Brazil Roundtable 2009: part two
IFR: I’d like to ask Fabio: you mentioned before that 128% of CDI was too little. And even though we are talking about the global bond market, I’d like to know what is too rich for you.
Fabio Moser: I did not say that. I said there were deals and that they got done. Some even enjoyed good demand and were oversubscribed. It is clear that you are going to demand a higher rate from companies with a lower rating. I believe that at the beginning of this year it is going to be important for companies to get back to economic values because there is uncertainty among certain companies about how they will perform.
There are a number of unknowns. We have just gone through a first phase focused on the question of derivatives, the question about what is on the balance sheet and the impact on the financial result, and just how much is the global crisis impacting the company’s result and how it is going to deal exactly with the leverage it has, or rather, what are its cashflow needs.
Now in terms of rates, you adjust along the way. For example, top quality banks are now issuing CDB and subordinated paper at 120% of CDI, with tenors of up to six years. You will probably end up asking more from a private-sector issuer. We tend to look at these parameters and select along the way, since you do not have the money to invest in everything, and you end up selecting the best paper.
So there is much competition between companies – between companies’ debentures, between the sectors and the companies’ capacity to implement their business plans, and the evaluation you have – the risk.
IFR: Why are Brazilian investors no longer buying local corporate paper at a time when companies are paying more than ever, at DI plus 5%? Why are they holding back when real money overseas has started increasing exposure again and under what conditions will the locals return again in full force? Has the market reached a turning point following a collapse in primary market liquidity in 2008?
Fabio Moser: First of all, I think we investors, at least we at PREVI, have not stopped buying. It goes back to the same point. I was talking to the people at the Treasury, saying that at the end of the year we even bought Brazilian treasury notes yielding 17%, and inflation plus 12%. And, I believe for the first time, it was not the Treasury directly paying this yield. Who was paying this was people who needed liquidity. So, truly, competition at the end of the year was very fierce.
If you have Brazil’s Treasury notes in the secondary market that you can buy at this yield, how much does a company have to pay you so you buy it instead of treasury notes? First-rank banks were paying 106% [of CDI], 105%, with daily liquidity. The competition became very fierce for corporates.
I think now, with the interest rate curve tightening, the market is a bit more stable. I think things are starting to get back into place a bit more. I think there is room for companies to start seeking something. I think the end of year was really a time when the companies that needed funding and were tapping the market, were really going to the short-term, very short-term market. They have to wait for the dust to settle so they can really start managing their capital needs versus what the market offers.
I would say that it was more the issue of competition, and not of you seeking, as was mentioned here, a level of DI plus 5%.
We at pension funds have little experience of looking at foreign issues because pension funds in Brazil have restrictions on foreign investments today save a few companies.
IFR: Local rates are tightening at the moment, do you think a fund like PREVI could change its strategy in terms of buying private-sector paper this year?
Fabio Moser: I believe so. We have some limits as we already mentioned, but there is space for private-sector paper and I think they will start to test the equity market at some point. I think some companies at some point will have to go after this market. I think the window is going to start to open.
IFR: Should Brazil issue local paper via Euroclear? Would this not open the door to a real liquid local sovereign and corporate issuance debt market and resolve Brazil’s liquidity challenges on its external Real-denominated curve at the same time – a move that would create a surge in local and international investor liquidity too?
Paulo Valle: This is an issue that is always present in our strategy and, like every decision, it has pros and cons. Five years ago, when we decided to create a programme called “Best” with the private sector, we thought about what would be better: should we open the market to Euroclear to increase demand, or invest and try to attract foreign investor money into the local market?
Despite the issue always being controversial, my personal vision is that the result was positive these last five years. We exempted foreign investors from a withholding tax in the local market, we worked to reduce red tape for the private and public sectors, and the majority of foreign investors looking to invest locally ended up migrating onshore.
The proof is that we were able to create a real-denominated curve in the external market and the other in the local in half the time, and there is currently little liquidity in the external market because most of it migrated to the domestic market.
This is something we constantly keep an eye on at the Treasury, always predicting the pros and cons. Our objective is to never have a protectionist view of the market, but for now our view is that the strategy has been successful and that there is no reason to change it at this moment.
Regarding the pros and cons, there was a debate. It was quite interesting as the World Bank was behind it, involving Mexico, Brazil, South Africa and Turkey.
Mexico and South Africa ended up defending Euroclear more, while Brazil and Turkey less. There are still some concerns. One of the issues that came up is the question about losing some control of your market.
A big issue is knowing your investor. There are two models. One involves having a centralisation of custody and knowing the holder, the end investor, and then you have the model where you only get to know the custodian and it is the custodian who knows who the investors are. In a period where there is a fight against money laundering, there is a trend of obliging custodians to get to know the end holder.
Here in Brazil, we have both models. And in this debate, what won the day was the move toward more detail and better knowledge of the end holder. It is a constant debate and we always have to look at the pros and cons before making any necessary alternations.
IFR: Could Brazil’s companies contribute to this debate? For example, many companies want to issue in Reais but there is no market abroad, there is no liquidity. If there were a Euroclear platform in place, could that not perhaps help the local private-sector market?
Paulo Valle: Today, the consensus is focused on making the system of investing domestically perfect. This is more important than simply creating a Euroclear platform here. Now this debate constantly goes on with the private sector. Today, this is the view. And how much demand would Euroclear add? It seems it is not that relevant. I would even like to hear the opinion of others on this.
Alexei Remizov: I think one thing to look at is probably the Mexico experience. Even though many Mexican corporate issuers are using the Euroclear system, I think Mexican local issuers – Katia, correct me if I’m wrong – are mainly distributed to locals, right? In Mexican Pesos? But of course, if you target external investors, then you do an external bond in dollars…
Katia Bouazza: We have done Europesos, but only in very selective instances, and with very selective names. The Luxembourg listing and the Euroclearance is necessary to comply with local approvals – local pension funds can buy it as a public registered deal – and it works better for foreign investors.
Two elements are important when investors are considering this product. One is that they are very comfortable with the credit, so they are focusing on the market technicalities, not focusing on whether this is a credit that will improve or deteriorate. So it has to have very solid grading, a very solid name.
And two, for international investors it has to be a view that they are taking on the currency, in the case of Mexico, the Peso - at the time when we did the Europesos, their view was that the Peso was strengthening, so maybe this would be another opportunity in the future once the Peso stabilises.
Local investors are focused mainly on the name and credit without the currency and curve technicalities. So again, for the international investors it’s a different perspective. In Mexico, more than Brazil, you have quite active pension funds and insurance companies, not only banks underwriting and holding a large portion of the paper, as tends to be more the case in debentures.
IFR: Are local banks asking for too much in terms of fees, spreads, provisions and first rights of refusal on takeouts, and how long will it last?
Denise Pavarina: I do not think so. I think that Fabio said something that I am going pick up. First: the Brazilian market makes very big movements. Either it goes too much to one side, or it goes too much to the other. And the wisdom lies in the balance. And I think we are once again moving toward the balance.
There was a time when the spreads were completely wrong, completely out – so much so that investors, when we visited them, would get furious with us. They would tell us that we were taking securities with very low spreads to them and they did not even want to talk to us. “If you bring me this paper, I will not even look at it, I will not even talk to you.”
And now we are in another situation with spreads having widened and, obviously, there is embedded risk. It is a matter of liquidity, of opportunity. So the price is very much according to the moment in the market. Nobody will practice anything that is not mutually agreed upon.
I think we can charge a little bit more, maybe because of the market, the liquidity situation, the fact that the number of banks that can provide liquidity is smaller. The number of investors is smaller, much smaller.
Today a company that needs to borrow at a longer tenor only has the banks to turn to. There are no investors today, with enough volume, to supply all of the demand.
I think it is the current market scenario that is, let’s say, creating this situation and that it will be adjusted over time.
And about the rights of first refusal in take-outs, as was mentioned in the other question, I think it is more of the contrary. What is happening is that companies want to do shorter paper to have the possibility to see how the market behaves in the short term.
Out of the companies that did it, there are several who will have to refinance now. But it was the company’s choice not to peg a very high spread to a long tenor. So now they ask us to refinance, to do the placement to see how the market is in that new moment, in a year, in six months.
So, in the end, it is an agreement. It is not so much the banks that are imposing it. It is an agreement that is good for both parties to have a new discussion a year from now.
Alexandre Aoude: Just to add a point – so that another Brazilian bank can make a suggestion – I think there are operations in which you have to offer a backstop guarantee. They are credit operations. So, when you question a bank if it is charging too much or not, I think we have to actually assess if this is a credit operation. Locally, they entail a backstop guarantee.
As the credit curves around the world dislocate, it is more than reasonable the banks charge for these dislocations here as well.
And second, I agree with Denise. I think today any debt placement undergoes a much tougher process than what it did one year ago. I think you have to talk to investors, you have to do distinctive issues, you have to add value to the deals. And it is part, actually, of a bank’s activity to know how to have some predictability on what is going to happen to a company when it provides a backstop guarantee, or not. It is underwriting an issuance. It is actually putting its name beside that deal.
Tying other mandates or stuff like that is part of banking. So I think – this thing of “banks are charging too much or not” – I think that if there is no price there is no deal.
I think Bonesio would not have done his deal if he thought it was costing him too much. And it is the same for Stefan, and everybody else here at the table. There is no such thing. The market always closes on the point where there is a deal. So, standing with Denise here in solidarity, I think it is very important to understand the dynamics of the market and would not just look at pricing purely.
Pedro Bonesio: I am going to say, and just to be consistent with what I say to all of the banks when we hold a preliminary meeting, that everything is really quite expensive. But in the end, I think that the prices being offered are what both sides are prepared to accept as fair. It is only a problem if the company is in a situation where it has no margin to negotiate anything, then it is different.
Alexandre Aoude: In that case the transaction would be horrible.
Pedro Bonesio: Yes it would be horrible.
Denise Pavarina: But then the embedded risk would suggest a higher price or non-negotiation.
IFR: Today I have already heard the retail market mentioned twice. I would like to know what is the current role of retail investors in local deals. Has it grown significantly? Has that also become one of the factors in the choice of leads – if the bank has a significant private account network, meaning issuers can rely on the retail accounts as well, not only on institutional investors?
Denise Pavarina: I would say this: we have some experience with retail accounts in deals including Petrobras, BNDESpar and more recently Bradespar, which was a deal that generated the comment that the book was 10 times oversubscribed on the debenture side and three times on the commercial paper side.
I would say we have started to notice that private banking is much more active than in the past. Before, it was very hard for you to sell volume to them. They would participate, but very modestly. Nowadays, the stock market is much harder to predict and much more complex and we have noticed a much larger demand from private accounts for fixed income securities.
It is still small if your goal is to create enough volume for a company to close a book. But I think it is gaining more relative importance every day.
I think the Bradespar operation was very interesting because it attracted the attention of a lot of people exactly because it generated a demand of 10 times book. So a lot of people who had never talked to us ended up seeking us out to understand how the operation happened. There are others in the pipeline that we know of. Alexandre knows too. And there are others to be talked about and many companies are going to use the private accounts avenue.
However, for volume it is still not something a company can count on as a solution. It will always be a component – every day it will become more relevant – but it is a gradual growth process. We have always talked about liquidity in the secondary market and I have always said this and continue to believe in it: the liquidity will come from the retail investors.
So, yes I think so, slowly they are becoming more important despite representing a small movement today.
Alexandre Aoude: I agree in every sense. I think the retail issue is far from the biggest factor. I think that first we are going to go through the privates and then we are going to get to retail. But I think that is a natural trend.
The movement of cash that ended up exiting diversified mutual funds (in Brazil) is going to end up in fixed-income.
But I also agree with Fabio about the competitiveness of other issuers. As rates fall, as they will, there will be a natural growing demand for this. And forward rates are signalling that they are going to drop, at least the curve is. What I imagine is that you are going to continue to see, as time goes by, a migration to corporate securities until it gets to retail. But I believe the retail end will be the last one to get on board this process. Private accounts are already showing demand. We believe this is already an important sign of this migration.
I think it is just a matter of time and opportunity. The return on money today if a guy keeps his savings in a bank will drop because interest rates are going to fall significantly.
Stefan Alexander: You are touching on a point that is of crucial importance to us as all of our communication and market transparency strategy is directed to the debt market.
When we think of issuing, besides thinking about how we can reduce volatility for the company, we look at what is the correct tenor and structure and from there we assess the conservative strategy. We also look at the quality of investors at hand. And when we say quality, I am even analysing if it is a private account or a retail investor or even a fund. And when I do this I am looking at what kind of market we are tapping, the regions and the characteristics. We believe this is a strategy that bears fruit in the long-term if you build a relationship with the investor base in the long-term.
Also, sometimes the absolute cost makes little difference on the issuance date. You may lose a little bit initially but you win on the deal in the long-term and start to develop this market. You effectively gain access in the long-term.
I think the first change involved a move from short-term investors and volatility players to longer-term real-money investors that now invest and look at the region. Five or 10 years ago, we would not have dared to talk so such investors. Now they have become common and frequent investors that visit the region and get in touch with us.
Fabio Moser: Underlining what was said, I believe that the key for this market is liquidity, and that is possible via a secondary market. When you look at a security, you usually look at carrying it until maturity because you know it does not have liquidity. So, when you are talking about longer tenors and talk about the retail investor market, the Treasury Direct only started to penetrate this market when it created the liquidity rule, or rather, the Treasury itself said it would offer liquidity. In other words, the person buys and knows that every Wednesday he can go there and sell and there will be somebody to buy it. If you don’t have a corporate securities market that provides this exit, that allows this secondary, this liquidity, this is not going to happen.
And right now, at the end of last year, we had the experience of seeing funds and companies seeking to sell corporate paper to us because they could not find a market for it. It is almost an over-the-counter market. Today, if you want to sell, you have to look for someone and offer a very attractive price. Therefore, I think that as long as it is this way it will keep retail investors away.
Maria Isabel Rezende Aboim: Everybody here knows BNDES did three local deals. These debenture deals did not make sense for us at the time in terms of funding costs or in terms of volume. They were not deals seeking volume, they were deals aimed at bringing a bit of the international experience to the local market and trying to help develop it.
We had to interrupt this process in the second half of last year because of market conditions. A [fourth] deal was suspended and we are waiting to see if it makes sense to return – this is our idea.
But just to give you an idea of what it meant in terms of small successes, the deal incorporated the arbitrage clause. In the secondary market, it is a debenture that makes up 80% of the trading sessions of the Bovespa Fix [fixed income platform of the local stock exchange]. It also has a marketmaker.
In terms of the primary placement, what we did, as the saying goes, was to leave money on the table. The first deal was priced very tight to the benchmark Brazilian treasury notes.
There is a clear benchmark in the market, the treasury notes. It is all about not straying too far from them. And in the first deal we strayed a little bit further than was necessary. But why did we do that? Because that way we increased substantially the number of retail investors. Instead of paying 20bp over treasury notes, we came with something like 30bp. This way we attracted a lot more investors.
In the second deal, the same kind of note was priced at 18bp over. So that was irrelevant. The most important thing was to attract more partners. Retail investors came in, despite the weird name of “debenture”. As that – what is his name? – reporter from [Brazilian news radio station] CBN, said: “this weird name that nobody knows what it means”.
It was a huge publicity effort, even explaining what a debenture was was hard, because none of the retail investors knew it. But it was not only retail investors that were important. The important thing was that even on the qualified investor side, we got about thirty. Then we were already talking about another issue. But it was not only on the retail side that you have to broaden the number of investors. Even on the institutional side, there was a sales effort. So, there has to be more of a sales effort.
We roadshowed even in Minas Gerais. There has to be something outside the Rio-Sao Paulo axis. There has to be more of a sales effort. There has to be more of an effort on secondary market support, which comes in the form of marketmakers. There has to be something that allows for daily trading of the securities.
These were three deals, three small deals that alone do not change anything. But now there is a model that is on the shelf. We invested a lot of effort with our agents. It worked very well. There is a shelf security.
Now, however, the market is really very difficult. The fourth deal is waiting. I do not think it makes sense for us to force the hand right now. We are waiting. I believe this year, maybe with a bit more stability, it is possible we will have a positive horizon.
Now, that’s it. The product exists and it is a product that I think is much more satisfactory. I think everybody who acquired the debentures has a good feeling about them. In the beginning there were a lot of doubts. There was a lot of scepticism around them. But I think later it became known that it was a good product. But that alone does not change anything.
Denise Pavarina: But I think the BNDES securities were crucial. Today, when we go out to sell a deal in the network – and we sell to 3,000 branches, to all the service points – we do not have to explain what a debenture is. We simply have to say what is the rate and the tenor. We overcame a key hurdle, which involved educating our branch managers on what is a debenture, a credit security, and that it competes with the bank’s CDs.
So we also had to create internal mechanisms to stimulate our salespeople to sell these securities. Today it is common knowledge, the mechanisms have been created, the securities are known and now everybody is going to benefit from the effort that BNDESpar and BNDES made to develop the retail market.
Click here for Part three of the Roundtable.