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Tuesday, 17 October 2017

Ballooning optimism

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  • Ballooning optimism

Brazil’s domestic bond market has surged this year as issuers take advantage of low yields and the market is expected to receive a significant boost as Brazilian companies issue infrastructure debentures that are highly attractive to foreign investors.

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For the year to September 10, total domestic debt issuance out of Latin America stood at US$15.9bn against US$24.1bn for the whole of last year and US$33.8bn in 2010, according to Thomson Reuters data. Brazil accounted for 56% of the issuance this year against only 18% last year; Mexico is making up 30% of the issuance this year against 68% last year.

For the year to September 10, total international issuance out of Latin America amounted to US$67bn against US$92.1bn for the whole of last year. Brazil is making up 44% of international issuance this year against 39% last year.

Brazilian issuers have been making the most of the low yields and investors have been more attracted to the domestic DCM because of the record low interest rates in Brazil, which the Central Bank reduced to 7.5% in August. In particular, Brazilian pension funds have actuarial targets to meet and this is leading them en masse to consider investing in corporate bonds.

At the end of last year, the government dropped the IOF tax, a tax on financial transactions, for so-called infrastructure debentures, bonds which back major infrastructural projects. The new instrument was targeted at domestic and foreign investors.

However, the failure in May of Rodovias, a toll road operator, to sell a debut, R$650m issue of the debenture because of concerns about its tax-exempt status left the market much more cautious about the new asset class. Since then, the authorities have amended the rules governing the instrument that now enable the borrower to use proceeds to refinance debt incurred during the construction phase of the projects.

Bankers now expect other toll road operators, including CCR’s AutoBan and Rodovia Raposo Tavares, to issue the new type of paper at the end of this year or at the start of next, attracting many domestic and foreign investors.

Growing appetite

“The local bond market has been very active this year and for many issuers represents the most efficient source of long-term financing,” said Eduardo Muller Borges, credit markets director at Santander Brazil. “The growing appetite of institutional investors combined with pressure over banks’ funding cost has given rise to an unprecedented disintermediation process, which tends to broaden over time in terms of issuer profile, both industry and credit risk wise.”

Gustavo Bellon, senior vice-president in DCM at Itau BBA, said: “The Brazilian domestic debt market has been very strong this year. It’s been an interesting and stable source of funds for domestic issuers and a lot less volatile than the international markets.

“International investors are more likely to close the window to new issuances of emerging markets companies depending on general market sentiment and economic news worldwide, whereas domestic investors are less affected by international events and more driven by the issuer’s fundamentals.”

Bankers say that the local bond market has been strictly high grade this year. However, following the easing of monetary cycle and the continuing pressure over both public and private debt yields, the surge of a high-yield market may be around the corner.

Companies rated at least A– on the domestic rating scale from various industrial sectors have issued in the local markets, although utilities (energy generation and transmission, telecoms), metals and mining, and retail have been the most important.

From a pure price perspective, bankers say it is becoming more attractive for Brazilian companies to issue in the local markets than in the international ones, because the swaps from the US dollar into the Brazilian reais have become more expensive in a lower Selic rate environment. However, the international markets still offer longer terms and more secondary liquidity.

“The sweet spot for the local markets are still somewhat concentrated in the five years while the international markets are 10 years,” added Muller Borges.

Five years ago, companies could rarely issue more than five years in the domestic bond market. However, today bankers say that deals with a tenor of up to 12 years are possible, although not yet common.

Companies have been taking advantage of low yields offered in the domestic markets. In August, Braskem, the petrochemical company, priced a five-year R$500m (US$247m) ABS deal after receiving R$1.047bn in demand. The bonds were priced at CDI plus 95bp, 15bp inside the ceiling rate of 1.10% over CDI. Asset managers absorbed most of the deal led by Banco do Brasil, JP Morgan and Santander.

Eletropaulo, the utility company, plans to issue a R$500m five-year bond in the Brazilian local market after establishing a ceiling rate of CDI plus 1.09%. Pricing on the transaction is expected to take place on or around September 27. Bradesco and Itau are bookrunners.

Many Brazilian companies have postponed IPOs or follow-ons this year and this has led them to seek alternative sources of financing, including in the domestic bond market. During the past three years, the lack of ECM activity has had an effect on the demand side as well, demonstrated by the significant migration from equity funds into fixed income.

One of the biggest issues for the domestic bond market has been a lack of liquidity in the secondary market. The local investor base in highly concentrated, with the 10 largest managers making up about 70% of all assets under management. This has led to a buy-and-hold culture, with investors rarely selling paper that they have bought. When bonds are first issued they are priced under a Dutch auction process, which leaves little room for a secondary market.

“When the new infrastructure debentures under [tax incentive] law 12.431 begin to be effectively structured and distributed, we may see large international investors participating more actively in the Brazilian domestic debt capital markets,” added Bellon. “This could help to create liquidity in the secondary market.”

In Brazil, there are two types of main issuance: firstly, paper linked to the CDI rate, the average of all inter-bank overnight transaction rates in Brazil; and, secondly, inflation-linked bonds. In the country, many banks have struck bilateral financing deals with companies using the CDI issuance. These are more akin to a private placement with just one buyer and some experts say they should be seen more as loans than securities.

“During the past few years, there has been strong growth in the Brazilian domestic bonds market, including an increasingly large volume of inflation-linked bonds, “ said Mario Leao, head of fixed income capital markets in Brazil at Morgan Stanley. “For some investors, these inflation-linked bonds represented an interest rate play and because of the compression of rates, such investors have made money by betting on real rates and locking them up for periods of five to seven years.

“Traditionally, many LPs have preferred CDI-linked issuance because of their experience of hyperinflation in Brazil and the desire to be very footloose. Most of their assets have been invested in government paper. However, in an environment of lower nominal and real interest rates, there is a strong incentive for them to consider corporate-issued bonds, which provide for a potentially interesting yield pick-up when compared to historically low government yields.”

As long as Brazilian interest rates remain low, Brazilian companies will remain attracted to issuing in the country’s domestic bond markets. The yields are appealing and a ready appetite on the part of local investors exists for corporate paper, as they flee sovereign bonds and look for alternative types of investment.

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