Real darling flutters her eyelids
Brazilian banks are expected to issue a flurry of Tier 2 bonds during the coming year before the implementation of Basel III rules in the country.
To view the digital version of this report, please click here.
Brazil’s financial institutions are forecast to issue between US$15bn and US$20bn during the next 12 months and a great proportion of the issuance is expected to count towards Tier 2, according to Fitch. The Brazilian central bank has not yet decided on the cut-off date for Tier 2 issuance but it is widely expected to be some time next year.
This year a number of Brazilian banks have already issued Tier 2 bonds. At the start of August, Itau Unibanco issued a US$1.375bn subordinated 10-year bond. This follows a US$1bn 5.75% 10-year from Bradesco, a US$750m 5.875% 10-year from Banco do Brasil and a US$500m retap by Itau of its 6.2% Tier 2 2021s, which came with a 6% yield.
“I think we can expect a number of the bigger and medium-sized banks in Brazil to issue debt that counts towards Tier 2 before Basel III is implemented,” said Mayra Rodriguez Valladares, managing principal at MRV Associates, a New York-based financial regulatory and capital markets consultancy. “Banks will be weighing up whether they want to issue this debt at the moment, as obviously it becomes a contingent liability and must be paid back one day.
“If they become too leveraged, ratings agencies could put them on ratings watch. It is also not clear whether there is investor appetite for more issuance from Brazil. Currently, international investors are showing risk aversion towards the emerging markets. Brazil has been the darling of the emerging markets for a long time and investors may feel that they already have enough exposure towards Brazil,” added Valladares.
For the year to September 11, financials from Latin America issued US$15.95bn of paper in 29 separate transactions in the international markets, according to Thomson Reuters. Brazil saw US$11.49bn of issuance in 18 separate transactions and made up 72% of the total.
Peru was the country with the second-highest amount of issuance among its financials: US$1.74bn in four separate deals.
Over the same period, Latin American financials raised a total of US$7.74bn from 36 separate deals in domestic markets. Brazil saw six issuances valued at a total of US$3.82bn, 49% of all domestic financial issuance out of LatAm. Mexico witnessed 15 issuances valued at a total of US$2.9bn.
It is not yet clear what the Brazilian central bank will qualify as regulatory capital following the phasing out of Tier 2 issuance and the implementation of Basel III. Banks are rushing to issue debt now because investors will charge higher premiums for new Basel III-compliant structures. Bankers expect the premiums to be between 150bp and 200bp more expensive because of the heightened risk faced by banks under Basel III.
“In the short term it makes sense for banks to issue Tier 2 bonds,” said Maria Rita Goncalves, a senior director at Fitch Ratings. “We expect to see this year’s level of issuance double during the next 12 months. The central bank is expected to make clear what counts as regulatory capital by the end of this year.”
Some Brazilian bankers predict that the implementation of Basel III will have a huge impact on the country’s banks because of the high volume of corporate debentures that have been underwritten by them. In Brazil, many banks have struck bilateral financing deals with companies using issuance linked to the CDI rate, the average of all interbank overnight transaction rates in Brazil. These are more akin to a private placement with just one buyer and some experts say they should be seen more as loans than securities.
“Currently, banks hold this type of debenture to maturity,” said Antonio Oliveira, head of local debt capital markets at HSBC. “They have not been marking to market, but under Basel III rules they will have to do so. As Brazil shifts to global standards during the next few years, the banks will have to dispose of billions of dollars of paper.”
Overall, Brazilian banks seem to be in rude health. Under Basel II rules, the minimum liquidity index for most banks is 8%. That will rise to about 11% under Basel III rules. Currently, the liquidity level of Brazilian banks is a robust 16%, according to central bank data.
Anthero Meirelles, a Brazilian central bank deputy governor, said that many Brazilian banks would be able to meet Basel III regulatory requirements without having to raise new capital, since they have enough in retained profits.
In July this year, the International Monetary Fund noted in a survey on Brazil’s financial stability that, “thanks to deft policies and built-in cushions, Brazil’s financial system weathered the global crisis that began in 2008 remarkably well”.
However, Dimitri Demekas, an assistant director in the IMF’s monetary and capital markets department and head of the team that conducted the assessment, said in the survey: “There is a risk that the financial system may become a victim of its own success at home. Rapid credit expansion in recent years has supported domestic economic growth and broader financial inclusion, but could also create vulnerabilities.”
On September 14, Brazil’s central bank ordered the liquidation of local lender Banco Cruzeiro do Sul and its subsidiary Banco Prosper, a day after it failed to secure a buyer for the troubled consumer lender.
This is the fourth time that the central bank has had to intervene in a mid-sized bank specialising in consumer lending in the last two years and it is the second failure of a financial institution since Banco Santos in 2005. Although in the Banco Cruzeiro do Sul and Banco Santos cases fraud was at the heart of the bank failures, experts warn that banks must keep a closer watch over the consumer credit expansion.
For example last year, vehicle financing surged by 49% and payment terms were extended to as long as 80 months.
“Even though the impact on Brazil’s financial system will be negligible due to the very small size of Banco Cruzeiro do Sul, this development is a significant departure from the regulators’ common approach in previous bank interventions where creditors did not suffer losses, especially because the solution came through mergers with healthier institutions, as encouraged by the Brazilian regulators,” said Fitch’s Goncalves.
“Investors should take note that this event may prove to be the start of a new posture going forward; aligned with global trends that also should lead investors and depositors to use more scrutiny on the banks with which they work.”
One of the biggest problems is that banks have been lending to new borrowers who do not have a proper credit history. Banks and private credit bureaus have information on defaults but not on a consumer’s overall debt load. In July, the consumer default rate rose to a new high of 7.9%, according to the central bank.
Brazilian banks have grown fast during the past few years, mostly on the back of a rapid credit expansion and a consumption boom. They remain in solid shape and should be able to cope easily with the implementation of Basel III. During the next 12 months there is likely to be a rush of new Tier 2 issuance out of the country.
However, the failure of Banco Cruzeiro do Sul is a wake-up call for the banks and the authorities, which must keep an even closer eye on the expansion of consumer credit.