Brazil Guide Dec 2012 v3.indd - Euromoney

The 2012 guide to

December 2012

Brazil

Published in conjunction with: Bradesco Deutsche Bank

Contents

Lower interest rates unleash fresh challenge

2

Bradesco powers ahead

4

Bradesco

This guide is for the use of professionals only. It states the position of the market as at the time of going to press and is not a substitute for detailed local knowledge. Euromoney Trading Ltd Nestor House Playhouse Yard London EC4V 5EX Telephone: +44 20 7779 8888 Facsimile: +44 20 7779 8739 / 8345 Chairman: Richard Ensor Directors: Sir Patrick Sergeant, The Viscount Rothermere, Christopher Fordham (managing director), Neil Osborn, Dan Cohen, John Botts, Colin Jones, Diane Alfano, Jaime Gonzalez, Jane Wilkinson, Martin Morgan, David Pritchard, Bashar Al-Rehany Advertising Production Manager: Amy Poole Journalist: Robert Dwyer Printed in the United Kingdom by: Wyndeham Group © Euromoney Trading Ltd London 2012 Euromoney is registered as a trademark in the United States and the United Kingdom.

Locals tighten their grip

6

Record DCM enjoys near-perfect conditions

8

ECM: banks hold their breath

10

M&A resilience shows Brazil’s continued attraction

11

2012: The corporate financiers’ perspective

12

Private sector seeks profitable role in infrastructure finance

14

Lower interest rates unleash fresh challenge With inflation fears ever-present, many are concerned about the sustainability of the government’s efforts to cut interest rates and stimulate further growth

Brazil’s economy is changing. The government has been using the slowdown in the world economy to its advantage. It has long wanted to cut chronically high interest rates, which it believes have been holding back the country’s growth potential. But in years such as 2010, when the GDP growth rate reached 7.5%, the government was unable to reduce its benchmark Selic rate without unleashing fears of inflation. Brazil’s economic history is one of battling hyper-inflation. So those running the country are particularly sensitive to charges that they are being lax on controlling rising prices. However, in the second half of 2011 and into 2012 the government responded quickly and purposefully to slower internal GDP growth by cutting the policy rate. From 12.5% in mid 2011 the Selic now stands at 7.25%. Inflation has yet to respond with significant upward momentum but many expect it to lead to monetary tightening at the beginning of 2013 as growth returns.

rates to trend downwards with each cycle. Therefore those in Brazil’s financial industries are working on strategies to adapt to this lower interest rate environment. “We believe Brazil remains attractive for international investors, mainly due to solid macroeconomic fundamentals, strong comparative advantage in the commodity sector and the ample domestic consumer market,” says José Carlos de Faria, senior economist, emerging markets research, at Deutsche Bank in Brazil. “Given the improvement in macro fundamentals over the last 10 years, implementation of economic reforms over the same period and consolidation of financial stability, we believe low interest rates are here to stay. This does not mean that the Selic overnight rate will stay at 7.25% for ever. The difficult global environment has allowed interest rates to decline below long-term equilibrium levels, but rates will probably rise again once the global

“We believe Brazil remains attractive for international investors, mainly due to solid macroeconomic fundamentals, strong comparative advantage in the commodity sector and the ample domestic consumer market” All of this leaves a question-mark over the financial sector’s attempts to adapt to the lower interest environment: is it sustainable? Most economists think the government will have to respond with higher interest rates. Some bankers believe the government’s strong focus on the foreign exchange rate (as this guide goes to press the real is heading to an exchange rate of $2.10, a significant devaluation from the $1.55 it was trading at in July 2011). “I believe the government is so focused on maintaining a weaker real that it will use its macroprudential weapons before it raises interest rates again. The last thing it wants, when it is finally winning the ‘currency wars’ is to give the initiative away,” said one banker - who declined to be named because his view runs contrary to the expectations of his bank’s chief economist. However, whether or not the Selic rises in 2013, it seems unlikely to rise to the peak of the last cycle. The trend appears to be for interest

economy recovers. However, we do not expect nominal interest rates to rise above 10% again, at least not for a long period of time.”

GDP growth

Despite recent low annual GDP growth – 2012 is expected to end at around 2% – the economy is in solid shape. Speaking to delegates at the Felaban Conference in Peru in November, Geraldo Magela, executive secretary of the Central Bank of Brazil, presented an overview of a country with fundamentals that continue to strengthen. In 2012 Brazil overtook the UK to become the sixth largest economy in the world; total economic output is now R$4.2 trillion, compared to R$1.6 trillion in 1990. The bank has, more or less, maintained inflation in its target band of 4.5% plus or minus two percentage points (some price shocks on food have occasionally led to the range being breached in the short term). The real interest rate has fallen to 1.8% in November

2012 from 15% a decade ago. The country’s trade balance is positive to the tune of $22 billion: The export sector’s total of $246 billion is still dominated by raw materials (50% of the total) and is exposed to fluctuations in commodity prices, but the country also exports semimanufactured goods (14%) and manufactured goods (37%). Brazil maintains a relatively small current account deficit (just $50 billion, or 2.2% of GDP in the 12 months to September), fully financed by foreign direct investment ($63.8 billion over the same period). This level of FDI is still strong (although down on 2011’s $86.7 billion) and is a big vote of confidence from the international financial community in the strong growth prospects for the country in the medium to long term. The country’s total external debt amounts to just $309 billion (13.3% of GDP). Brazil is one of the few countries running a primary fiscal surplus, and has a net public debt of just 35% of GDP.

Attractive prospects

Brazil’s future, therefore, seems to be one of continued strengthening, although the story will not be linear. The rating agencies all now rate the country as investment grade, although they point to a slowing in the rate of upgrades. Fiscal policy will be the hardest area to reform, but will be necessary if the country continues to improve. The government under President Dilma Rousseff has hinted that it would like to tackle the high level of state spending and at times onerous tax rates but politically this will be hard to achieve for a left-wing political party that relies on a wide coalition of support. Central support for the economy, especially through the state development bank BNDES, continues to be critical. In February, the government announced that state and private spending on Brazilian infrastructure would increase by 28% from R$504 billion to R$646 billion to provide domestic demand-led economic stimulus to compensate for the reduced external growth caused by the financial crisis. Petrobras is also

“I believe the government is so focused on maintaining a weaker real that it will use its macro-prudential weapons before it raises interest rates again. The last thing it wants, when it is finally winning the ‘currency wars’ is to give the initiative away”

The banking system remains strong and well regulated. The capital reserve requirements remain above the levels as stipulated under Basle III and pose no issue to the system. Some small bank failures have identified areas of bad or fraudulent accounting practices but they have not been systemic issues. The Central Bank and the securities regulator, the CVM, have been quick to respond with tighter reporting requirements for the securitized products that have been affected. The Central Bank continues to build its foreign currency reserves, which now stand at $378 billion – up from $4 billion in 1982. Some question the efficacy of continuing to build up holdings of a mountain of US Treasury bills but Magela says the policy provides liquidity that enables Brazil to withstand global financial crises. He points out that, though large, Brazil’s FX reserves are, at 16.3% of GDP, outside the top 10 around the world. He says the central bank feels it has the policy willingness to continue to build reserves in the future.

investing hugely in its pre-salt fields. The projects are all vital to the country’s prosperity but there remain questions from the private sector about the dominance of BNDES’s subsidized financial support for infrastructure. “In 2013, we believe the main challenge will be to pave the way for aggregate investment to recover and lead a rebound in sustainable economic growth,” says de Faria. “We believe that lower interest rates and ample credit supply will make it easier for investment to recover, although this will also depend on the state of the global economy, which remains very unlikely given so many challenges in Europe, the US and China. We think the government could also help investment recover by providing a more stable and predictable regulatory environment, and reducing the heavy tax burden on the private sector.” That fiscal challenge will be the critical factor, not just for 2013 but for the rest of the decade and will likely be the most important factor in determining the long-term trend growth rate for the country. This guide will therefore look at how these trends are affecting the key areas of Brazil’s economy and its financial markets. In particular it will assess how the capital markets, with regard to both equity and debt, are responding to the challenges of the lower interest rate environments and the structural shifts they are having on the investment community and its risk appetites. There are also chapters on M&A activity – which continues to thrive – and the outlook and financial opportunities presented by the country’s infrastructure needs.

2012 Guide to Brazil

Brazil’s 200 million people provide a strong and stable internal market and continue to become more affluent, with millions every year entering the middle class (or as Magela calls it, the “consumer class”), adding fuel to the engine of domestic demand-led growth. The Central Bank has sponsored the development of the banking sector into new areas of the country. In 2012 the banked population reached 174.8 million – effectively the entire eligible population, up from 87.6 million in 2002. Progress in widening the base of the banked population has added to economic growth as new customers access bank products for the first time. It also extends the reach of the federal tax authorities, facilitating collection of tax receipts.

3

Bradesco powers ahead

Improving efficiency, attracting millions of new customers and offering a broad range of products and services to individual and corporate clients are among the key factors driving Bradesco, as it takes advantage of the opportunities offered by Brazil’s economy.

Amongst Brazil’s largest banks, Bradesco is present in every single Brazilian municipality and has a total of 72.2 million clients Bradesco, one of the largest Brazilian banks, is pinning its hopes on increased efficiency to squeeze costs and improve its performance as it aims to reap the benefits from Brazil’s economy, in which the socioeconomic middle-income group C has grown enormously.

Its investments in organic growth helped expand the client base by around one million, and three million new credit cards were issued. Client growth increased the volume of transactions, raising the bank’s fee income.

The bank is expanding at a breathtaking rate that saw it open 1,009 new branches last year, an impressive figure even for a continentalsized country such as Brazil.

Its insurance group reported higher revenues.

Most of these new openings were concentrated in the fast-growing north and northeast of the country. Bradesco is present in every single Brazilian municipality and has a total of 72.2 million clients. It aims to expand access to the banking system to areas and people that have been excluded. Massive investments in technology allow it to offer state-of-the-art solutions at low cost in remote areas, guaranteeing clients the same treatment as in Brazil’s more advanced areas. The results are already apparent in terms of efficiency and earnings. Its 12-month efficiency ratio dropped to 42.1% in the third quarter this year, the lowest level for the last nine quarters. The adjusted net income reached R$8.605 billion – R$178 million higher or 2.1% up on the same period last year. The third-quarter adjusted net income came in at R$2.893 billion.

At the end of September, its total assets amounted to more than R$856 billion, 18.6% up on September last year, while its expanded loan portfolio increased by 11.8% during the same period, totalling R$372 billion. Assets under management ended the quarter at R$1.172 trillion, a 20.4% increase over September 2011. Its delinquency ratio dropped to 4.1%. At the end of September, the bank had a tier 1 capital-to-risk weighted assets ratio of 11.3% against 12.2% in September last year. At the end of the third quarter, it had a net interest margin of 7.4% against 7.6% at the same time last year. The bank has set an efficiency ratio target of 39% by the end of 2014 and remains confident it will reach that target through volume expansion and cost reduction. For the first nine months this year, Bradesco had an annualized return on average equity (ROAE) of 20% against 22% for the same period last year. As of September 12 this year, the bank had a total market capitalization of R$113.1 billion, with an overall free float of 60.5% of equity.

A number of factors were behind this increase, in Bradesco’s view. The higher volume of operations boosted net interest income, which offset the upturn in delinquency costs.

Bradesco had an 11.6% market share of the whole lending market in Brazil and a 21.5% market share of the lending market among the country’s private banks by the end of the third quarter.

It had an 18.3% share of the whole asset management industry and a 26.2% share of the asset management industry among private banks. It enjoyed a 24.5% share of the entire insurance, private pension plans and savings bonds markets, and a 31.8% share of those markets among the private banks.

“Those people are going to want insurance for their cars, homes and life assurance,” said Nachbar. “Bradesco’s insurance arm saw its written premiums, pension plans´ contribution and savings bond income grow 21% last year, and this year growth should be at the top end of our forecast range of 15% to 19%.”

At the end of September, the bank had 4,665 branches, 41,713 Bradesco Expresso outlets – in supermarkets, drug stores and other types of store – and 47,542 ATM machines.

The Bradesco share (BBDC4) has outperformed those of Brazil’s largest banks and risen by around 12.8% since the start of the year – adjusted for dividends delivered. This compares with a fall of 0.9% by the BM&FBovespa index.

Efficiency is the keyword at Bradesco. Its 12-month efficiency ratio dropped to 42.1% in the third quarter this year. One of the reasons for this is that Bradesco has been planning for the day when interest rates in Brazil would lower and the bank would face more pressure on its spreads. That time has come. Over the years, it has invested hugely in new technology. It had a total of 28 projects in place under its IT programme. All but one – an upgrade to the bank’s systems – have now been completed and the last project will be finished next year. The projects aim to improve the efficiency ratio and keep costs down, so that the bank can retain its profitability. Brazilian banks have made very big strides in recent years by making greater use of IT. They have invested considerable sums in client-facing technology, and are now investing a great deal in their back offices. “That is the main reason in which we will see an increase in productivity among banking employees, through the greater application of technology and review processes,” said the executive. The bank’s return on equity (RoE) has reduced over the past few years, and next year it expects this to come to between 18% and 20%. The reduction was mainly due to the drop in interest rates and the tighter spreads the bank has faced. Executive director Moacir Nachbar says that by improving the efficiency ratio, the bank will maintain a good level of ROAE. He highlights the opportunities from the low rate of access to the banking system in Brazil.

“We have seen a drop in the delinquency ratio and that has pleased banking analysts,” said Nachbar. “Bradesco also has a very disciplined and consistent strategy based on the domestic market. The bank is participating in cities and municipalities throughout Brazil. “It believes in Brazil and feels there is a huge opportunity to expand its business. It is striking the right balance between the banking and the insurance sides of the business. Currently, the challenge is to improve the efficiency ratio and expanding volumes.”

Growth with sustainability

Sustainability is another important area. Bradesco is a member of the Dow Jones Sustainability World Index and, for the seventh straight year, its shares have been included in BM&FBovespa’s Corporate Sustainability Index. The bank set up the Bradesco Foundation in 1956, with the purpose of providing education and helping to professionalize children, teenagers and adults. It has 40 schools in 26 states and the federal district, and more than 111,000 students. For Bradesco, there are three aspects to sustainability: sustainable finances, responsible management and social and environmental investments. The bank tries to educate the public about finance, about how to take out loans responsibly and about how to mitigate risk. Bradesco has also set up an internal process that ensures that loans are not granted to companies that have a negative impact upon the environment. The bank has also adopted internal controls that help to ensure that it itself abides by high standards of sustainability.

“Bradesco is very much focused on the domestic market, where it feels the biggest opportunities lie,” he said. “Over time, we expect this to be reflected in our financial results.” Bradesco also owns one of the biggest insurers and private pension plan providers in Brazil. The insurance arm contributes around 30% of the results and is a very important business for the bank. Nachbar realizes there are huge opportunities for the insurance market to grow. “Brazil has the world’s sixth-biggest economy, but in terms of total written insurance premiums, it is ranked 14th in the world, according to Swiss Re,” he added. The proportion of written premiums against GDP stands at only 3.2% in Brazil against 8.1% in the US, 11.8% in the UK and 9.5% in France. Only 10% of homes and 30% of cars are insured in Brazil. Only 8% of the population has private dental insurance. The socio-economic middleincome group C has grown enormously in size to 57.4% of the population today from 38.8% in January 2004.

Market Relations Department Institutional Service: (55 11) 2178-4406 Individual Service: (55 11) 2178-6217 Email: [email protected]

2012 Guide to Brazil • Bradesco powers ahead

Efficiency is keyword for Bradesco

5

Locals tighten their grip Banking continues to have a strong local flavour, with Brazilian players pushing the big international investment banks down the rankings

In 2012 Brazilian banks continued to drive home their dominance of the local investment banking market. The top three or four banks are Brazilian, depending on your view of Credit Suisse, whose presence in Brazil is based on the acquisition of Garantia in 1998. This acquisition continues to give the Swiss bank’s operation a uniquely local flavour among the international banks (unique since UBS sold BTG Pactual back to Andre Esteves). Even if Credit Suisse is classified as an international bank, next year the top three could be bone fide Brazilians: Bradesco BBI increased its market share by 1.9 percentage points while Credit Suisse dropped by 3.2 percentage points to 10.2%. With a gap of just 1.6 percentage points between these two, they will trade positions next year on current form (although it should be noted that Credit Suisse claims its fees are significantly higher than it is awarded by data provider Dealogic, arguing that its strength in M&A – where it is ranked number one but fees are often opaque – under-estimates its actual revenues).

Meanwhile, Citi’s resurgence in Brazil continues, bringing it back into the top 10 with nearly 5% of the fee pool. Goldman slides to ninth but with a stable share of fees and HSBC again rounds out the top 10.

New entrants

If the domestic competition is not already tough enough for the international banks there are also a couple of new entrants that may at some point present a challenge. Plural Capital, a financial advisory firm led by former BTG partners Rodolfo Riechart and Andre Schwarz, has succeeded in obtaining a banking licence and aims to begin competing on M&A and equity capital market advisory. Plural has also bought Brazilian brokerage firm Geração Futuro. Meanwhile, BR Partners, led by founding partner Ricardo Lacerda, plans to add an equity research division in a bid to become an active participant in the local ECM market. The firm is recruiting equity analysts and expects to build an in-house team over the next couple of months, with a medium-term target of coverage of between 80 and 100 Brazilian companies.

“As interest rates fall, the banks should be able to increase the tenor of credit products and the penetration of mortgage finance – which at just 5% of GDP is one of the lowest in Latin America – providing big opportunities” BTG retains the top spot, ahead of its close local rival Itaú BBA. In 2011 only 0.7 percentage points separated these two but, with only about six weeks to go until the end of the year, Itaú trails Andre Esteves’s bank by 10.1 percentage points – a gap that is too large to be associated with BTG Pactual’s large IPO. As for the internationals, Bank of America Merrill Lynch has enjoyed a good year, jumping three places to number five. Banco do Brasil secured enough bookrunning credit from clients on its huge balance sheet to gain sixth position but its credentials as a serious contender are well behind those of the two leading local investment banks. Interestingly, Bradesco BBI is coming under fire from bankers at local and international competitors alike for winning its business through its wholesale banking relationships. However, the same charge used to be levelled at Itaú BBA and it is certainly possible that Bradesco BBI will continue to improve its reputation and credibility as it adds to its deal tally.

Lacerda told Euromoney that he expects there to be a role for smaller banks in ECM transactions in the coming years, despite the fierce competition for ECM mandates from the large Brazilian banks. Many of the international investment banks also continue to invest in their Brazilian equities capabilities. Lacerda says that he doesn’t expect the bank to achieve a hit rate comparable to the leading local banks but does foresee it having an important role as a niche player. He argues that the decision to bring research in-house is a display of the firm’s commitment to growing its ECM business. He is also targeting the second quarter of 2013 for its first ECM deal.

Regional focus

And it gets worse for the internationals, which now have more to worry about from the Brazilian banks than their ability to win business in their home market. This year saw the first meaningful steps in the development of regional networks by Itaú BBA and BTG Pactual. The latter closed its acquisition of Chilean investment bank

Celfin and also announced that it is to buy Colombian brokerdealer Bolsa Y Renta (complete with a nascent investment bank). Persio Arida, partner at BTG Pactual and chairman of the bank’s asset management division, told Euromoney following the Bolsa Y Renta announcement in June that the bank’s next target will be in Mexico City: “Our next country is going to be Mexico,” said Arida. “We are still discussing between ourselves how best to approach the Mexican market – there are a number of alternatives. We might decide shortly... but clearly Mexico is the next target, not necessarily in terms of acquisition but we definitely want to have a presence in Mexico.”

As interest rates fall, the banks should be able to increase the tenor of credit products and the penetration of mortgage finance – which at just 5% of GDP is one of the lowest in Latin America –providing big opportunities. The development of cross-selling of financial products, such as insurance, will also provide financial institutions with opportunities as users of bank debt to migrate up the socioeconomic ladder. The cost of bank and credit card debt is so high - credit card rates can be 200% annually - that attractive clients don’t seek them out. This reinforces the problem of high delinquency rates. Even in 2012, with record low unemployment, the banks faced large and growing proportions of NPLs to individuals.

After Mexico, the bank’s network will be complete, at least in the medium term, with Celfin´s operations also providing significant Peruvian capability. Other countries in Latin America are not being contemplated for now, Arida said.

This is one reason why the private banks argue that they can’t pass on the lower benchmark interest rates to clients. In response, the government has sought to use state banks Caixa Econômica and Banco do Brasil to lower interest rates offered to Brazilians. As yet the private banks have not responded, remembering the experience of the downturn in 2007 and 2008, when the state banks acted as a counter-cyclical provider of credit to the economy. The state banks won market share, only to relax their aggressive lending stance when growth returned, allowing the private banks to win it back.

Meanwhile Itaú BBA has begun operating its greenfield operation in Colombia, its latest regional operation after Chile and Argentina. The bank decided to open its own office in Colombia after analyzing the market and declining to move forward through acquisition. It has capitalized its Colombian subsidiary with R$395 million. The US and European banks may face a headache from these emerging Brazilian investment banks’ regional operations. And it’s not only the Brazilians: in December last year Banco de Crédito del Perú bought 51% of Colombian brokerage firm Correval and in April acquired 60.6% of Chilean investment bank IMTrust to create a panAndean investment bank.

New retail environment

The Brazilian banks’ success in investment banking comes as their retail businesses face a new operating environment. The industry’s net interest margins (NIMs) have fallen and, with rising nonperforming loans (NPLs), the sector is facing pressures on its balance sheet. The large retail banks have the scale and the management teams in place to suggest that their current focus on improving efficiency and capitalizing on cross-selling opportunities will lead to return on equity (ROE), now under pressure, returning to an average of around 20%.

However, Brazil’s smaller banks are also facing a lapse in investor confidence following recent bank failures, such as that of Banco Cruzeiro do Sul, which has provided extra liquidity challenges at a time when they were already struggling with the cost of funding, greater supervision and competition from the larger banks.

Private banking

Private Banking continues to grow for domestic and international banks alike – at least in terms of revenue. Margins continue to be squeezed as greater competition reduces profitability, especially in the ultra-high-net-worth category. Most banks report growth in assets under management of 15% or above in 2012, but with profits flat. However, the market may be set to pick up as the lower interest rate environment forces clients to seek yield in corporate credit, structured credit, equities, private equity and multimercados. The switch away from what has been almost commoditized investment strategies will lead to greater emphasis on portfolio performance, but will enable banks to charge performance fees.

Brazil Core IB (M&A ECM DCM) Rankings

Rank 1 2 3 4 5 6 7 8 9 10

Bank BTG Pactual Itau BBA Credit Suisse Bradesco BBI Bank of America Merrill Lynch Banco do Brasil SA Citi JPMorgan Goldman Sachs HSBC

Source: Dealogic

2011 Net Revenue ($m) 130 66 65 54 36 31 30 29 29 23

%share 20.5 10.4 10.2 8.6 5.7 4.9 4.7 4.6 4.6 3.7

Rank 1 2 3 4 5 6 7 8 9 10

Bank Itau BBA BTG Pactual Credit Suisse JPMorgan Bradesco BBI Deutsche Bank Goldman Sachs Bank of America Merrill Lynch Santander HSBC

Net Revenue ($m) 142 137 114 64 57 40 37 33 28 23

%share 16.7 16.0 13.4 7.5 6.7 4.7 4.4 3.9 3.3 2.7


2012 YTD

7

Record DCM enjoys near-perfect conditions

It’s been a banner year for Brazil’s debt capital markets, with record levels of issuance and strong demand, and prospects for 2013 are good

Fixed income enjoyed a record year in 2012. International investors had huge levels of liquidity and, with bonds from developed market issuers offering lower yields than those from emerging markets such as Brazil, the demand for Latin American bonds was unprecedented. Countries like Brazil also enjoy relatively positive credit fundamentals and outlook when compared to developed markets. These factors combined to create the ideal environment for debt capital markets. In 2012, as of mid-November, Brazilian-based issuers had printed 65 dollar-denominated deals worth a total of $50.5 billion. In 2007 the volume was just $7.7 billion from 29 deals. In 2010 and 2011, both bumper years for DCM bankers themselves, the fullyear volumes reached $39.5 billion and $38.5 billion respectively. This year, and throughout the year, banks repeatedly reported huge oversubscriptions; prices tightened nearly every time deals closed, and deal sizes were often revised upwards. In 2010, the previous record year for DCM issuance, the average deal size was $556 million. In 2012 the average is $776 million, and yet yields continue to tighten. In November, Cielo, a Brazilian card-payment processor, created a new record low yield for a Brazilian corporate issuer of 10-year debt. The $875 million transaction was rated BBB+/Baa2 and priced at 99.316 with a 3.75% coupon to yield 3.833% or US Treasuries plus 225% basis points. Leandro Miranda, managing director and head of fixed income for Bradesco BBI, which led Cielo’s transaction along with Banco do Brasil and Goldman Sachs, predicts that this pricing record will be beaten in the near future as demand by far outstrips supply. “Price is going to go much closer to the US, that´s our view,” Miranda told Euromoney soon after Cielo closed its deal. “Emerging market accounts and US investors are willing to diversify their portfolios into bonds from different regions, and especially the BRICs. The amount that these investors are willing to invest is far higher than the [volume] of securities that is being offered and the competition will drive yields down.” Despite this record demand for Brazilian credits, risk aversion remains a theme, with non-dollar denominated deals from investment grade issuers falling slightly to $6.6 billion equivalent from six deals, down from last year’s record of $7.2 billion equivalent from 10 deals. High yield volumes also fell, down to $7.2 billion from 17 deals in 2012 (year to date) when compared with 2010’s high water mark of $11.5 billion from 34 deals.

League tables

JPMorgan entered the final month and a half of the year ranked first in international DCM underwriting, up from third place in 2011. The US bank had claimed 10.6% of total issuance, up from 8.6% in all of 2011. HBSC and Itaú BBA remained at second and fourth place in the table respectively, with Citi jumping to third place from sixth last year, claiming 9.2% of business, up from 6.6% a year ago. Banco do Brasil is the other bank with momentum in the international DCM league tables, jumping from ninth place and 5.5% of market share last year to sixth and 9.2% of market share in 2012. In spite of the huge level of capital raised by Brazilian issuers in the international markets, domestic issuance also remained high. As the year draws to a close, the figures suggest that 2012 will be close to, or a little higher than, 2011’s record of $13.7 billion equivalent from 78 deals, with $12.6 billion equivalent from 53 deals raised with half of the fourth quarter remaining. Unsurprisingly, the local banks dominated deal activity, with Itaú BBA heading the league table with 28.6% of the share of issuance by volume, followed by Bradesco BBI (16.1%). BTG Pactual switches places with Banco do Brasil to come in third with 14.5% of deal volumes. Banco do Brasil led on deals worth 13.4% of the total. JPMorgan, which has committed balance sheet and has been hiring to compete with the locals in selected areas of the domestic debt capital markets, made it into the top 10 for the first time in 2012, underwriting three deals worth 1.7% of total volume. Local issuance remains healthy because not all companies in Brazil can access the international markets. Even for those that can, despite rates being at historically low levels, the all-in cost of funding, when adding in the cost of swapping funds into local currency (for those issuers with real-denominated costs and revenues) makes the local markets more competitive. Therefore, the bulk of international capital market issuers tend to be companies with dollar exposures or that need longer tenors of debt than are available in the domestic market. Bankers report, though, that some companies are considering entering the international markets, despite the marginally higher cost, to broaden their investor base and begin the process of engagement with and education of international investors. Local debt capital markets have been boosted in recent years with the

introduction of Regulation 476, introduced in 2009 to speed up access. Documentation is simpler and quicker for deals that satisfy certain criteria – the most important being that a deal is marketed to fewer than 50 investors and sold to fewer than 20. It has proved popular with issuers and banks either retain the debt on their balance sheet or conduct highly targeted transactions such as that of Telefónica, which was sold to a single investor. However, while leading to more volume the regulation has weakened transparency and looks likely to frustrate efforts to create a liquid secondary market for bonds. One senior DCM banker in Brazil says he believes the CVM should look again at Regulation 476 because it was preventing the homogeneity of local bonds that would encourage secondary trading. However, Alexei Remizov, managing director, debt capital markets in Brazil at HSBC Securities, believes the failure of the secondary market to develop “is more related to the buy-and-hold profile of the largest local investors that together manage over 85% of assets under management. They tend to absorb most of deals. Rule 476 tends to have a limited impact on the secondary market. We find Rule 400 [the pre-existing and more laborious securities law] to have a greater impact than Rule 476. Local secondary trading activity also continues to be extremely affected by the way that investors are allocated in Brazil in the primary market in both Rule 476 and Rule 400 deals. In Brazil, all investors are allocated based on a Dutch auction where the lowest pricing not secondary liquidity is the priority for the issuers.” Some believe the positives of 476 outweigh the negatives. Says André Silva, co-head of capital markets and treasury solutions for Latin America at Deutsche Bank: “Although indeed Rule 476 has had a negative impact on secondary trading, it has created an easier and faster process for companies willing to access the domestic debt capital market. It is particularly beneficial for first-time issuers that are still not fully prepared to bear the costs and regulatory requirements of a public placed instrument.” He also forecasts strong growth to come: “The Brazilian domestic debt capital market is still highly underdeveloped when compared to other mature economies. This fact, combined with record low interest rates in Brazil, should allow the domestic market to develop at a fast pace. Companies will continue to take advantage

of lower borrowing costs while diversifying away from bank loans and investors are forced to look for higher yielding paper compared to Brazilian federal government securities.”

To 2013 and beyond

While the equity capital markets continue to splutter the outlook for future debt capital markets issuance from Brazilian companies – both internationally and domestically – is good. Domestically, capacity constraints of public bank financing alone should drive capital market fundraising – especially for large infrastructure and capex projects, while many companies will continue to replace bank loans by debentures. Tax incentives should further stimulate issuance of long-term debentures to finance investment. Meanwhile, given Brazil’s relatively low savings rate, international investors will be required to finance the gap between savings and investment. So long as yields from Brazil remain attractive compared to other jurisdictions, attracting these investors should be easy. Bankers expect a strong year in 2013 and, depending on market volatility from events elsewhere, high yield issuers could emerge as a theme, along with ‘international BRL’ transactions and structures such as inflation-linked bonds and perpetuals. “Absent generalized global risk aversion, high yield will be one of the main themes for 2013 as high-grade issuers continue to offer increasingly tighter returns in both local and international markets over time. Given uncertainty in the inflation trajectory, inflation-linked issues are likely to continue to be in high demand by investors,” says Katia Bouazza, co-head, debt capital markets for the Americas at HSBC Securities. Deutsche Bank’s Silva agrees: “We expect frequent issuers to continue active in the market with similar levels of those observed in 2012. Additionally, we believe that high yield and first-time issuers will continue to tap the international markets to take advantage of historical low yields as well as a strategy to diversify funding sources. We could see the return of local currency offshore issuances, although this market is still not expected to be available at all times and to all credit ratings. The swing between fixed rate and inflation-linked interest from investors will depend on the macroeconomic scenario and the expectation for FX, interest rate and inflation.”

Brazil International DCM Rankings

Rank 1 2 3 4 5 6 7 8 9 10

Bookrunner JPMorgan HSBC Citi Itau BBA Banco do Brasil SA Deutsche Bank Santander Bank of America Merrill Lynch BTG Pactual Bradesco BBI

Source: Dealogic

2011 Deal Value $m 5,049 4,712 4,389 4,332 4,320 3,358 3,198 2,785 2,341 2,089

No. 17 23 15 20 19 15 12 16 13 12

%share 10.6 9.9 9.2 9.1 9.1 7.1 6.7 5.9 4.9 4.4

Rank 1 2 3 4 5 6 7 8 9 10

Bookrunner Santander HSBC JPMorgan Itau BBA Bank of America Merrill Lynch Citi Deutsche Bank Bradesco BBI Banco do Brasil SA Credit Suisse

Deal Value $m 5,261 4,037 3,290 3,042 2,641 2,528 2,224 2,150 2,116 1,838

No. 14 17 12 13 14 8 12 13 12 6

%share 13.7 10.5 8.6 7.9 6.9 6.6 5.8 5.6 5.5 4.8


2012 YTD

9

ECM: banks hold their breath The weak recent performance of Brazilian equities is not entirely down to struggling commodity stocks When it comes to the development of Brazil’s equity capital markets, it seems the difference between theory and practice is time. Brazil’s falling interest rates mean that both institutional and private banking investors no longer receive high returns from portfolios of virtually risk-free investments. Investment theory would dictate that, as well as leading to investors taking exposure to greater risk through corporate credit, to achieve spreads for greater returns, this would persuade investors to allocate more of their portfolios to equities. Yet the Bovespa is down by over 5% in the past 12 months, while Mexico’s IPC is up over 11% and the S&P500 up almost 10%.

of the valuations of deals that are brought to them. One leading investor says that he automatically discounts a deal’s valuation. However, this year’s remaining offering shows that investors will still pay for strong, well-managed deals. BTG Pactual’s IPO was sandwiched between those for Locamerica and Unicasa. It was large and liquid, and offered access to a unique business with a strong management team and a demonstrable track record. The deal’s execution also emphasized deal performance over maximizing value by choosing a price of R$31.25, right in the middle of its range of R$28.75-33.75, despite having sufficient demand to price at the top, which pleased investors.

Part of this poor performance can be attributed to the make-up of the index. It is heavily weighted to commodity-based stocks, which have fared badly as the global economy continues to stall. Many equity funds, based on stock-picking strategies, have fared better and made positive returns by focusing on consumer-orientated stocks in sectors such as healthcare, education and retail.

Local domination

Poor showing on IPOs

This doesn’t fully explain why the primary issuance market has performed so badly. As 2012 draws to a close, there have only been three IPOs from Brazil this year – fewer than in Mexico. For a country that typically dominates the region’s new equity trades this is a poor showing. Of those three deals, two failed to price in their ranges despite being retail-orientated companies. Car rental company Locamerica’s weak performance – it priced a small $167 million deal at R$9 a share, below its range of R$11 to R$14 – was widely expected. “All it brought [to the market] was a discounted valuation,” said one banker at the time, noting a discount of more than 50% compared with the strong market leader Localiza. There had been higher expectations for a successful deal from Unicasa. The furniture maker had a good track record, strong growth prospects and no direct competitors within the broader retail segment. Its bookrunners – BTG Pactual, Itaú BBA and Santander – had also been heard talking up a strong order book in the days before the issue, but it too priced well below its range of R$16.50-20.50, at R$14. “Brazil equities have fallen out of favour for many reasons, but key among them are slowing domestic growth, concerns about government involvement in corporate governance and poor execution of prior offerings,” says Jeffrey Rosichan, vice chairman in equity capital markets for Deutsche Bank. The last point is particularly problematic, with investors sceptical

The thin volumes make drawing conclusions from the league tables problematic. However, the domination of the locals looks like an established theme. Low volumes, with secondary equities trading also well down this year, raise questions about the viability of the banks’ equities teams. Each bank expects the others to start rationalizing their equity teams, but as yet there have been no significant withdrawals. If anything, more are arriving: start-up boutiques such as BR Partners and Plural Investimentos plan to enter the equity bookrunning fray and Deutsche Bank plans an aggressive business development campaign in Latin American equities. Whether there will be casualties in the next 12 months depends largely on the speed of the recovery of the markets. On a positive note, the fall in the Bovespa makes the country’s equities look relatively cheap compared to other Latin American markets; many believe it is close to the bottom, which should encourage investment next year. Domestic demand for fresh equity issuance, which is already typically more than 50% of a Brazilian deal’s demand, could continue to grow, especially if interest rates remain low and spur portfolio diversification into the asset class. One senior Brazil-based equity banker believes that the Bovespa could quickly double as portfolios that are heavily biased to fixed income investments add equities, creating a positive growth story that attracts more investors to the Bovespa as its valuation improves. Bankers also report issuers are considering approaching the market. However, for the past several years local bankers have overestimated the performance of the market and the number of equity transactions for the following year. But one projection that must come true is that there will be more IPOs in 2013 than in 2012.

Brazil ECM Rankings

2012 YTD Rank 1 2 3 4 5 6 7 8 9 10

Bookrunner BTG Pactual Banco do Brasil SA Goldman Sachs Bradesco BBI Itau BBA Bank of America Merrill Lynch JPMorgan Citi Santander Credit Suisse

Source: Dealogic

2011 Deal Value $m 1,083 631 564 542 455 431 380 347 298 137

No. 12 5 3 4 7 5 2 2 3 2

%share 21.9 12.8 11.4 11.0 9.2 8.7 7.7 7.0 6.0 2.8

Rank 1 2 3 4 5 6 7 8 9 10

Bookrunner Itau BBA BTG Pactual Bradesco BBI Credit Suisse Santander Bank of America Merrill Lynch Goldman Sachs Morgan Stanley Banco do Brasil SA JPMorgan

Deal Value $m 2,814 1,964 1,644 1,334 708 629 596 420 229 220

No. 22 13 10 13 8 4 5 4 2 3

%share 25.2 17.6 14.7 11.9 6.3 5.6 5.3 3.8 2.1 2.0

M&A resilience shows Brazil’s continued attraction International investors still want to buy into Brazil M&A volumes have fallen in Brazil in 2012 but they haven’t collapsed to the same extent as equity capital markets. In fact, according to a recent Thomson report, the number of deals increased in the first three quarters of the year when compared to 2011, by 38 to almost 600. However, the volume of deals fell by 10% to $54 billion, the lowest level since 2007. M&A fell around the world in 2012, of course, as the global economic uncertainty - largely driven by Europe, but aided and abetted by questions over China and the US - persisted. In Brazil the sector had some unique issues. Greater government intervention in the regulation of some sectors, such as the electricity industry, as well as what was perceived to be intervention in the management of industrial flagship companies Vale and Petrobras, increased the perception of political risk, although it is hard to quantify this impact. Another Brazil-specific factor, the introduction of a new anti-trust regulation and governance body, had a more immediate and transparent effect. The Conselho Administrativo de Defesa Economica (Cade) came into force at the end of May. During the preceding three months, according to Dealogic, 428 deals were announced but in the three months after Cade began operating only 190 deals were announced. Some of the discrepancy can be attributed to a rush of deals being announced before the new regime began, to avoid expected delays and confusion under the new body. Cade requires companies with operations in Brazil to seek regulatory approval for deals when one Brazilian organization has revenues of more than R$400 million and the other more than $30 million. Previously, deals could close and become subject to regulatory clearance in special circumstances. However, as 2012 ends the new regulator is drawing strong praise from lawyers and bankers and any fears of reduced M&A on the grounds of regulatory risk appear to have faded. Instead, the banks continue to do deals. Credit Suisse has enjoyed a resurgence in large M&A mandates in 2012. The bank’s new Brazilian

CEO, Jose Olympio Pereira, told Euromoney that the bank has been successful in contrasting its lack of private equity funds with that of other leading banks in the country, notably the local banks (BTG Pactual has long held widespread private equity interests and Itaú has recently launch a new PE fund called Kinea) and JPMorgan, with its acquisition of Gavea. Olympio said the potential for conflict of interest in leading on M&As and running PE was, along with its established network, a key reason in its recent success in winning mandates. However, JPMorgan’s links with Gavea didn’t seem to harm its ability to report a strong year in 2012, rising to fourth place compared to sixth last year. The bank’s ties to sovereign wealth funds and global private equity funds helped secure some mandates for large deals as it is a strong league table performance this year. The bank is now close, in terms of deal volume, to the two Brazilian firms, BTG Pactual and Itaú, which with Credit Suisse round out the top three. The other major local investment bank, Bradesco BBI, hasn’t capitalized on its recent momentum. In 2011 it came eighth in the table after jumping 12 positions from 20th in 2010. However, the sheer size of the bank’s corporate network may enable it to challenge for a top five position in the near future. One of Credit Suisse’s recent deals, which helped it secure an impressive 40.8% share of deal volume, was advising AMIL on its $5 billion sale to United Healthcare. The deal was big, believed to be the largest cross-border acquisition of a Brazilian company by a US company and shows the strong attraction that the country still holds for companies in developed markets looking for growth opportunities. “[United Healthcare] paid more than a 50% premium if you consider where AMIL was trading on the Bovespa, so it shows that people are willing to pay to enter Brazil,” says Fábio Mourão, head for M&A in Brazil for Credit Suisse. “United had to justify the price to its board and shareholders - as well as analysts – and they were all very happy. I think you are going to see the same in other sectors. Everything that is lacking in the rest of the world [in terms of growth opportunities] is in Brazil.” He adds that the deal proves that acquirers are looking beyond the recent low GDP growth rates and taking a 10-year perspective.

Brazil M&A Rankings

Rank 1 2 3 4 5 6 7 8 9 10

Adviser Credit Suisse Itau BBA BTG Pactual JPMorgan Bank of America Merrill Lynch Citi Rothschild Bradesco BBI Goldman Sachs Morgan Stanley

Source: Dealogic

2011 Deal Value $m 30,627 25,596 24,590 20,817 18,138 17,013 16,410 15,676 12,943 9,100

No. 37 41 62 14 14 6 13 21 11 8

%share 40.8 34.1 32.8 27.7 24.2 22.7 21.9 20.9 17.2 12.1

Rank 1 2 3 4 5 6 7 8 9 10

Adviser BTG Pactual Itau BBA Goldman Sachs Bank of America Merrill Lynch Citi JPMorgan Credit Suisse Bradesco BBI Santander Rothschild

Deal Value $m 25,550 21,780 17,036 15,636 14,864 14,747 14,028 12,224 12,001 10,486

No. 51 42 19 15 10 17 29 23 7 15

%share 28.1 23.9 18.7 17.2 16.3 16.2 15.4 13.4 13.2 11.5


2012 YTD

11

2012: The corporate financiers’ perspective Corporates in Brazil faced unprecedented access to low-cost financing in the capital markets. But with banks facing regulatory pressures on providing capital to clients, how did Brazilian companies change financing strategy and were they able easily to access new pockets of liquidity? Lucas Cive Barbosa, treasurer and head of investor relations at Construtora Noberto Odebrecht, and Alexandre Toledo, treasury manager at Cosan, give their impressions of a rapidly changing corporate finance market Participants

Lucas Cive Barbosa (LCB) is treasurer and head of investor relations at Construtora Noberto Odebrecht. Construtora Noberto Odebrecht is the engineering and construction arm of the Odebrecht Group and the largest such company in Latin America.

Alexandre Toledo (AT) is treasury manager at Cosan. Cosan’s origins and growth came from consolidating the Brazilian sugar-ethanol industry, but it has since grown and diversified its business into other areas linked to Brazil’s development, such as infrastructure and energy.

Euromoney: From your company’s viewpoint, was there any change in the availability or cost of corporate financing tools when comparing 2012 with 2011?

In the domestic market the banks’ liquidity combined with low interest rates allowed corporates to access the local bond market (debentures) at a very competitive price level with a longer duration than before.

Lucas Cive Barbosa (LCB): Yes. In a world of low yields, we saw this year a bigger appetite from investors to buy emerging market bonds looking for better returns. Regarding that point, the international debt capital markets became more competitive in terms of price/ tenor and attracted a lot of new names. On the other hand, bank loans and other kinds of credit facilities from financial institutions continued to show weakness due to the problems that are still present in the sector.

Euromoney: If your company accessed the international debt capital markets please explain briefly your decision in regard to timing and purpose of funds? And how did your pre-deal expectations meet with reality in regard to demand and pricing? Are current yields on offer to Brazilian companies sustainable?

Alexandre Toledo (AT): In the international market we observed banks’ credit departments being more restrictive towards funding non-residents, thus lending reached higher prices for corporates. On the other hand, during first-half 2012, debt capital markets were extremely bullish, allowing high yield corporates to print bonds at a very attractive price. In the second half, we observed a more restrictive approach from investors leaving windows mainly to investment grade papers.

LCB: The year 2012, markedly its second half, has been good for those companies able to access the international debt capital markets, especially companies that are investment grade. The market really rallied since the beginning of this year but volatility also demands a swifter decision-making process for those companies interested in accessing its resources. The yields offered to Brazilian companies these days show the improvement in their credit quality in the past couple of years as well as the growing stability of the Brazilian economy as a whole. However, this trend can only be considered to be sustainable if we assume that Brazil and its companies will keep improving their credit qualities and provided no new international crisis arises.

AT: We did not access the international debt capital markets, although we have followed the markets closely since we printed a perp re-tap last year. Current yields offered to Brazilian companies are sustainable until international investors fulfill their needs to spice up their portfolios with a good combination of risk and return. We normally observe investment cycles and its funding impacts on the international market in order to forsee windows of opportunity. Euromoney: Are the local debt capital markets becoming more competitive in terms of pricing and tenor to other sources of capital? AT: Without a doubt. The current level of interest rates combined with recent changes in central bank policies and international environment led the local market to be more active and corporates pushed banks to a new level of pricing and tenors. LCB: Yes. Among all the changes Brazil faced in recent years, the reduction of interest rates in the LTM and the new local infrastructure debentures rule would create a good environment in the short term to establish the local debt capital market as a permanent and competitive source of capital for companies and projects. Euromoney: Is developing secondary trading of local debt capital markets important to you from a corporate finance perspective? Do you think Rule 476 makes secondary liquidity less likely while making primary issuance easier?

and therefore a lower interest rate environment is likely to remain. Based on this assumption we will design funding and investment strategies accordingly. Markets shall maintain their independence from the political scenario. LCB: The low interest rate environment in Brazil is sustainable to the extent that the international rates environment sustains its current low levels. CNO is a price-sensitive company with respect to fund raising and so we’ll analyze very carefully each opportunity and always take into account the local and international environment. Euromoney: Have you worked with new banks this year? If so, in what areas? AT: Yes. As the group expands its business we try to diversify as much as possible the pool of banks in the relationship and we are always trying to get the best of each one. This year we included a new bank relationship in order to accommodate the offshore loan and international cash management. LCB: Yes. For credit facilities we have seen some Japanese and Canadian banks take the places that some European and American banks left behind after the crisis. Euromoney: Is who provides treasury solutions/cash management services a factor in deciding capital market mandates?

“The yields offered to Brazilian companies these days show the improvement in their credit quality in the past couple of years as well as the growing stability of the Brazilian economy as a whole”

AT: Secondary trading of local DCM is important from a corporate finance perspective in order to benchmark peers and to quantify the cost of funding of corporates, not to mention the easier refinancing or buying back of the papers. Rule 476, due its regulatory background, does not boost the secondary market. On the other hand, with the majority of its issuance being on proprietary desks the funds industry will be the one that benefits most out of it. Euromoney: Do you think the new lower interest rate environment in Brazil will be sustained and, if so, how will this change your mediumterm approach to corporate finance? AT: We are prone to assume this is a part of the government’s strategy

LCB: Not necessarily. We always look to the skills and capabilities of each bank to give a market mandate. AT: I agree: not necessarily. More and more we tend to view banks as ‘niche’ seekers in order to deliver a better service and price level. The concept of one-stop shop within this global scenario is neither sustainable nor desirable. Each bank has its sweet spot and we will focus on that. Euromoney: Looking forward to 2013 – what changes in the availability/cost of these products do you expect? What products do you think will be more important to you in the future and why? LCB: I believe that the nominal cost of funds may stabilize or improve in the next year while we face a situation of low interest rates in the international market. One important product for companies to maintain their liquidity and deal with the market volatility will be revolving credit facilities. AT: Products within local markets will definitely play a key role. We expect to have a friendlier regulatory environment in order to make the international capital markets financially viable to the Brazilian corporate. The ‘all-in’ cost of an international bond is not competitive with the local cost, even when taking advantage of the foreign exchange arbitrage.


LCB: Yes. The local secondary market development is one of the most important issues for the establishment of a strong local DCM, which will increase companies’ sources of funding. One of the biggest problems of the local market, besides price, tenor and bureaucracy, is also the number of investors, and I believe that, provided we see new rules that facilitate the entrance of new players in this market, it will become more and more liquid. Regarding the Rule 476 issue, it is certainly a controversial topic, since it provides less bureaucracy for the issuers but at the same time plays against the secondary market liquidity, due to the obligation that these debentures can only be purchased in the primary offer by qualified investors.

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Private sector seeks profitable role in infrastructure finance Brazil has huge needs for infrastructure investment but getting the private sector involved is going to be a long haul

There are five things everyone in Brazil agrees about when it comes to infrastructure. First, there is an urgent and great need to invest. Second, state development bank BNDES can’t fund all the country’s needs but, third, it will remain the dominant source of finance – in 2011 the bank backed R$56 billion worth of infrastructure projects, up 7% from the year before. Fourth, the private sector needs to find ways to participate more actively in this area and, fifth, this private sector development won’t be achieved quickly or easily.

the commercial banks to finance infrastructure projects,” says Ana Maria Vidaurre, principal investment officer of the Inter-American Development Bank’s infrastructure division. “Between October 2011 and March 2012 bank financing was down by 40%, largely led by the withdrawal of the European banks because of their requirements to deleverage. That has led the ECAs [export credit agencies] to try to raise the tenors of their finance and provide structures that mitigate the construction risk to increase investor participation.”

The private sector is not alone in pinning its hopes on the development of the infrastructure or ‘capex’ bond. Introduced by the Brazilian government in September 2011, Lei 12431 allows the issue of infrastructure-related corporate bonds that are income tax exempt for domestic and international investors and IOF (financial operations tax) exempt for foreign investors. To qualify for tax-exempt status, the bonds

Offsetting the risk

Investors in the debt capital markets traditionally don’t like to take on construction risk of projects. The IADB and some specialized private sector organizations aim to provide capital market investors with the guarantees for this part of the project and thereby facilitate the use of debentures for infrastructure finance. Mauricio Gutiérrez De Gregori, managing director of

“We had a challenge: how to make institutional investors take complex project risks. So we worked with credit enhancement. We sourced financial guarantors to increase the credit rating” must be related to an infrastructure project and have a tenor of at least four years. The president of BNDES, Luciano Coutinho, has gone on record to say he hopes R$45 billion to R$50 billion of these bonds will be issued in the coming years to take the burden of finance provision from the state bank. But, even though the first Lei 12431 approved transactions emerged at the end of 2012, the market is a long way from issuing regular and large volumes. And with uncertainty about whether these bonds can be denominated in US dollars, their suitability for international investors – which certainly have the liquidity to have an effect on Brazilian infrastructure finance – is not yet clear. Adding to the imperative to grow this asset class is the impact that the European solvency crisis and Basle III regulations are having on traditional bank finance. “In Latin America there is less appetite from

project finance at Chilean firm Celfin Capital (which was bought by Brazilian investment bank BTG Pactual this year), says the Chilean experience can be used to encourage private sector participation. “In Chile the capital markets became involved in projects years ago in response to PPP [public-private partnership] requests from the government. The projects, which were mainly toll roads, were large in scale, especially when compared to the size of the Chilean banks. The country needed to raise $8 billion, which had to be in local currency because the toll road revenues were denominated in Chilean pesos. We had a challenge: how to make institutional investors take complex project risks. So we worked with credit enhancement. We sourced financial guarantors to increase the credit rating.” With the financial guarantees in place the rating agencies felt more comfortable. For example, a toll road project linking Santiago to the coast, incorporating construction risk, was backed by the IADB and therefore achieved a AAA local rating. Investors might not understand construction

risk but they understand AAA ratings and the project bond closed on a $500 million equivalent financing with a 23-year tenor. The construction phase completed on time and the guarantors didn’t need to pay, and so this type of credit enhancement could be employed in Brazil. “I hope something similar will happen in Brazil – enhancement is the bridge to help local investors feel comfortable in taking the risks,” says Gutiérrez. “Long-term interest rates are lowering in the country and that is opening the space for project bonds to take a role alongside BNDES.” Brazil’s benchmark interest rate, the Selic, has fallen from 12.5% in the middle of 2011 to an historic low of 7.25% at the end of 2012. This is raising hopes that long-term financing will become more attractive to sponsors of infrastructure projects – as well as driving up the potential demand for long-term infrastructure bonds. The real interest rate is now around 3% in Brazil and institutional investors and private banking clients alike are beginning to accept that they will have to add risk to their fixed income portfolios if they are to maintain targeted returns. This is all great in theory, but the BNDES interest rate – the TJLP – is just 5.5% and many private sector financiers say that,

Other bankers say they believe there will be a market outside Brazil for real-denominated bonds that go up to 10 years – or maybe even 12. But beyond those tenors the derivatives that would be needed to swap the position into US dollars are illiquid and prohibitively expensive. Sergio Monaro, head of project finance in Brazil for HSBC, believes that there is another underlying obstacle to the development of private sector confidence in infrastructure projects. “The government always wants the lowest tariffs. If the government wants to fund the market that’s great but if you have a regulatory system that always has the lowest tariffs – and Brazil’s tariffs are low even when compared to similar projects in other parts of Latin America – it is important to note the challenge for institutional investors [to get involved].” However, Paul Kriss, infrastructure sector leader at the World Bank, says that the government’s regime of low tariff-based projects doesn’t necessarily prevent private sector involvement. “Governments can subsidize tariffs in private sector projects – this has been done in China,” he says. “But if governments do go down that route they need to provide sponsors with the comfort that the state will subsidize the project to a level for the lifetime of a project, to enable the sponsor to

“The natural market should be the local, Brazilian market. It is more of a natural hedge, given the currency match and local inflation rates”

“The expectation is that it will take at least two to three years for the private sector to begin to be involved [in a meaningful way],” says Diego Barreto, head of corporate finance and investor relations at OAS. “Infrastructure bonds are not going to replace BNDES and Caixa Economica [another state bank that provides infrastructure finance] and the currency issues will delay the participation of foreign investors in the sector.” Some believe the appeal for foreign investors is a myth: the currency risk and the lack of experience in participating and understanding long-term project finance risk in Brazil may limit their interest. A wellknown sponsor, such as Vale or Odebrecht, could issue a bond and attract sufficient demand but ultimately that wouldn’t be very different from an unsecured bond deal, and wouldn’t necessarily lead to new international financing for other projects and sponsors, which is what is needed.

Looking to the locals

“The natural market should be the local, Brazilian market,” says Celfin’s Gutiérrez. “It is more of a natural hedge, given the currency match and local inflation rates. And local institutions that have been very conservative have been buying federal paper with tenors of up to 40 years in local currency. So local investors are going longer term and I think that the elements are falling into place to be able issue local paper that has a spread [over government debentures] and that will reduce the need to go to international investors with real-denominated paper.”

have confidence that the project will generate a decent internal rate of return. In my view, if the Brazilian government is able to stabilize FX and inflation, it will provide the financial climate that will encourage the international banks to get involved.” Bankers predict there will also still be a role for pure bank debt. “Basle III will give banks less competitiveness than the capital markets but we won’t be competing with the capital markets,” says Alberto Zoffman, global head of project finance at Itaú BBA. “We will take part in the most risky part of the project. We have a very strong project finance team and we think long term.” Duncan Caird, HSBC’s head of project and export finance for the Americas, agrees: “Banks will still offer shorter tenors, whereas before loans were for 25 or 30 years they will now be for six to 12 years. This does expose sponsors to refinancing risk but the key message is that banks will continue to find solutions that incorporate bank debt with capital markets products.” That blend of private sector finance will enable banks to take on complex risks at certain stages in a project lifecycle – most notably the construction phase, and then bring in capital market investors to cover the financing for projects that suit the risk profile (ie, lower risk, lower returns) of those investors. It’s the reason why Morgan Stanley announced it was teaming up its capital markets capabilities with Bank of Tokyo Mitsubishi, which is an expert in bank debt financing of projects. So in the years to come, bank debt, capital markets and BNDES should blend better together to offer greater depth to infrastructure finance in Brazil. This will be welcomed by everyone, given the huge pipeline of projects that is waiting.


while the subsidized rate is available and while the BNDES cherrypicks the projects it backs, it is preventing the growth of private sector involvement.

15