Date April 23, 2013 April 23, 2013 Tenor at Issue 12 Years 30 Years Time Remaining Till Maturity 11.99 Years 29.99 Years Duration 9.26 14.59 Maturity Date April 30, 2025 April 30, 2043 Maturity Type Bullet Bullet Coupon 4.375% p.a. semi-annual (April 30 & October 30) 5.625% p.a. semi-annual (April 30 & October 30) Day Count Basis 30/360 30/360 Bond Rating Baa3 (Moodys; April 2013), BB (S&P; April 2013), BB+ (Fitch; April 2013) Baa3 (Moodys; April 2013), BB (S&P; April 2013), BB+ (Fitch; April 2013) Use of Proceeds Repay / Refinance Debt Repay / Refinance Debt Governing Law New York Price/Yield Data 2 Price: $102.034 Yield to Maturity: 4.157% Price: $102.923 Yield to Maturity: 5.426% Recommendation HOLD HOLD 2 As at May 13, 2013 Page 2 of 10
Republic of Costa Rica Bonds - Analysis Country Overview The Republic of Costa Rica is an upper middle-income country located in Central American. It is the 5 th largest country by area on the Central American mainland. The country maintains a stable constitutional democracy and is characterised by political stability and a fairly high standard of living relative to its Latin American neighbours. There is a well-developed social benefits system in place which has aided in reducing poverty. Costa Rica is a popular destination for regional immigration as a result of numerous job opportunities and social programmes. Many foreign investors have also become attracted to the country s political stability, relatively high levels of education and free trade zone incentives. The country s major income earners fall into the tourism, agriculture and electronic exports sectors. To complement this, the Republic devotes a great deal of its resources to education and culture, ecotourism, protection of primary resources and land preservation. Costa Rica has experienced steady economic growth over the past three decades as a result of an export-oriented strategy which has been focused on foreign investment and gradual trade liberalisation. In keeping with steady growth, Costa Rica is also exercising its efforts on improving competitiveness and the general business climate. In the past, Costa Rica has been struck by a number of corruption scandals involving political figures and pay-back schemes with multinational corporations that implicated three former presidents. It has also been suffering from several socio-economic challenges inclusive of the country being a popular transhipment point for the trade of illegal drugs along with rising levels of crime and violence. In an attempt to battle these challenges the Government has prioritized citizen security while having partially restored political participation. Amongst this fairly new wave of political evolution, this democratic republic has been operating with chief of state and head of government, President Laura Chinchilla Miranda since May 2010. She is the first female President of Costa Rica and has engaged in political programmes that emphasize anti-crime legislation, pro- free-trade and environmental protection policies. Page 3 of 10
Costa Rica: Economic Indicators 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% -1.0% -2.0% Real GDP Growth Rates 4.7% 5.0% 4.2% -1.0% 2009 2010 2011 2012 As a result of the global economic contraction in 2009, Costa Rica recorded negative growth of -1%. Since 2010, the economy has achieved moderate recovery of real GDP growth rates, which is expected to continue in 2013. Unemployment Rate 8.6% 8.4% 8.4% 8.2% 8.3% 8.0% 7.8% 7.5% 7.6% 7.3% 7.4% 7.2% 2009 2010 2011 2012 Over the review period, unemployment rates have been relatively stable between 7.3% and 8.4%. As of 2012, unemployment levels declined from 8.3% (2011) to 7.5% as a result of increased new jobs creation. Despite these positive indicators, it is essential for the relevant authorities of the Republic to monitor the quality of available work and employment conditions. Page 4 of 10
Costa Rica: Economic Indicators Inflation, Consumer Prices % 2012 4.6% 2011 4.7% 2010 5.8% 2009 4.0% 0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 7.0% Costa Rica has recorded moderate levels of inflation over the review period, ranging from 4% to 5.8%. At the close of 2012, Costa Rica s inflation rate was 4.6%, which was actually in line with the central bank s target rate for the year. Going forward, it is essential that the Republic of Costa Rica ensures prudent monitoring to minimise inflation and maintain its overall international competitiveness over the medium to long term. Public Debt (% of GDP) 60.0% 50.0% 40.0% 35.4% 27.2% 29.2% 30.9% 30.0% 20.0% 10.0% 0.0% 2009 2010 2011 2012 Over the review period, Costa Rica s public debt has been gradually increasing as a percentage of GDP. As at 2012, the estimated figure stands at 35.4% of GDP, which indicates that even though the public debt is steadily increasing, Costa Rica has managed to exercise fiscal prudence and effective economic management of the country s debt burden. Page 5 of 10
Costa Rica: Economic Indicators Weeks of Imports Net International Reserves 24 22 22.8 20 18 19.6 16 17.6 14 14 12 10 Oct-09 May-10 Nov-10 Jun-11 Dec-11 Jul-12 Jan-13 Costa Rica s net international reserves have been fluctuating over the review period; however it has remained above the optimal and acceptable levels as stipulated by the International Monetary Fund (IMF) of 12 weeks of goods and service imports. As of December 31, 2012, Costa Rica s reserves were the equivalent of 17.6 weeks. Real Interest Rates 12.0% 11.0% 10.5% 11.5% 10.0% 9.0% 8.0% 8.9% 8.4% 7.0% 2009 2010 2011 2012 As of 2012, interest rates, despite being fairly high for an economy performing relatively well, have been on the decline. It appears that the Republic of Costa Rica is looking to balance out and bolster economic growth without excessive expenditure or risk of inflation. In conjunction with this Costa Rica has also planned to lower interest rates in 2013 as part of a series of measures to reduce capital inflows and prevent the risk of rapid overheating. Page 6 of 10
Costa Rica Bonds Historical Data 3 150 Costa Rica Average Historical Prices 140 130 120 110 100 90 Feb-12 Apr-12 May-12 Jul-12 Aug-12 Oct-12 Dec-12 Jan-13 Mar-13 May-13 Jun-13 2014, 6.548% 2020, 9.995% 2023, 4.25% 2025, 4.375% 2043, 5.625% Costa Rican bond prices have slightly increased over the period while declining yields have made these bonds less attractive to investors looking for attractive returns. As a result of the rating, Costa Rican bonds are considered as medium grade and, as such, may possess certain speculative characteristics. Despite moderate risk, the full suite of Costa Rican bonds may not be particularly enticing to investors looking for attractive yields or entry price points. This is particularly evident with the 2020 issue which recorded a price/yield (ask) of $137.543/3.956% as of May 13, 2013. It is for this reason that we believe investors may want to look elsewhere for attractive bonds that will offer both attractive yields and capital accumulation opportunities. 3 Historical Data Retrieved from Bloomberg Terminal as at May 13 2013 Page 7 of 10
Costa Rica Bonds Spread Analysis 7.000% Costa Rica Historical Spread Analysis 6.000% 5.000% 4.000% 3.000% 2.000% 1.000% 0.000% Nov-12 Nov-12 Dec-12 Jan-13 Jan-13 Feb-13 Mar-13 Mar-13 Apr-13 May-13 May-13 Aruba 2015 vs Costa Rica 2014 Trinidad 2020 vs Costa Rica 2020 US 10 Year vs Costa Rica 2023 Venezuela 2027 vs Costa Rica 2025 Brazil 2041 vs Costa Rica 2043 Relative to Caribbean and Latin American benchmarks, Aruba (A-; S&P and BBB; Fitch), Trinidad (Baa1; Moody s and A; S&P), Venezuela (B2; Moody s and B+; S&P) and Brazil (Baa2; Moody s and BBB; Fitch) bonds, the yields on Costa Rican bonds (Baa3; Moody s and BB; S&P) are deemed to be representative of a lower level of risk which the market factors in for holding these bonds. This is mainly due to the fact that Costa Rican bonds are seen as medium grade, with some speculative elements and a moderate credit risk. There is a premium for holding the Trinidad and Tobago 2020 and Aruba 2015 bond over Costa Rica (2020 and 2014 issues) with spreads of 129.3 and 181.2 bps respectively as of May 2013. Interestingly enough, both Trinidad & Tobago and Aruba have higher ratings than Costa Rica, which indicates to potential investors that there may be better opportunities for capital accumulation and attractive yields at tolerable levels of risk. On the farthest end of the Costa Rican bond curve, it has been illustrated that there is a premium for holding the Brazil 2041 over the Costa Rica 2043 issue. As of May 2013, there was a spread of 112.5 bps which also signifies the relative attractiveness of all Caribbean and Latin American benchmark issues over Costa Rican bonds. Page 8 of 10
For the purpose of this analysis it was also necessary to compare Costa Rican bonds to the yields offered on securities with one of the lowest possible risks of default, US Treasury Bonds. The spread of Costa Rica 2023 bonds over US 10-Year Treasuries as of May 2013 was 203.9 bps and, in this case, indicates the reasonable premium that investors can expect to receive for holding more risky debt over securities which hold one of the lowest risks of default (US treasuries). The 10-Year US Treasuries are backed by the full faith and credit of the U.S. government. Hence, these securities offer lower yields relative to other bonds. Costa Rica Bonds: Risk Factors 1. Costa Rica is a foreign sovereign state. As a result, it may be difficult or impossible for investors to obtain or enforce judgments against Costa Rica whether in an investor s own jurisdiction or elsewhere. 2. Costa Rica s economy remains vulnerable to external shocks and contagion, inclusive of global financial/ economic crises (such as the financial crisis in 2008). 3. Costa Rica s economic health is highly dependent on revenue obtained from tourism. If the global economic condition rapidly deteriorates, this could directly affect the viability of tourism as a significant revenue earner for Costa Rica. 4. Even though there is not an inherent liquidity risk associated with Costa Rican bonds at this time, potential investors must be cognizant of the fact that market conditions may fluctuate and this could affect the availability of Costa Rican bonds on the secondary market. 5. Policies imposed by the administrative authorities of Costa Rica in the future such as the adjusting of any interest rates will have an impact on bond prices. By way of duration analysis, the interest rate risk and the sensitivity of bond prices to a change in interest rates is measured. Based on the duration calculations, for every 100 basis-point (1%) decrease in interest rates for Costa Rican bonds, it is expected that bond prices will increase by 0.83% (2014), 5.41% (2020), 8.28% (2023), 9.26% (2025) and 14.59% (2043) respectively. The aforementioned Costa Rican bonds are fixed-rate in nature and consequently, if there is any change in interest rates, investors Page 9 of 10
will see bond price changes reflective of the increasing volatility associated with a longer time until maturity. Outlook & Recommendation The Costa Rican economy is heavily dependent on tourism, agriculture and electronics exports. The productivity of these sectors, coupled with strategic economic policies has allowed the Republic to emerge strongly from a contraction and record positive growth for the past three years. As it relates to the aforementioned Costa Rican sovereign bonds, the ability of the country to generate revenues and service its debt appears to remain fairly robust and we recommend the full suite of Costa Rica bonds as a HOLD at this time. This is due to the fact that even though Costa Rica is notably one of the more stable economies in the region, the sovereign USD bonds available to potential investors are not comparably attractive in yields relative to market benchmarks. Keeping this in mind, it is clear that a diversified and balanced portfolio is what will bring favourable returns to avid investors in this uncertain global macro-economic climate. Sources: Central Bank of Costa Rica, International Monetary Fund (IMF), World Bank, World Economic Outlook, Central Intelligence Agency (CIA) World Factbook 2012, Bloomberg. Disclaimer: This Research Paper is for information purposes only. The information stated herein may reflect the opinion and views of VM Wealth Management in relation to market conditions and does not constitute any representation or warranties in relation to investment returns and the credibility of the sources of information relied upon in the preparation of this report, without further research and verification. Before making any investment decision, please consult a VM Wealth Management Advisor. Page 10 of 10