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Saturday, 18 November 2017

Latin America Bond

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Betting on Basel III: In a year that saw its fair share of bank issuance as financial institutions moved to get ahead of global regulatory changes, Banco do Brasil’s US$1.75bn Tier 1 Basel III-compliant perp was a step ahead of the rest, standing out for its ability to create a benchmark for others to follow. It is IFR’s Latin America Bond of the Year.

To see the full digital edition of the IFR Review of the Year, please click here.

Designed to qualify as Tier 1 capital under the new Basel III rules and pre-empt a surge in supply across the globe, Banco do Brasil’s US$1.75bn Tier 1 perpetual bond tested new ground.

It may not have been the first instrument of this type – Credit Suisse and Rabobank had already tried their own versions – but this was a debut for the emerging market universe and an important benchmark for Brazilian and Latin American financial institutions.

Banco do Brasil settled for a format that was closer to Rabobank’s write-down structure, as Credit Suisse’s CoCo-style transaction would have required debt being converted to equity, which is prohibited in Brazil.

However, Banco do Brasil’s non-cumulative junior subordinated perp did come with a set of bells and whistles, which made for a structure that struck a fine balance between investors’ needs and future regulatory requirements.

“The Banco do Brasil perp was a level of structuring and complexity that was in a differential league,” said Katia Bouazza, co-head of global capital markets, Latin America, at HSBC, which acted as joint bookrunners on the transaction along with BB Securities, BNP Paribas, Citigroup and Standard Chartered.

By raising loss-absorbing Tier 1 capital ahead of any clarity on the post-Basel III landscape, the bank was clearly taking a risk. Brazilian banks had in the past issued Tier 1 capital only to see the Central Bank disqualify them, and then to be left with expensive Tier 2 bonds.

As a result, the borrower opted for a floating indenture that would adapt to rules that the Central Bank would eventually establish, but also set clear definitions with regards to thresholds for core capital ratios.

“Banco do Brasil had two Tier 1 instruments outstanding, but none of these were compliant with the new generation of instruments,” said Marcelo Delmar, head of Latin America DCM at BNP Paribas. “And to complicate matters, the regulations were still not in place in Brazil for new Tier 1 Basel III instruments.”

To mitigate risks over regulatory uncertainties, the leads decided on a structure that had the principal being written down if Tier 1 ratios fell below 6.125%, rather than the lower 5.125% established by Basel III. This gave the bank some wiggle room in case the Brazilian Central Bank erred on the conservative side, which it tends to do.

It also came with other qualifying amendments to allow for the conversion of the securities – such as a non-viability clause, complete optionality on coupon payments, a potential write-up clause, and other amendments that would allow the bank to make it Brazilian Basel III compliant as long as they did not work against the commercial interest of investors.

Pricing proved tricky, as few if any true benchmarks existed. It was also somewhat controversial after the initial trade came at what many considered an expensive 9.25% yield. Indeed, in that context, the original US$1bn deal drew a decent crowd, with the books reaching US$6.2bn after the leads took the bank on a two-team global roadshow.

A considerable tightening in the secondary market only seemed to confirm sceptics’ suspicions in March when the bank returned to retap the bond for another US$750m, pricing it at 108.50 to yield 8.488%.

Bankers involved said that the novelty of the trade made pricing an art rather than a science, and the bond was bound to rally as it became clearer how the Central Bank would respond to Basel II requirements.

Either way, the state-owned bank played an important role in creating a clear pricing benchmark for Brazil’s other large commercial banks.

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