Monday, 17 December 2018

Brazil Roundtable 2007: Part 2

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IFR: We didn’t include the CVM for the reason that the whole roundtable risked being solely focused on complaints about the regulator. But we will get them in next time.

Gerald Massenet (Calyon): Regarding the debentures market, there is one important problem: new projects arising from infrastructure. For example, you cannot fund tollroad projects in dollars. It is complicated and not just because of the FX risk, there is also the problem of duration. You cannot finance such a transaction within seven years. Longer tenors of 12 to 15 years are necessary.

Now, there are going to be projects that need long-term financing and Brazil is going to have to come up with a solution.

I expect corporates to make the most of this in the local market as infrastructure projects develop. If you look at the other markets within LatAm, for example Peru, you can issue long-term local bonds of 20 years or more. But this is because they had a number of motorway privatisations. They found a solution when there was no market. This is going to be a big challenge for the CVM to find a solution and create an environment for longer term financing. Again a seven-year is much better than what was possible three or four years ago when companies tried to finance infrastructure projects.

Moura: This is already happening in CCBs with tenors of 12 or 15 years.

IFR: This question is to Paulo Valle. We already have various sovereigns across LatAm that are able to tap locally at the 30-year point. When do you think Brazil will manage to extend to 30-years on its fixed-rate curve?

Valle: We have had an annual financing plan in place for the last seven years and year after year our focus has been on creating a curve and today we are doing this with fixed-rate assets, but very gradually so as to make sure there is enough liquidity.

Our focus is not simply about creating various points on the curve but it is about creating liquidity. That is what we are talking about. This year became the first year that we managed to place 10-year fixed-rate paper.

Our objective is to get R$11bn–R$12bn in volume on the 2017 point and we are working to build up liquidity on this point.

We understand that on the local curve we already have a well defined point extending up to 2045. There is already significant volume. You can get daily prices from ANDIMA [the National Associations Of Financial Market Institutions] and there is a secondary market almost every day.

We are busy creating a fixed-rate curve right up to the 10-year point but only plan to extend when it is well consolidated. Overseas, we have already extended our local currency curve to 2028 and plan to do our first 30-year depending on market conditions.

Our big concern is that we are always asked about what will be the timing – but this will only happen if the market allows it to happen. There is a big focus about consolidating the market by increasing and bringing more investors to this Real-denominated market before taking the next step.

Coming to market when it is not robust could hurt the first issuers with their first transactions. The idea has always been to move very gradually to create attractive benchmarks and turn them into real benchmarks.

If you ask when, we do not have a specific date. It all depends on the market so that we can move in a robust manner. But once you create that point you are committed toward reopening it as many times as deemed necessary – until there is a sufficiently large volume to create a liquid secondary market.

IFR: And a 30-year in Reais? Not this year right?

Valle: It depends on market conditions. In three months just about everything has happened. At this moment, we, as an issuer are in waiting mode. We are in a comfortable position regarding our funding needs and we are able to wait until the volatility has passed. Since we have no committed funding deadlines for this year and also for next year, there is no point in adding new supply during shaky market conditions.

Our main goal is not to mess up the good things we have already done. For example the BRL 2028, which has US$2bn outstanding, might have felt the pressure but I am sure it will recover at some point and when it is strong again, there is the possibility of accessing the market again, but we are definitely not in a hurry.

IFR: This is a question for all, but specifically for the deputy secretary first, you have a dual role in this country of developing a curve for the companies and creating points of reference and comparables used by companies to raise money and price their transactions. I wanted to know in your view why companies have not done more to issue in local currency overseas? I also wanted to ask this of the issuers here. You talked about a natural hedge but this is an opportunity that a lot of companies have not even started to take.

Peebles: It isn’t because of a lack of will.

Valle: I take the following view. There are already companies overseas tapping in BRL. And that this is part of a process that began in 2005. The first sovereign issue in BRL was the 2016. Until that point, the idea of a 10-year was something quite new. Today, we have a curve extending across 10, 15 and 20 years. And we already see local companies raising money at the 10-year point. Our view on the overseas market today is that we see the national treasury more as a fomenter of markets. Today we see our external curve as a creation of a well-defined curve serving as a point of reference for companies.

Morais: The banks have already issued quite a lot in Reais overseas. The old chestnut is liquidity, principally in the local market. The external market too and this market specifically suffers from this liquidity issue. Investors want papers with a decent size in order to be able to have liquidity.

Neto: Recently, SG acquired Cacique bank in Brazil and the idea was to finance the acquisition with an offshore Real transaction by SG Paris. Unfortunately some international banks entered this market – I believe they did it without too much care – and ended up distorting the curve. They came with a really attractive rate of return despite having good ratings and credit quality better than those in Brazil. I believe they did a disservice to this market because the rating no longer became the reference for risk.

Peebles: I think it’s the following:

I think the local currency eurobond market is here to stay, not just in Brazil; in Mexico it’s routine to issue in pesos in the eurobond market. You see it in other Latin American countries; you see it in Europe. It’s a feature that’s here to stay. It’s the credit risk itself you’re looking at as well as the FX risk. So the complexity of the analysis for these bonds is greater. There also aren’t many investors in the market who are prepared to analyse and assume both risks. They’re not prepared to deal with the complexity. Other investors love that – “you know what, I love this, I get that extra risk, I understand the risks, I can hedge myself” – but I believe not all investors want this. When you take out a significant part of the investor base, which is what you do with these more complex issues, you can leave yourself with a smaller group, and so the volumes that can be issued are smaller, and the pricing less tight.

There’s a market out there probably, as I see it, but, with the pricing as it is today, most issuers will just say, “I think I’ll wait”. That’s my own view. I think the local currency eurobond market will come back. It’s a question of where we are in the recovery from the recent volatility. It is going to come back; maybe not this year, but we’ll see more of this stuff come back.

Berlfein: The idea of interest rates falling and expectations that the Real would keep appreciating was a key component for an investor when deciding to take on BRL bonds risk or not. Such Sovereign BRL paper was too attractive for the investor to just let it pass. But since the sovereign came to market, the yield tightened dramatically against local rates. This created an opportunity for foreign banks with strong ratings to raise money in BRL and swap it via a competitive financing plan as part of the bank’s funding base. The BRL issue after the swap turned to be an attractive funding for the foreign banks. As a result the aggressive levels of the BRL curve distorted the yield-rating relationship. But investors bought it as funds looked to the play on interest rates and play on FX and looked to capturing the gains.

Fadigas: I believe it is for this reason that the natural stop for Brazilian corporate issuance is the local market. But we always skid on that same question of liquidity. When issuing locally in Reais, you have to compete because when you look at the volume of national savings you will see it is channeled into the Republic. Such competition makes it very difficult to issue. In this case when someone is a buyer of sovereign paper it invariably means fund managers do not have to do any credit work because they are comfortable with what they just about consider to be risk free. The Republic is the reference for any issue done in Reais.

So when you come to the local market, you are rubbing up against a big neighbour who commands the money in that market. This leads to a number of inefficiencies that we have already discussed such as liquidity, a collection of fragmented indexations while CCBs are taking a bite at the volumes.

When we talk about the various reference indices, issuers carry the risk of a pricing mismatch with the issue. When we talk about CDI, you have a mismatch with inflation, or vice-versa, and when you are indexed to rates, nothing may happen to inflation if the rates go up, and when you go overseas you have all sorts of inefficiencies that we have already mentioned.

So it is amazing to see in other local markets where issuers are able to raise long-term money. Brazil has a bigger GDP and its capital markets are theoretically better developed and yet we do not have a mechanism for long-term financing. I hope that demand can create pressure for such a change alongside those who organise this market, but I expect this to come more from the financial institutions than the issuers, perhaps CVRD should have asked for a market maker when it issued a debenture last year, but it is difficult for an issuer to engage in such an implicit cost in its transaction.

Moura: We are CVRD’s market maker, just to let you know. We are, but nobody wants to sell. As I said, it is a buy-to-hold market.

Neto: It is also difficult to put the onus on the issuer to develop the local market. Issuers hope that the pressure stemming from the need to improve the market and its deficiencies, which are being addressed by ANBID, will prompt bodies representing the capital markets to organise it a bit better at the same time as the state gradually reduces its debt.

We also have this issue of duration. I find seven years to be a reasonable period of time but on the international market there has been relatively little issuance on the 30-year point of the curve. Locally, the seven-year point remains limited. You cannot use a seven-year to pay down a long-term infrastructure project.

Achoa: I believe this is going to be a process that happens naturally when interest rates start to fall. From that point, investors are going to come to you. The same thing happened with perpetual bonds. Do you remember the story? While US interest rates are high, investors show little interest in perpetuals. But when rates drop, that spread is going to look fat and investors will want in. Something along these lines will happen.

IFR: Are you saying this would be the key reason behind the change? At least structurally here in Brazil when it comes to issuing locally whether it be ABS or debenture or can more be done to bring about this change? Perhaps ANBID should be more aggressive?

Achoa: Yes, but you have to adjust for the key issues. When I am dealing with the local market, I see its intricacies in the same way as Denise. I believe that the issue of falling interest rates will force people to think “And now? How am I going to make money?” The investors sit down, look at the risk-free sovereign bond and are going to have to think about margin – though I am not saying that the government is wrong, the government is all about placing benchmarks. But interest rates are still high.

Jana: Indeed, spreads in Brazil – when compared to those trading overseas – are very high.

Achoa: If the domestic issuer were to pay the spread that a comparable overseas issuer of the same rating paid, the resulting yield in Reais would be prohibitive. So the issuer would never issue something domestically until the rates go down.

Neto: What we can see is that the rating system here is not a very good reference. Many times you will see that the pricing of a deal is the same as the firm guarantee offered by the bank coordinating the transaction. It does not reflect the market. To compete, banks sometimes concede on the return and end up deciding to offer a really low spread. This was clear before the crisis. You look at July issuance, principally real estate, and you can see real competition.

I believe that another problem that we have – I spent two years at Moody’s – is that the ratings agencies are not prepared to give the correct rating to our issuers because their methodology uses a global standard that penalises small companies. You can see that one of those who rate the CCB market is Austin. Why does Austin dominate this market?

Its methodology reflects the local reality. At Moody’s, I can say that I worked on developing several types of methodologies and if the issuer is small then it will get a bad rating.

I accompanied your ratings at Moody’s and can say that your ratings are wrong. If you had another post code your ratings would be different. Why?

When the committee was discussing Cosan with the people in Europe and US, the only comparable to Cosan was a company in France. There is no other company if you take the French one out of the equation.

The rating of Cosan should really be A. You know what your rating is. It is the same thing for Braskem. I believe that the agencies should be questioned in Brazil because their methodology is lacking.

Take J. Macedo. It is very much a cyclical business with an A– rating. Then you go to Eletropaulo which is a stable business with a concession to distribute electricity. Its rating is A. You cannot compare the two businesses. And yet it gets worse when you look at the pricing. You cannot say that an A rated issuer pays so much and A+ rated issuer pays so much. Indeed, you see this increasingly with the banks. Mid-sized banks are going to have a serious problem because everybody has a Triple A rating from Moody’s. Just look at the distortion.

Our A rated entities are a new thing, our pension funds are a new thing, and until recently investors had an excellent safe-haven for investing – the government. And it was not until a few years ago when they finally started to analyse private-sector paper. Many are still not yet prepared to analyse such paper.

Take ABS. When SG came to Brazil it looked at the ABS market and said: “The FIDC pricing is all wrong. How can ABS, which is backed by receivables, pay less than senior securities?” Here it is the opposite. Debentures are cheaper than FIDCs. Plus FIDCs are an expensive structure.

These are distortions that the local market has created. I believe the government should create a level-playing field when it comes to infrastructure projects. It should eliminate the withholding tax on foreign investors. Then we are going to see what would be the impact; then we will be able to discuss and see what is possible. Those investors who buy long-term in Mexico are not Mexican. It is the foreign investor.

Peebles: But it is the BNDES that took the first step toward funding infrastructure projects.

Neto: The good news is that the BNDES is not going to support all of the infrastructure projects by itself. That would create a log jam. The move is going to force the market to develop.

Peebles: We should invite the BNDES next time.

IFR: Yes we would have liked to have them here. Perhaps next time. But going back to Antonio, should the issuers demand more from their ratings agencies or is it up to the sovereign to do the work and carry the corporate sector with it?

Neto: I have the following to say: I have sat on more than 50 Moody’s committees. Very few issuers that were rated came and said the rating was wrong. Very few said: “This rating is wrong, let me see your methodology.” A recent case that I saw was that of Braskem. Braskem said, “let me see your methodology”. The staff at Braskem had put together their own expected rating and they got the methodology and used it to arrive at a rating. That was how they did it. Now, a good thing is that the agencies have to publish their methodology to show how they arrive at a rating.

For Braskem, it went and got the Moody’s model and point by point arrived at the rating. Braskem already knew what its rating should be. So Braskem basically worked toward defending itself before the ratings agency’s committee. When it comes to the committee, you can appeal its decision as many times as you would want. In Cosan’s case it was the same thing. These are companies that are in the market with a clearer idea of what the business should be.

What I have seen overseas is that the banks have rating advisors. Here it is just the rating. The rating advisor overseas is an expensive business and it is used with the best issuers.

Jana: You have a rating differential. Here you do not have a differentiated price in function of the rating.

Moura: We have a far graver situation here. We only have buyers for ratings of A– or higher. What we don’t have are buyers of paper with a different class of risk. People have to educate themselves about credits carrying risk lower than A–. If you do, then you will create a culture or price versus risk. But it does not exist. I buy and carry it because I like it. If I do not like it, I do not buy it. There is no price for that.


Click here for Part three of the Roundtable.

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