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Thursday, 23 November 2017

Brazil Roundtable

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IFR: Brazil's debt market is expected to further open up to foreign investors this year amid hopes the government will remove a number of tax barriers. Where are the opportunities for foreign investors and banks?

Ricardo Moura (Treasury): Unfortunately I don’t think that there is much that I can say on the specifics of the changes. The only thing that I can say is what everyone already knows. There is a serious intention of senior people in the government to increase the participation of foreign investors in the domestic debt market.

Clearly if we reach what we intend, if we increase the liquidity or we increase participation, then there will certainly be more opportunity for both investors and banks.

There may be some shift in business and may be less credit linked notes and more local participation and so on. The net result we expect to be positive in terms of more opportunities. That’s why we are trying to open the market. We’re trying to have more business done, trying to have more liquidity in the Treasury market.

IFR: Do you expect significant changes in the short term? Is it something you can see happening over the next year, or will it take much longer?

Ricardo Moura: The changes are being studied and are being proposed. They are being discussed internally. And I think that, if it happens as the finance area of the government wants, it’s something closer than next year. [It is] something for the real near-term.

Denise Moura (Bradesco): I think the opportunities for foreign investors are clear. We have opened up a lot of new alternatives for them to invest, with higher yields than the very highly rated companies that are always issuing paper outside of Brazil.

For banks, there is an opportunity because we probably will see companies that today have some problems raising money, and different types of risks that are not always welcomed by local investors. Maybe those investors can [help create a] culture of high-yield investment. So I think for the companies, it’s very good.

IFR: Are we seeing the same foreign investors that Ricardo, perhaps you talked to, wanting to get involved on the local side as well? Do you see that migration?

Ricardo Moura: I don’t know if there is a bias in the type of people with whom I speak, but . . . everyone is interested in the local market. I don’t remember even one that said that it is not looking to play in the internal market.

Henry Gonzalez (Santander): Brazil pays a thousand basis points over inflation. And the average, probably in Triple A, Double A plus countries is 200bp over inflation. It seems to be the opportunity. It makes no sense. At the end of the day Brazil will pay. And it’s a huge premium, enormous.

Cynthia Powell (JPMorgan): There are two things. Number one, you asked about the investors, are they the same investors. And I think one of the things that we’ve seen happening over the last year – and I’m sure everyone else has seen happening – is that the strategic inflows that are coming into the market are much more heavily focused on local markets now than on external markets.

So those mandates may be going to the same money managers who have been the money managers on the external side for a long time. But a lot of that is new money into Brazil and into the region, so it’s coming from pension funds and Asian investors, the Middle East. It really is net new money into the region, and I think much more than we’ve seen in the past.

I think secondly, the tax changes are one important change, and it’s a huge change, but obviously it’s not the only change we need to fully open up the market.

If you compare Brazil to Mexico, for example, you still have registration requirements; you’re still unable to settle in the currency externally in Euroclear. So those would also be big changes that presumably Brazil will target in the long term. But the lack of some of those other changes may still mean that some foreign investors are unable to access the local market.

Fernando Fontes Iunes (Itau BBA): We have to understand the dynamics of the local market. I think there are some differences here. First of all, I think as you rightly said, the premium that’s paid in Brazil is enormous, particularly if you compare it to international markets. And the gain in the international bond market has been made already with the tightening of spreads. You should expect tightening in Brazil.

But again, the dynamics are very different. As Henry said, I think the local market is in Reais. Brazil will pay those bonds, definitely, because we have a huge industry in Brazil, the asset management industry in Brazil is very large and the banks are also financing this public debt. And it’s local financing so those dynamics, I think, should be understood by international investors.

And the second thing, trading in public debt is liquid , so that clearly is of interest to international investors. And by contrast, the international bond market is fixed rate, in Brazil it is still a floating rate market. So some of the capital gains that some clients are expecting will never occur. Except for inflation-linked bond markets, which are the longer ones, most bonds are CDI-linked [tied to the daily benchmark interbank floating-rate]. In that case you end up gaining from not real capital gains, in the sense that you’ll be playing interest rates and interest rates will probably come down. The swap market is also liquid. But again, the dynamics of the market have to be understood clearly. So I think there’s a number of opportunities for foreign investors who don't actually play the Brazilian market as they do in Mexico.

Coming to private sector bonds, as Denise mentioned, that’s a different dynamic. First of all, there’s no liquidity there. It’s a market that keeps growing, but there’s no liquidity. And premiums are somehow higher than those on public debt, and I think there are very good issuers going to the market, so the credit risks continue to be very good. But there is no liquidity. That’s an issue. So people tend to look more carefully at how they play this market.

Most of the financing that we expect to occur for Brazil to continue growing will come from the private sector. Hopefully the government will take a look and be able also to consider a reduction in tax on private debt.

Cristiane Valle (ABN AMRO): Even though local debt is mostly floating, I think one change that may happen to increase foreign investors going to the local market is buying fixed-rate paper. There’s a lot more appetite from foreign investors to buy fixed-rate paper from Brazil. The government has been doing an excellent job in terms of changing the profile of local debt. If you compare the profile of local debt in 2002 with 2005, the changes are enormous.

In 2002 a big portion of local debt was foreign exchange linked. We had basically zero fixed rate. If you look at 2005 we have almost 30% fixed rate. You have almost nothing foreign exchange linked. And you have inflation linked growing. You have almost 15% – this is growing substantially.

The Brazilian government did an auction yesterday of IPCA [consumer price inflation] notes and the demand was huge. And this is clearly being led by foreign investors.

So foreign investors have the opportunity to participate in the local market, they will clearly bring demand for fixed-rate notes, they will bring demand for inflation-linked bonds. But they will also be able to extend maturities for local debt.

Johannes Van de Ven (Unibanco): The local dynamics are changing for the good of Brazil, and [given] the liquidity in international markets, I think the market is waiting for some changes in legislation in Brazil. The market is ready to take advantage of it.

During company roadshows in the US [we had] questions about local legislation and when [investors] would be able to bring in more money.

If you look at the quality of the investor, for example, [in the] IGP-M [wholesale price inflation] bonds issued by Unibanco, there were some big hedge funds buying. Then we got a lot of private banking retail money coming in. And now we get questions from the big asset managers, the big pension funds.

I think the Asians, the Europeans and the Americans, they are ready to buy into the IPCA, IGP-M, the more fixed-rate domestic debt. The international environment is ready. Brazil should take advantage of it.

IFR: What is their expectation of the timing for those changes?

Van de Ven: I think they are waiting for it to happen as soon as possible. I think the market is already anticipating it. If you look at the local yield curve, it has been anticipating the move any time.

IFR: So it’s a question of weeks?

Van de Ven: A question of weeks.

I’m mean, that’s [according to] the questions we get, and that’s the reports we get, people taking advantage of locking in a high CDI fixed rate. The gap has been closing quickly.

I think the momentum is there in the market to make a move.

Iunes: The government has done an excellent job in carrying out liability management, but with the opportunity that is presented by foreign investors, now that you can start placing fixed-rate bonds in the local markets and increasing the tenors, this is definitely something that the government should benefit from and should take advantage of.

I think that’s a step that we need to take in terms of both liability management and the development of the local markets. To have a yield curve locally. Not rely too much on CDI or any other floating rates.

We do have IGP-M of course, and some ICPA. But I think fixed-rate notes are something that the government should benefit from.

IFR: How are foreign banks positioning themselves for this?

Powell: I think foreign banks have already been bringing investors into the market through structured products. That may not change substantially, to the extent that investors have restrictions on their ability to go in, as long as the registration requirements are there, and the convertibility issues are still there. I think you’ll have greater liquidity overall in the market. And obviously lower yields overall, so that’s to the benefit of Brazilian issuers.

I think it’s going to be a continuation of the strengthening of that. And presumably over time we’ll start to see more issuers in Reais. I think that [Treasury Secretary Joaquim] Levy came out yesterday and said specifically that he didn’t expect to change the taxes for private sector issuers.

Sandy Severino (Citigroup): What’s interesting is, as Cindy said, the foreign banks have been playing in the credit linked notes markets. Citigroup felt that this was a great product a couple of years ago and started coming out with these for Uruguay, Colombia etc. But it was always supposed to be – especially for Brazil – a bridge, to these type of changes locally, which the government obviously has accelerated. And I think it’s great.

Strategically, investors are giving the Treasury and the government a big thumbs up. And you've seen that reflected in your spreads.

The debt buyback announcement was very positive, but I do think overall strategically people view this as very positive for Brazil in terms of getting them to be able to issue more in Reais and reducing their FX risk.

But the devil is in the detail. My concern is that investors are so excited about all the possibilities that they may be possibly a little disappointed that they don’t get everything. This is not going to a Mexico situation.

And the big question we have – and I’m sure many of the foreign banks here [have] – is whether there is still going to be the possibility of these external local currency issues in the future. They possibly will be Euroclearable, and they will have some of the benefits that – even under the new regime, let’s say a new tax regime – some of the local instruments may not have.

I’m not so sure that the external local currency instruments are necessarily dead. Certainly for corporates right now, especially if the tax regime doesn’t change, they will still be a possibility.

It’ll be interesting to see if, for the government, though, whether these type of issues have met their usefulness and nobody will do them any more, or if they continue to be a bridge to when Brazil opens up the markets even more. And I think that’s to be determined. Investors right now have a high expectation.

Gerardo Mato (HSBC): At the beginning when there was so much interest from investors in the local market in Brazil, we saw there were many hedge funds and it was not real interest in the long term, it was mainly an arbitrage, an opportunistic trade because rates were so high.

What we’re seeing right now is that . . . investors are taking us to the local markets. And investors are pushing the government, rather than what Mexico did, which was to try to convince investors.

Investors are trying to convince the Brazilian government to make the changes in regulations and taxes happen very quickly. And I think it’s our task as international banks to help investors make their lives easy to invest in Brazil. And that has to be worked in conjunction with the local banks and with the regulators, and with the sovereign as well. That I think is the main job now in Brazil.

But I think, again, we need to start differentiating. I think some did rush into this local market for what is an arbitrage or opportunistic trade. Because we have elections all over Latin America, we don’t want everybody to try to [exit at once] if that’s something that creates volatility. So we have to be very careful how we manage investors in these local markets.

IFR: What about on the bank side?

In Mexico when the domestic market heated up and the borrowing from corporates really got going, a lot of banks moved there to participate in local lending and local underwriting. Is the same thing going to happen in Brazil?

Iunes: Hopefully not.

Gonzalez: Banks are already there. Everybody's there.

IFR: The foreign banks don’t have the same size of operations as the locals. They don’t have the positioning, they don’t have the depth. How are the foreign banks going to capitalise more?

Mato: We are actually building our local capital markets team this year in Brazil, the first time for HSBC. We actually are investing in local sales and trading and we are putting together a local capital markets team, as we did in Mexico last year, which actually was very successful.

Charles Achoa (Credit Suisse): I think that this is probably going to be a continuation of whatever coverage the international banks nowadays have with local clients. If a local client trusts an international bank like us, Citi, JP, to bring their issues to the international market, I mean basically we’re just going to be leveraging that. Of course, Bradesco and Itau probably have the same kind of coverage of those clients and there’s going to be healthy competition, I believe.

Severino: I think the big issue of the local corporate market is, when is it going to stop being a basically club deal type of situation where four banks, five banks underwrite. It’s not a real capital market. And that’s the issue. And that’s why banks like ourselves, and I’m sure others here, have a hard time coming in because at the end of the day we have very powerful local competitors around this table, and it’s tough to compete with them.

What we hope is that all these new regulations will help open up that market and bring some liquidity. When will this market really be a true capital market and not a quasi-loan syndication, or a club deal type situation? That’s what we want to get to.

Enrique Bustamante (DrKW): It’s all a function of convincing issuers. I mean, they’re obviously in a very comfortable position. They get guaranteed execution at razor-thin pricing. [What we need is to move] into what is a truly open and competitive market where it’s really demand, that includes being credit profiled, that drives yields.

We’ve been trying to work out what the correct strategy is. We clearly, at this point, have no intention of going to start bumping heads with all the other large banks. [We] really want to find out what the correct strategy is to get into the market, be it perhaps by starting to provide some liquidity to certain issuers, perhaps providing access to foreign investors in certain structured products.

Valle: If you compare the local market today with three years ago, I think it’s improved substantially. Today the Real market is a real source of financing for Brazilian issuers.

But I agree with Sandy. It is a bond-loan market. The market is extremely concentrated. The pension funds and the insurance companies are a very small portion of the market. Most of the market is comprised of asset managers and banks. And the market is so liquid right now. Banks are so liquid . . . everybody gives a firm proposal to clients. And the secondary market is non-existent.

I think there’s some push from the local banks in the sense of trying to improve liquidity in the secondary market, so most of the banks playing in the debenture market are coming out with electronic platforms and auto execution pages and all of that. So I think we’re improving substantially. I think it’s a matter of time. It won't happen in one day, but it’s moving along.

Denise Moura: It’s not our fault. First of all, we are doing the job, because investors are not looking for private credit. Investors are very happy with the rates that the government pays, so the issuers that come to market are the bigger ones. So everything’s concentrated. Demand is concentrated, big companies are also concerned about the local cost, they are very competitive, they can raise money but they are very liquid. So we have a lot of things going on together.

It’s true, the local market has improved, but it still needs to go through this reduction in interest rates and [entry] of new investors. If we have a [significant] reduction in real interest rates, I’m sure investors will look for private credit. And then we may need more people working with us.

We don’t like to concentrate all the risk. Sometimes we are not allowed to lend more money to our clients because, you know, we booked so much money to one single client that it’s not healthy for anybody. But we don’t have investors, local investors, looking for private credit. They are looking for government credit because it’s very good and the rate is great.

Gonzalez: In the next [few] years, I guess, if the government keeps the policy, maybe there is a crowding-in effect for the first time in maybe 20 years. If the government keeps the surplus and the interest rate declines, the government will retire debt. The government, in the next year, probably, they’ll retire debt. So there is a crowding in effect, and my impression is that corporates will step up.

Valle: We’ve seen that already. If you talk to some asset managers in Brazil, they are saying I need paper, everybody’s looking for paper. And companies are very cash rich in Brazil.

Iunes: So truly there is a capital market business in Brazil. It’s true that it’s underwritten by a few banks and it’s kind of a club. But unfortunately, as Denise said, the market is very concentrated, the asset management industry in Brazil is largely concentrated. That’s one thing. So basically you have three or four asset management companies responsible for 60% of the market.

The second thing I’d like to say, which may be controversial here, but the Brazilian banks have been invested in Brazil for many years and have established longstanding relationships with clients. That’s not the case at some of the foreign banks. Some of the foreign banks step in when the sun is shining, but prefer to go out when it starts raining. I’m sorry to say that. Maybe it’s too controversial.

But I hope companies like Votorantim and others will be continue to do more business with Brazilian banks, because we are supporting them in any climate. Unfortunately, that’s the issue. When Brazil is in fashion, you know, maybe [external] board members will go oh, OK, let’s invest in Brazil. When Brazil is not in fashion that’s not the case.

I hope the Treasury, I hope the corporates [understand] the investment that the banks are making in Brazil – and not only domestic banks, Santander made a huge investment in Brazil and it’s capturing the benefit, ABN the same. So that’s the way the business should be.

The capital markets have evolved considerably in Brazil. It’s true that still it’s a few players, and it’s true that unfortunately it’s not that liquid.

Coming back to the dynamics of the market, we don’t have a yield curve for corporate bonds. We don’t have fixed-rate issuance for domestic bonds in Brazil. So there are a few things that should continue to evolve.

But again, as Denise said, it’s not our fault. We have done a lot to improve the capital markets in Brazil. We’ve been working very hard on that.

IFR: You mentioned an issuer, and I don’t want to put him on the spot, but we have a special guest from Grupo Votorantim. I just wondered what you make of this, whether it does make a difference to you that foreign banks enter the marketplace.

Luis Schiriak (Grupo Votorantium): We have an excellent relationship with everybody here in this business. We’re extremely active. Last year we were in the market very often with the support of both the local and the foreign banks. And I think the participation of the foreign banks brought the costs down drastically. And [it helped] the local banks to be world class players. Because now Brazilian banks, you know, can give you the same quality of service as foreign banks. They have improved a lot.

The Brazilian banking industry also probably has a legacy of the hyperinflation times. In terms of systems, and also technology, sometimes, when we compare this, it's ahead of the foreign banks. So it’s good that there's competition.

Valle: There’s business for everyone.

Schiriak: Business for everyone, right.

Mato: Everybody has a role in this market. Picking up on what Sandy said about the club and the loans, I think the definition of the local capital markets is mainly trying to underwrite as much as we can, not to keep on our books as much as we can. Because then you’re not creating a real market, you’re bringing rates to [a level] that is not going to be attractive for international investors. So it’s in everybody’s interest, if you really want to make this an opening for international investors to have a liquid secondary market and fair market rates. And that is not going to happen if there is so much liquidity, that actually you’re buying the bonds to hold them as a loan. Denise Moura: What we don’t have is a culture of different yields for different risks. And this is, again, is a matter of having much more people coming in, more investors, so you can give build different yield curves.

The problem is investors want to buy and keep [bonds] until maturity. They just don’t sell – if it’s good, they want it, if it’s not as good as they want, they don't buy it. There is a binary position and no middle position.

We need people who are willing to run different types of risk. And we don’t have investors like that in Brazil yet.

Achoa: That’s where the international banks will play a very large role.

We also have access to new investors so we can distribute paper into Asia, Europe and the US to the point that you made in the beginning of the conversation, which was to bring the high yield culture per se into Brazil, so that you don’t only sell credit as obvious as Votorantim for example, which is very easy to sell.

Schiriak: The problem is what you said before, the basic yield is so high that if you are going to pay a premium on top of that, who is going to be able to pay those interest rates, 150% of CDI. And so what kind of business would give a sufficient return to repay those loans? I think we know that if interest rates don’t come down it’s going to be very difficult.

Valle: Real interest rates in Brazil are very high. But if you look on a CDI basis the yield that top tier companies are paying to access the market, this is coming down substantially. The premium that the companies are paying over the government is almost non-existent. So the search for yield is not only in international markets but the local market as well.

At some point, people will be willing to look further down the ratings spectrum, because there’s no yield anymore. And the local market is very high-grade, companies below A minus have no access to the local market.

I think, again, it’s a matter of time. But we will see companies in the Triple B sector coming to market.

Powell: And that’s where developments like securities laws and disclosure and things like that will be more important. Investors are comfortable with less disclosure for issuers like Votorantim and the CVRDs and the Petrobras' of the world. But for newer names, disclosure and corporate research and all of those things will be much more important than it is now. And as you say, everybody just wants the blue chip names.

Iunes: Two good points raised. First of all, interest rates. It’s true that if you swap some of the domestic rates that are being paid in Brazil into dollars, in some cases they are cheaper than borrowing dollars.

Valle: Much cheaper.

Iunes: Much cheaper, yes. And that’s something that’s important to raise here, so that there is a myth that we’re paying a lot in terms of interest rate, but then you swap it into dollars, it’s not that expensive, that’s one thing. So you need to play the currency in order to get the benefit from any gains, and that's what foreign investors have to understand. And again, the liquidity in the local market both in swaps and currency markets is increasing.

The second thing, I completely agree with Cindy about transparency. But again, there’s been a lot of involvement in the local market in terms of transparency. In some cases I think there are issues that should be addressed and I’ll give you some examples.

We as an association of investment banks [ANBID, the Brazilian organisation], we do have a self-regulatory commission, which all the banks here are part of probably. And a prospectus for a Brazilian bond is similar to what you would expect in the international market. So there is some involvement in the transparency as well. But companies should be aware that, similar to the equity market, they should have the same sort of transparency with fixed-income.

One thing I would like to raise is regulatory issues. That’s a weak point here because any company, to raise money in Brazil, must be publicly listed. That doesn’t mean they should have listed shares, but they should be registered with the CVM, which is the Brazilian equivalent of the Securities and Exchange Commission. That precludes – something that I insist should be changed – that precludes companies like, you know, Volkswagen in Brazil, or whatever, or the multinational subsidiaries from borrowing locally, because they would never be in favour of registering with the Brazilian Securities and Exchange Commission.

That’s a mistake both from the CVM and a mistake from the subsidiaries of foreign companies, because I think you should have changes in the legislation to allow a subsidiary of an international company with an adequate level of transparency, with a prospectus and so on, with the commitment to continue providing financial reports, to be able to raise money in Brazil. Because that would increase the number of companies issuing in Brazil. There is a universe of companies that currently are not raising money in Brazil, they’re raising probably only in the loan market, but they could raise in the domestic capital markets. And that would be very good. I think that’s one of the changes I would like to see in the future, companies raising money in Brazil in the capital markets [that are] subsidiaries of multinationals.

IFR: What’s going to change that?

Iunes: I think CVM is debating how they would change this. My suggestion is they should have a different sort of setting of requirements for those who are accessing the debt market, different from the equity market. In terms of making it simpler for companies to decide whether they could issue domestically.

IFR: You mentioned, Denise, that there's no yield to rating correlation in the local market. But there certainly is in the cross-border market and we've seen a lot more Single B and even Triple C product coming out of Brazil. How long can that can go on? Are there very significant risks building up?

Powell: In general Brazilian corporates have access to a much broader array of capital than they did before. [Not just] the local and external bond markets, but also the equity markets and the bank market. But it’s had a bit of a virtuous circle effect in that many companies have been able to transform themselves by terming out their debt and lowering their cost of debt. And of course they’ve benefited at the same time from very buoyant global external economic and domestic economic conditions and strong commodity prices. So I think as long as the global backdrop is there, we will continue to see, just as Denise was saying, that local investors are looking more for incremental yield because the government yields are so low, just as yields on Brazilian external debt are low now. I think we all see more international investors looking for corporate paper. And more traditional high-yield players are looking.

Bustamante: Basically, a lot of what you’re seeing is driven by the investors themselves. I mean, in talking to a couple of institutional investors over the past couple of weeks, a lot of them, because yields on sovereign paper are so low, are forced to shift some of their portfolios into equities, for example. You know, you have some large funds, not only hedge funds but also some long only institutional funds who because of the lack of yield were forced to shift into equities. And they also obviously have to go further down the curve to see additional yield. And a lot of them really do have very good credit capabilities. They can analyse and evaluate some of the risks involved in a lot of these companies.

Is there a kind of inflection point where you get to credit that really becomes dangerous in terms of what's out in the market? I don’t think we’re there yet, but I think all the banks are trying to be as careful as possible not to stretch out that demand. I think there have to be some criteria on where to draw the line.

It is positive for a lot of these companies because they are getting term funding. They are getting competitive costs. And that eventually helps them out of whatever difficult credit position they might be in in the short term.

Nadine Cavusoglu (UBS): Just to expand on what Enrique was saying, what we found, especially in Europe, [was that] a lot of institutional investors who used to only buy sovereign paper – and there isn’t that much sovereign issuance any more because some, like Mexico, are issuing mostly in the domestic market – now have to start thinking about buying corporates, because they have a lot of new money coming in and they don’t have enough sovereign paper to invest in.

So we have new investors coming into the corporate world. And in terms of the lower credits, a Brazilian company that’s, let’s say, rated B plus, from a credit perspective I guess if they were in the US, that company, even though it’s not constrained by the sovereign ceiling, would not be B plus. They are still penalised for being in Brazil. I guess devaluation could be a major risk, but other than the last Grupo Rede deal that came to market, all the other single B type issuers from Brazil have a lot of exports . . . so they’re pretty much protected.

S&P rates utilities in Brazil lower than they should be rated. So just because they’re B minus doesn’t mean that they’re a true B minus credit. So I also don’t feel that there’s imminent danger of a crisis or a default.

Valle: The initiative is coming from investors, they are completely desperate to find new companies that have never accessed the market before. They are willing to listen to the story, to understand the story, and be rewarded with higher yield.

On the other hand, we have the investment-grade companies now, which are somehow moving to another investor base. All the companies that are raising prices through the sovereign curve, they are finding demand from high-grade investors. So there are some changes, the top-tier companies in Brazil are shifting towards a high-grade investor base. With this continuous inflow of funds into emerging markets, people still looking for new paper. And the companies are cash rich.

We did a seminar in Brazil a couple of weeks ago, and we put together several companies which had never accessed the market before, small companies, medium-sized companies. And investors were crazy about the story.

I think they are good companies. Maybe below the sovereign ceiling but as Nadine said, a B plus company in Brazil sometimes is a good company. And if they were in the US, they would be a Double B company.

IFR: Are investors doing more credit work because they want to diversify?

Valle: Absolutely. They want to go visit the plant, they want to see management, they want to go to Brazil to do due diligence.

Powell: The other thing that’s happening, as Enrique said, a lot of these investors have already started to put a portion of their portfolios into equities. So in some cases they’re getting to know these companies through the equity side. And that obviously involves even more credit analysis.

Severino: We’ve been surprised over the last couple years at the number of institutional investors now who are really gearing up with research analysts. I’ve seen a distinct jump in the quality and number of corporate research analysts. You see across the board you can go into Europe, and even Asia now because of the Brazil perps, they’re starting to do much more analysis.

They are willing to take an extra look where before they’d probably look at the top tier and not be willing to do the credit analysis that we’re seeing today. Though I will have to say that this kind of reminds me a little bit about ’96, ’97, when you had all these start-up cable companies – nobody even thought about a devaluation back then, right? Nobody thought about any speed bump in the road.

And I think Brazil today is very different. However, my concern, depending on the type of investor who’s buying this, is what happens if there is some type of devaluation in the currency? They have dollar obligations, Real revenues.

But that being said, I think the exporters are still in good shape, investors are much more likely to buy those. It's the companies that don’t have access to foreign currency revenues that I think investors get a little bit more nervous about. But they’re doing their homework. Greed is overcoming fear right now.

Mato: If you look at what’s happening with the main corporates in Brazil, the whole emerging market situation has changed in the last couple of years, with lower rates and also with the price of commodities. [And] as Sandy was mentioning, the export sector, the growth in demand from China . . .

So this is in some way allowing not only investors to focus on this type of company, but also Asian investors to start looking outside their region, and focus on Latin America. And maybe [look at] those companies, those with which they can have reciprocity in terms not only of the financial side but also on the commercial side. All these perpetuals that have been happening in Brazil, they’re all also related to this equation.

Van de Ven: In perpetuals, and the utility deal we just did [Celpa/Cemat], it’s a B minus credit, and even in the US, the 144a market, even in Asia there was demand for a B minus utility. That’s a very good example of how the quality of the end investor is really very good. It’s not only hedge funds and asset management firms buying into Brazil, now it’s retail across the board and even pension funds – Asian pension funds, European pension funds.

Valle: There are some differences in the sense that we have very sophisticated investors from the US looking to buy high-yield paper in Brazil doing credit work, going to Brazil for due diligence etc. On the other hand, we have all this Asian and European retail base which is buying perps like crazy, hoping that the company will exercise the call option after year five, which I’m not sure [will happen].

They think they’re getting a very high yield for a short period of time. So in that sense, that reminds me more of 1997 than the other side, which is more sophisticated investors going to Brazil to do due diligence.

IFR: I want to come back to something Denise Moura said about quality of investors and yields not being reflected in the quality of the credit. Looking at ABS bonds, FIDCs, what could be done to further reduce the cost of FIDCs, which are in many ways a lot cheaper than debentures. And also, does pricing truly reflect the quality of the receivables?

Valle: I think it’s getting there. I mean in the beginning, FIDCs with a Triple A rating were accessing the market and paying 115% of CDI. Now I think the FIDC is really providing an opportunity for medium-sized companies, lower-rated companies, to go to this market.

The yield that an FIDC is paying is getting very close to the yield on a debenture of a similar rating. Costs are coming down substantially.

In the beginning we had two major costs, administration and custody. Each one used to be 50bp a year. And that, without yield to investors was already extremely expensive for the company. This is coming down now, with the two together close to 20bp a year. There is room to be reduced even further, but I think it has evolved substantially.

Denise Moura: We still can have some extra reduction. And there is a group that is working on regulation, to increase maybe the percentage that a pension fund can invest in FIDCs, because they have limits. Some of them are just booked. We again get to the same underwriting problem, so we have to underwrite the FIDC because otherwise the company will not sell it.

With receivables, if you ask me whether they are reflecting exactly the risk, I think people are getting used to FIDCs. When we looked at having retail credit as receivables in FIDCs, many investors didn’t like it because they felt they could not understand each of the small credits that are there. They prefer an FIDC like CESP, where you have five, six, seven big contracts where you can analyse the final risk.

People are still getting used to this product. When they are more used to it, that’s when the cost will come down.

If you look at structuring costs, they are very low already. The CVM is not so expensive, custody costs, as Cristiane said, came down, and structuring (depending on how big the structuring is and how difficult) is not a major issue today.

Many investors are not allowed to buy any type of credit, FIDC or bond, that is less than B plus. So that’s a problem too sometimes. It’s a new product.

Iunes: We paid the price to pioneer this market. Initially, investors didn’t understand very well the risks involved in FIDCs so you had Triple A ratings paying enormous amounts. And for that kind of thing, the Parmalat event was very good.

We did a securitisation with Parmalat Receivables in November and a month after Parmalat had the problem, the structure was tested. And in the end, all investors [got paid], and so I think it was a good case. It was one of the first.

And from then on, a lot of investors became more aware that things can work. And then they started reducing yields and costs. So I think it’s a good programme. Particularly because companies that are privately held – I mean not listed – can establish an FIDC fund, and tap the capital markets.

Schiriak: It's a good product, I like it very much. We have one.

IFR: Luis, isn’t that the problem, that you could never price through CDI. You’ll always be capped at CDI.

Schiriak: The issue is that it serves as a cash management tool. The more efficiency in your collection lowers the borrowing cost. We’re happy with it.

IFR: Moving to another issue, what can be done to change the investing culture in Brazil? Can Brazilians by themselves end their own dependence on public debt or are foreign investors going to turn this around?

Gonzalez: It’s a wise decision. I mean, for my mother having her pension in CDI paid off in the last 25 years. It was a very good decision, she was getting the lowest possible risk, and probably 11% of inflation in the last 20 years. And daily liquidity. Why should she change? If we start losing money, maybe we'll change.

Denise Moura: There are some new products. One of them is what they call the CRI, which is a receivable for a mortgage, or for rentals. But this is just the beginning.

Valle: I think it is changing somehow. Everybody, because of the high inflation we've had in the past, everybody is looking for liquidity, and protection. Everybody invests in funds in Brazil, and funds, in order to provide liquidity, have to invest in government paper. And government paper used to be majority linked to CDI, so the whole industry was in CDI. But this is changing.

The government is moving away from CDI, the government is putting more fixed-rate paper in the market, the government's putting in more inflation-linked paper. And as rates start coming down, people will also be looking for duration, so they’d be willing to take more risk and maybe give up liquidity.

Gonzalez: It depends on the Central Bank of Brazil taking the decision not to pay inflation plus 12% for one-day money.

Ricardo Moura: On the fiscal side we are changing the profile of the debt. If rates really decrease, I’m not sure that people who will buy LFT [local government floating-rate debt] will be in a better position in one or two years. Anyway, I think trading strategies are made of market views, [but] I’m not sure LFT will be the best view

IFR: What scope is there for the sovereign to issue inflation-indexed Globals, or conduct further liability management?

Ricardo Moura: Everybody is aware of the debt buyback that the Central Bank is undertaking on behalf of the Treasury. And up to the day that we announced, it was a silent buyback, and I think that the Central Bank did a really nice job in buying back US$2bn face amount without putting real pressure on the price, or creating any big rumours.

And even on the price, I mean, I follow the total return for the different countries, and Brazil was never first, second or third, which means that there was no real price pressure on the bonds. From now on, of course, it’s not a silent buyback any more. It’s public, and in this way I think that the programme will move much slower.

If we think about the buyback conceptually, what we are doing is exchanging some of the debt into domestic debt because we’re not just using the reserves to buy the bonds back. We are giving Reais to the Central Bank, buying dollars and the Central Bank is paying for the debt. So again, in the end it's a swap, it’s a shift from external debt into domestic debt.

On the inflation-linked bond, of course every investor is saying that they would love to buy, and there is no mystery, the reason is very clear. I keep saying that the other side of the demand is that there is a high cost for us to lock in long-term real rates as they are now. But anyway, the real position is that we have no decision on that yet, for one single reason, and it’s that we are in the midst of some changes. So we’d rather see how things move before deciding to issue external debt linked to inflation.

IFR: What changes?

Ricardo Moura: Tax changes. There is no decision on whether we should first build the fixed rate curve, and then start the inflation linked.

IFR: Based on that, is it difficult to see whether future Reais issuance externally makes sense for Brazil.

Ricardo Moura: That’s a very good point. First of all, there was some concern in the market when we said that we were going to buy back external debt. [People] said, you mean that you’re not going to be issuing more external debt?

Well, not really. Of course, there are intentions to reduce external debt. But we still want to have some presence in the market, especially in the longer term. We want to have liquid benchmarks in the main currencies.

Of course, we don’t expect the same issuance activity that we've had in the past. But we still intend to have external debt as a liquid benchmark for Brazil risk. Ideally, we want to have those benchmarks in the main currencies, including the Real. The only thing that I expect is that building these curves may not be as fast as we are used to, or would be expected, right? Because we also intend to take some advantage of the current account on the balance of payments to shift the composition of the debt, as we are doing in the Central Bank buyback.

IFR: Does it make sense for corporates to issue in Reais overseas?

Schiriak: It definitely makes sense. But the problem is that there is not a clear curve. Last year we saw an excellent transaction from the Central Bank in Reais.

Ricardo Moura: By the Treasury.

Schiriak: It really left us sleepless for a couple of nights. We were really excited but unfortunately after that nobody else was really successful in issuing. The position now is that we’re waiting to see where the curve is for issuing in Reais offshore.

Actually the first one to issue in the private sector was Banco Votorantim. But unfortunately the trend did not continue as we all expected.

We would love to issue external Reais, but we don’t want to pioneer.

IFR: What has to happen next for this market to open up?

Powell: After the [sovereign] 2016 [bond issue in September] there were a lot of Brazilian issuers that came and said that they would like to issue. And I think that part of it is that nominal rates are still high enough that investors don’t need to take that extra risk. I think one of the things that the '16 did was it brought liquidity to a market that didn’t have liquidity.

A lot of people were buying local markets through structured product. The downside of that structured product was no liquidity.

Suddenly you had an instrument that was trading, you know, very frequently in a 10 cent-bid offer for big size. So investors were spoiled with the liquidity there. And I think [investors] didn’t feel like they needed to take the extra step, to get extra yield in buying corporates. I think as the yields come down we may see corporates issuing.

And certainly from an investor’s standpoint, the availability of sovereign debt like that means that you can buy a corporate instrument and hedge out the currency risk and the local rate risk if you want to. So it should actually make it more attractive for investors to write corporate paper.

Schiriak: For the issuer too, to manage your exposure.

Valle: The problem is sometimes that companies looking to raise Real funding, they look at a bond in Reais offshore, they also look at the debenture market. In the offshore bond they have withholding tax and that increases the cost substantially.

IFR: So it’s a very limited market?

Valle: Well, the market is more limited than dollars, that’s for sure. But there is demand to buy corporate paper at similar rates to what the companies are paying in Brazil. But for the companies it becomes more expensive because of the withholding tax.

IFR: Moving to the equity capital markets, looking at the liquidity challenges for this year, we’re seeing in ECM at least, increasingly smaller issues. Foreign investors are being tested with just how much liquidity they can deal with. And given that the multiples have changed significantly, is equity still more expensive than debt?

Mato: We have one situation where we have done a perpetual, not because they were looking at a fixed income trade, or because it was much more expensive to place equity than doing a perpetual transaction.

Gonzalez: Multiples are much lower than international standards.

Iunes: But it’s going up. We have seen an impressive volume in Brazilian equity capital markets. We haven't seen such activity in maybe 20 years or more. And I think multiples are going up. The difference now is that investors are definitely looking at the investment case in taking their decisions.

When we did jointly with UBS Natura for instance people said come on, it’s crazy to buy this at eight times Ebitda. It's very expensive for an average Brazilian market of four or five times. Since then, Natura has risen to 15 times Ebitda.

A lot of domestic accounts didn’t jump into the deal saying it’s too expensive, and now they regret it. So the market has changed. I think multiples are definitely going up.

It’s true the cost of equity is more expensive than the cost of debt. By definition it’s more expensive. But in any event we’ve seen multiples at double-digit levels. And the interest of both international and local investors is enormous. We've seen deals 10 times oversubscribed, five times, six times, and performing well.

Over this last 18 months we have something like 31 issuers. There are a lot of new IPOs. We have something like 25 already. And there’s an enormous volume in the pipeline for the next few months.

In the past there was a premium for liquidity. Now, I think investors do not require that much premium for liquidity, you will see smaller issues.

Now we have to look at more and more details, and again, look at new companies, and the investment story, the investment case. You have to do your homework. So there will be some new issues coming in, and I think it’s a great moment.

Gonzalez: Price is driven by international investors, right? Seventy-five percent of the deals go outside Brazil?

Cavusoglu: It’s changing. What I’ve heard from my equity colleagues is that it was 50% of the last deals.

Iunes: Of the last three deals going to the market we were involved in two. And we’ve seen around 40% to 50% of the interest [from Brazilian investors], and that’s irrespective of size. We’ve done one, Tractebel, which was R$1bn. It was a reasonably large deal. And it was around 50% domestic/international.

And we’ve done one recently this year, the first of the year, Vivax. The deal was R$450m. And close to 50% of demand – at the end the allocation was slightly smaller – was domestic.

I think as interest rates continue to decline, there's a shift from fixed income to equities, and hopefully you will see some more demand in the local market. It’s also an important movement in the market.

Denise Moura: I would say that's a movement driven by investors. We were not able to allocate to the local market before. In [recent] transactions we were able to allocate 50% to local investors.

I don’t think there’s a change yet. I don’t think that we see many local investors being so well positioned to buy equities in Brazil. I still believe that when it’s a great deal, it will be more for foreign investors.

As we go to the second-tier companies, that’s a totally different transaction. There are many, many small companies that want to come to the market and that’s not possible because of their size. Still we don’t have enough liquidity in the local market to bring them.

IFR: Moving on. The market is almost 100% bullish on Brazil now, which is starting to worry me a bit. And there is an election coming up. And last time there was an election things didn’t go too well in the markets. What are the risks building up?

Mato: In some ways it’s ironic. We were roadshowing the government recently and I remember before Lula's election people were asking what’s going to happen if Lula is elected. Now we are getting the opposite. We had the question, "What happens if Lula is not elected?"

IFR: So is there no risk?

Schiriak: It's a non issue.

Achoa: If there is a problem, it won’t come from Brazil, most likely. It’s probably going to come from another country.

IFR: You mentioned 1996?

Severino: This is completely different. I’m just saying the appetite for risk is like ’96. I haven’t seen this appetite since 1996 for corporate credit. Brazil is in a completely different situation. Globally we’re in a different situation.

But I think the market right now is pricing in no risk, which is a little scary.

Schiriak: There will be some volatility.

Severino: Yes, there going to be a little volatility. I think Brazil is in a situation where it’s proved itself. Look what happened last summer with all the political noise and there was not a blip in [Brazilian] external debt. So I agree with Charles. I think if there is any blip it will probably come from outside, something in Iran, Korea, oil prices, something that we’re not, or the market’s not pricing in right now.

I don’t see Brazil being the catalyst for this. I do think there’ll be a little of a election [noise]. Right now I know the market’s not pricing in any risk which is interesting.

Denise Moura: And not reasonable.

Gonzalez: There is great convergence. I mean, the difference in opinion now in Brazil, I mean, it’s small.

Powell: In general people see two leaders in the polls, and they’re comfortable with both of them.

Severino: That’s right.

Denise Moura: The current government was tested in some ways, and proved to be much more conservative than it looked, much more to the centre than anybody could imagine, maybe more to the centre than the previous governments. So I think our expectation is that they don’t change. It’s tough to see something that’s really, really a problem.

In the local market, the questions of corruption that we had are basically solved or being taken care of, or forgotten. I think the assumption is that there will not be any huge change.

IFR: One last question to our guest issuers. Many people talk about this year being the year of liability management. But how do you see this? Both of you have done a great deal of work on revamping your curves, lengthening tenors, taking great strides in many ways.

Schiriak: We still have some transactions. There are a few things that we’re reviewing, but [nothing] major because . . . we’re expecting some volatility. Many companies chose last year to do most of their liability management. Things are looking better than what we expected, but we did not want to run the risk of going for liability management during an election. I guess there are some new issues but we are very, very quiet.

Ricardo Moura: The biggest amount of liability management will be shifting from external debt into internal debt, indirectly as we are doing with the Central Bank debt buyback. Maybe there are still some opportunities for liability management in the external market, but I keep saying they are not obvious. And some of the ideas that we see are not really exactly what we want to do.

There will be some opportunities, but they are not really obvious for everyone. We need to be very selective.

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