Closing the gap

To view the digital version of this report, please <a href="http://edition.pagesuite-professional.co.uk/Launch.aspx?EID=9af20490-a62f-49dd-ac38-f87804f6d81e" onclick="window.open(this.href);return false;" onkeypress="window.open(this.href);return false;">click here</a>.It’s been a good twelve months to be a market outside of Europe and the US. With many developed nations struggling under the weight of public and private debt, most emerging markets have been arousing a lot of attention from growth-hungry investors. But some markets have emerged more than others, and Latin America is definitely home to some of the sexier examples.InBrazil, the continent has a country that has benefitted from being one of the BRICs – indeed, many say that within the grouping it has by far the best long term-prospects. In Mexico, there is a country with a well-developed debt market that draws the attention of many investors that would not consider themselves consumers of emerging market investment products.Meanwhile,Argentina has surprised many by being one of the most notable come-back stories in recent financial market history – from basket case to investor darling in little over a decade. Not to mention Chile and Peru, which are regarded as bright prospects by many investors, and countries that are trying to establish themselves as regional financial hubs.Within the bond space, the recent global success of local currency issues is testament to the interest many now have in Latin America. Investors around the world have had a lot to consider – from the demographic challenges in Europe, to mounting public debt and inflationary pressure across the developed world. Latin America offers something different: commodity-rich creditor countries that some believe will ultimately prove safe havens if confidence in the dollar collapses.Indeed, Latin American issuers are finding themselves presented with an increasing array of choices. Domestic markets are gaining sophistication and – slowly – liquidity. Brazilian domestic bonds in particular have made great strides to become a viable alternative to US dollar-denominated debt for local institutions, and reforms have been formulated that are designed to encourage the trend. Mexico rivals Brazil as the most developed domestic market, while Colombia, Chile and Argentina see activity in this area.At the same time, issuance in the traditional US dollar format remains as popular as ever, with Brazil attempting to break last year’s record for international issuance and Mexico also on track for a very respectable year.The loans market has been a rock that has anchored Latin American corporates in recent years as the fortunes of other asset classes has waxed and waned. While volumes remain well off their pre-crisis peaks, bank lending remains an important form of funding for corporates across the region.And in the equity markets, things look to be hotting up too. Mexico, already a regional leader in the DCM sphere, is catching up on powerhouse Brazil in the equity space too. Valuations have been high – some argue too high – not just there but in Colombia, Chile and Peru. A number of regional initiatives are also in the offing, designed to stimulate growth in the region, including an MoU between the Lima and Colombian stock exchanges, and the formation of an equity index – Mila – that will have a market capitalisation second only to Brazil’s Bovespa in the region.

To view the digital version of this report, please click here.The local debt capital markets in Brazil have grown rapidly in the past two years, coming to almost rival its neighbour Mexico both in terms of issuance size and maturities. It is now open to a wider array of issuers from further down the credit spectrum, and provides Brazilian firms with primary recourse to local debt, rather than looking to dollar-based funding in the Eurobond markets.A number of factors have contributed to the swift expansion of Brazil’s local markets, not least the rapid recovery and strong economic growth that Brazil has enjoyed over the past couple of years – in marked contrast to many developed economies. Brazil’s economy recovered much faster and stronger than anticipated in the second half of 2009 and throughout 2010.In the last quarter of 2009 GDP grew 5%, according to Alfredo Coutino, director at Moody’s Economy.com. “GDP expanded at an average rate of 7.5% in 2010,” he said. Coutino puts GDP growth at a more moderate 5% for 2011 and 5.7% for 2012.With strong growth, increasing trade and solid domestic demand, companies in Brazil are looking for debt to fund growth, and both local and international investors are increasingly keen to add real-denominated debt to their portfolios.In addition, debt financing from the Brazilian development bank BNDES, which traditionally directed very cheap funding to the corporate market, is getting harder and more expensive, pushing companies to the local public debt markets. Domestic companies’ financing needs have grown, particularly with massive infrastructure projects planned over the coming years. And the government needs to cut back on its spending to maintain macro-economic stability.However, BNDES will clearly continue to be an important funding source for the foreseeable future, said Jose Carlos de Faria, analyst at Deutsche Bank in Sao Paulo. “Although Minister Guido Mantega claimed that Treasury loans to the BNDES could be cut by as much as 50% in 2011, he did not provide details,” he said. “We doubt that the new administration would be willing to reduce an important source of financing for infrastructure investments so quickly.” The government recently announced an offer of up to R20bn in subsidised BNDES loans for a high-speed train project between Rio de Janeiro and Sao Paulo.Helping handIn order to help push development of the local debt markets, Brazilian policymakers have expanded an existing tax exemption on domestic infrastructure investment to foreign investors, in particular investors in long-term local corporate bonds. The exemption includes investment in toll roads and other infrastructure projects, all utility companies – especially energy companies – and construction companies.In addition, the Brazilian securities commission enacted a rule over a year ago to make it easier for companies to launch a public offering. Rule 476 – which is somewhat similar to a 144a procedure in the US and speeds up and eases public launches, with some restrictions – were first used in 2009. Since then a number of companies have launched issues using this procedure.These changes have affected the type of company that is now accessing the market, and what tenors and deal size that can be launched.  “Although there has been a big concentration in the utility sector, there is now a substantial change happening in the market – especially as the country now has a lot of infrastructure investments to make in order to support growth,” said Antonio Olivera, head of local debt capital markets at HSBC Brazil. “For example, with the World Cup and the Olympics, Brazil has to build infrastructure to receive these events.”Toll Road Autovias, for example, came to the domestic markets with a R405m debenture due in 2015 through bookrunners Banco Itau and Banco BTG Pactual early in 2010. The Vianorte toll road outside Sao Paulo – owned Spanish firm OHL – came to market with a R400m deal in March last year through bookrunn

To view the digital version of this report, please click here.The Brazilian domestic bond market has traditionally revolved around floating rate debt, indexed to the short-term CDI rate, the average of all overnight transactions rates in the country, even for longer tenors. However, the markets are excited by a recent presidential decree and provisional measure, taking effect on January 1, aimed at increasing the level of long-term financing.Following the changes, non-residents from low tax jurisdictions pay a zero-rate withholding tax on income from publicly-traded bonds and securities, so long as the debt is issued by private non-financial entities. However, to qualify, the securities must be indexed to  pre-fixed rates linked to a pricing index or a reference rate know as TR in the local market; have an average term of at least 4 years; and cannot be repurchased by the issuer before two years of issuance.“Perhaps the Brazilian market has clung to the floating rate CDI construct for a bit too long,” said Chris Gilfond managing director and co-head of Latin America debt markets at Citi. “The changes present a very clear message and show the desired direction of development for the market. They will help to make the Brazilian market even more dynamic.”

To view the digital version of this report, please click here.Solid economic performance in most major markets is expected to continue throughout the coming year, which should help maintain the cycle of growth and increased trade now being enjoyed by Latin American companies.“Latin America has been growing faster than expected at the end of 2010 due to strong domestic demand growth, improved terms of trade and strong capital inflows,” Juan Rutz, chief economist for economic scenarios at BBVA Research, said in a report. “Nevertheless, we expect GDP growth to continue converging to potential growth of about 4% for the region as a whole.”This will further the desire for debt to fund growth—both through acquisitions and organically.Katia Bouazza, head of global capital markets, Latin America, at HSBC, said: “Both Brazil and Mexico were developing markets. Mexico has taken the leadership in terms of developing a more liquid and broadly distributed market on the debt side for local peso bonds. But Brazil has caught up quite nicely.”  Bouazza said: “Mexico and Brazil are markets that can absorb larger size debt transactions, different types of structures, and longer maturities. Although other markets in Latin America, such as Colombia and Chile and even Argentina see some local market activity, none are as active as Brazil and Mexico.”Increasing regional investor appetite for intra-regional debt, coupled with increasing intra-regional and inter-regional M&A activity are likely to continue pushing growth in domestic markets. “We will see a lot of companies raising substantial amounts to buy companies here and outside the region,” said one banker.

To view the digital version of this report, please click here.Last year, total international issuance by Brazilian corporates amounted to US$38.68bn, its highest level ever. In 2009 only US$25.8bn had been issued internationally; and only US$6.58bn in 2008, according to ThomsonReuters data. Last year, there were 69 transactions against 35 in 2009 and 25 in 2008.This year the trend has continued. By February 22 Brazilian companies had sold a total of US$11.1bn of debt overseas in 13 separate deals, including the US$6bn sold by Petrobras, Brazil’s state-controlled energy producer, the country’s largest corporate bond offering ever. The total figure is expected to rise and set a new record.“It’s not unreasonable to think that overseas sales will hit US$40bn this year,” said Sandy Severino, the New York-based head of international debt markets at BTG Pactual, the independent Brazilian investment bank. “We got a very high figure last year without the Petrobras deal. There is also a chance that Petrobras will sell debt in other currencies later this year.”Petrobras activity is supported by a growing number of issuers active in the market. “One thing that is notable at the moment is the sheer number of issuers,” said Severino. “Most are repeat issuers but we are seeing more and more new names.”The hunt for returns“There has been a very healthy level of DCM activity coming out of Latin America,” said Gustavo Ferraro, the head of Latin America debt capital markets at Barclays Capital. “It has been very attractive to investors as they have been searching for additional yield by focusing on attractive credit spreads to complement historically low Treasury rates.”Things have started to change. “US Treasuries recently backed up and this is making issuers more realistic,” Ferraro said. “There has been a degree of external market volatility since November, so investors are becoming more selective about transactions from Latin America and emerging markets in general.”In January, Petrobras sold US$2.5bn of five-year notes to yield 190 basis points more than US Treasuries of a similar maturity. It also issued US$2.5bn of 10-year bonds to yield 195 basis points over Treasuries and US$1bn of 30-year debt at 220 basis points over Treasuries.Other important issuers this year have been Itau Unibanco, Brazil’s biggest retail bank; Votorantim Cimentos, South America’s largest cement maker; and BR Properties, the Brazilian property developer. Itau Unibanco and Bradesco, another large cap Brazilian bank, have also been active issuers.International bond issuance by Mexican corporates also reached a record level last year, with US$26.4bn sold in 35 deals, compared with US$18.8bn in 2009 from 29 deals. In 2008, US$8.6bn was sold in nine deals, giving a sense of the rate of growth of this market.Brazil and Mexico dominate overseas sales: international issuance for the whole of Latin America amounted to US$94bn last year, from 166 transactions. In 2009 the figure was US$68.9bn from 105 deals.Most overseas issuers from Brazil come from sectors such as oil and gas and financials, which have been traditionally active in this market. However, increasingly exporters, including meat, sugar and ethanol producers, and electricity generation companies are tapping overseas markets.In Colombia and Peru, banks cannot keep pace with demand from exporters and are also issuing greater sums abroad.“Companies turn to overseas market because they want to extend their debt maturities,” explained Severino. “They cannot get seven- or ten-year tenors in the Brazilian domestic markets. They also do not want to saturate the local markets and to some extent want to diversify away from them. The key theme this year will be the growing breadth of issuers in Brazil. Global investors also have an appetite for new names out of Brazil; they do not want to concentrate on the traditional players too much.”High grade issues are getting done, as well as Single B deals. There have been a numbe

To view the digital version of this report, please click here.Uruguay, Peru, Brazil, Chile and Colombia are all Latin American issuers with outstanding global local currency debt. Uruguay tapped the market in 2006 and Peru in 2007, while the latter three launched transactions last year. Colombia sold US$1.3bn of 11-year debt denominated in Colombian pesos in April. Chile issued US$520m of 10-year bonds denominated in Chilean pesos in July. Brazil sold R1bn (US$597m) of 2028 bonds in October, the country’s first offering of local currency debt in international markets since 2007.Supply of global local currency bonds this year could struggle to match 2010 volumes. Brazil and Colombia are likely to continue issuing, said Nick Chamie, head of emerging markets research at RBC Capital Markets. But Chile and Peru are not in dire need of financing means and are unlikely to tap the global markets, while Argentina and Venezuela are also unlikely candidates.Mexico is in the unique position of having Euroclear-able domestic bonds that can be purchased by foreign investors, negating the need for the sovereign to access the global local currency markets. Peru also allows foreigners full access to its local debt markets.“It is up to the Ministry of Finance to decide how they refinance their debt and they will determine how much Global local currency bonds will be issued upon the demand of the investor community,” said Frank Ehrich, fixed income portfolio manager of emerging markets debt at Union Investment.Small but growingVolumes of global local currency bonds are unlikely to rival the size of the US dollar-denominated external debt market any time soon and local government debt curves will still be a primary source of funding for sovereigns. However, the global local currency bond market is a very important development, and is likely to be a fast-growing source of funding for countries in the region, predicted Chamie.“It is extremely difficult for investors to get access to local government debt given the fact that all currencies, bar the Mexican peso, are non-deliverable. Investors would have to open up local custody accounts in order to invest in domestic bonds,” said Chamie. “Issuing in the global markets provides easier access for international investors and the scarcity value of the bonds means that governments are able to issue at lower yields than they would typically in their local debt markets.”Chile, for instance, shaved 20bps off its domestic funding cost with its July global bond issuing at 5.5% compared to 5.7% for local five-year debt. Brazil launched its global real transaction 350bp tighter than its domestic local debt curve.The global local currency bond market is most liquid where there is restricted access to onshore debt. Colombia has a very high withholding tax which restricts onshore investment because the tax-adjusted yield is so low. “These taxes actually restrict onshore access and promote the global market as a liquid viable alternative,” said Siobhan Morden, head of Latin America research and strategy at RBS Securities. “Whether this global market exists or not depends on the accessibility to onshore markets.”The huge onshore/offshore differential in Brazilian debt prompted the majority of investors to open local custodian agents onshore, lured by the opportunity to pick up incremental yield of up to 300bp from domestic bonds. Though this resulted in a rapid decline in the offshore market, that migration onshore has been restricted because of the subsequent success of the IOF tax hike to 6% on bond investments in October last year.“That market segmentation and restricted access onshore is the catalyst for the re-opening of the offshore market and Brazil is unique, as it is forcing liquidity into its offshore bonds because of tax risk,” said Morden. “However, the majority of issuers in Latin America are refraining from external issuance because they do not want to add to currency strength. So I would not expect mu

To view the digital version of this report, please click here.Peru and Chile have long harboured ambitions to serve as regional financing hubs for Latin American issuers. Many have looked to them in the hope they could evolve into centres that would ensure issuers can continue issuing debt and circumvent any troubles that arise in the international capital markets. Telefonica del Peru, Repsol, America Movil and Southern Copper have all recently taken advantage of the bond markets in those two countries.But the development of independent capital markets in Latin America, at both the local and regional levels, has been a slow process. Some experts even suggest this vision is theoretical in nature, and are unconvinced it can be achieved in practise.Governments across Latin America have been working to deepen local markets in individual countries. Some have also tried to foster regional financing hubs, such as an Inca bond market in Peru or a Huaso bond market in Chile. These markets were designed to allow issuers from across the continent to borrow in the local currencies of those countries. But while the idea makes sense for both practicality and cost reasons, regional markets have not gained much traction. Experts do not expect this to change anytime soon.According to Richard Francis, sovereign analyst covering Peru for Standard and Poor’s, the greatest impediment to the growth of both local and regional bond markets in Latin America is the limited number of companies in a position to issue bonds.“In the case of Peru, there really are only a few names that can issue bonds, whether locally, regionally or internationally, and this is why we have not had so many issues,” he said. “You mainly see the local subsidiaries of international companies that tap the markets, because the bulk of the private sector in Peru and in other countries, too, is made up of small- and medium-sized industries for which the cost of issuing debt is prohibitively high.”It is a similar picture for regional stock markets, which are also dominated by a small number of names – even in Brazil, which has the broadest and most liquid equity market.“Companies that can issue bonds in Latin America need to be large firms with high standards of financial transparency and financial reporting, and they need to be large enough to overcome the fixed cost of issuing that bond,” said Eduardo Borensztein, Regional Economic Advisor at the Southern Cone Department of the Inter-American Development Bank (IDB) in Washington, D.C. “In Latin America, you do have a number of large and well-known names, but given the size of most of the business sector, the bond market is really not an option, and this is why the bank market dominates.”Need money? Get a loanBank lending remains the dominant form of funding for corporate borrowers across Latin America. While governments take advantage of local currency markets to issue bonds for their own funding needs, the bank loan market is still the lender of choice for corporates. This trend became even more pronounced in the aftermath of the financial crisis, when banks across Latin America were lending to companies at very cheap rates.Now rates have risen and there is a chance for capital market financing to become attractive again to some companies, said a banker at Spanish bank BBVA in Lima, Peru.To date only a few big-name companies have had – and taken – the opportunity to sell regional Huaso or Inca bonds. But where they have occurred these issues have been attractive to local investors, providing access to the debt of recognised, international companies that they would otherwise be unable to access.The S150m, five-year bond issued last year by beer brewing company SABMiller is a case in point, eliciting a great deal of interest from local investors.  “This kind of issue allows a company to take advantage of a growing local investor base and it also gives more people a chance to participate in a different type of financing,” the banker

To view the digital version of this report, please click here.Last year, the total issuance of Certificates of Real Estate Receivables (CRI, by its initials in Portuguese), the country’s main asset backed security for real estate finance, reached R8bn (US$4.8bn) against R4bn in 2009, according to research by Jones Lang LaSalle, the global commercial real estate group.In 2009 and 2010 around R1bn of this issuance was backed by credits originated from individuals, arising generally from the sale of residential property. The remainder was backed by credits that originated from corporations, which normally arise from  the capital requirements to finance real estate projects (usually commercial, industrial or retail developments).Under Brazilian rules, 65% of all deposits in national savings and loans accounts must be invested in real estate finance. In practice financial institutions have used these deposits to invest in CRI instruments backed by credits originated from individuals and from corporations. From February 28, only CRI instruments backed by credits originated from individuals will be eligible for the 65% allocation.Experts are unsure what effect the change will have on the country’s real estate market, but it is likely to lead to greater sums of financing being available for residential projects, at the expense of commercial, retail and industrial development. Before the change, the cost of financing commercial projects through the CRI varied from 10.5% plus an inflation measure, known as TR, to 11.5 % plus TR. It is now expected to rise to 13.5% plus TR. Investors in the national savings and loans account receive 6% plus TR.At the end of 2010 the government also created an incentive for foreign investors to invest in the CRI instrument. Any income they earn from investing in it is now exempt from taxation, which could open up a major source of financing for all types of real estate development.“The CRI instrument has become an important source of finance for commercial property developers,” said Andre Rosa, regional director of capital markets at Jones Lang LaSalle in Brazil. “However, the government wants to encourage residential real estate development and the cost of finance is now set to increase for commercial property developers,” he added.“We are still not sure about the implications of all these changes. Although commercial projects will lose a source of financing from national savings and loans accounts, the new tax incentive could lead to foreign investors starting to back commercial development in a big way.”Local experts believe that Brazil’s real estate finance and mortgage markets have the potentially to grow markedly during the next few years because they start from a low base: total bank credit against GDP is 45.9%, according to Inter-American Development Bank. And total mortgage credit is around 5% of GDP, according to Jones Lang LaSalle.Coalition of the willingOne of the most traditional forms of real estate finance in Latin American countries, including Brazil and Mexico, has been for a group of wealthy families to come together to back a project. In Brazil, in particular, developers have preferred to sell equity in a project to a group of wealthy investors rather than take out a bank loan, because of historically very high interest rates.“To some extent this still happens in Brazil,” said Rosa. “But during the past five years property developers have become more professional and it has become much more common for a property company to raise capital through a public offering or a follow on. Equity is still the main way real estate development is financed in Brazil, although debt is becoming more important.”In 2007, 17 home builders realised IPOs in Brazil and an additional four follow ons took place, raising a total of R12bn. The share price of several of the companies dropped markedly during the international financial crisis and the number of groups has been reduced to 13 through consolidation.Pro

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To view the digital version of this report, please click here.Last year the volume of syndicated loans in Latin America reached US$20.5bn with 59 separate deals, according to ThomsonReuters data. Mexico and Brazil were the two key markets: Mexico saw US$9.34bn raised from 16 deals, while Brazil’s 19 transactions raised US$6.35bn. In 2009, a total of US$26.1bn was raised in the whole of Latin America, in 52 deals, of which US$13.3bn (19 deals) came from Brazil and US$9.84bn (13) from Mexico.Volume is a long way off its peak of 2006 and 2007, when US$71.8bn and US$65.2bn was raised, respectively, throughout Latin America (114 deals in 2006, 108 deals in 2007). In 2007, Brazil raised US$25.2bn (34) and Mexico US$19.8bn (29).“Currently, Latin American syndicated loans activity is much slower than many people expected at the start of last year,” said Michael Jakob, head of the loan syndicate for Latin America at Credit Suisse. “They thought that strong M&A activity would drive it but overall we have seen very little M&A-driven activity.”One M&A deal that stood out was the acquisition by Sigma Alimentos, Mexico´s largest producer and distributor of refrigerated and frozen food, of Bar-S Foods, the US processed meats producer. The deal required a US$575m syndicated loan issued in September, with Bank of America, Grupo Financiero Inbursa, BBVA, Rabobank and ING acting as bookrunners. The loan had a final maturity of September 2013 and was priced at Libor plus 237.5 basis points, with the terms of the acquisition not disclosed.Last year, the biggest two deals both came out of Mexico in December: a US$2bn loan issued by CFE, the electricity generation and distribution group, and another US$2bn loan issued by Pemex, Mexico’s state-owned petroleum company. The CFE deal matures in June 2014 and was priced at Libor plus 130 basis points, with Bank of America and Bank of Tokyo-Mitsubishi acting as bookrunners. Pemex matures in December 2015 and was priced at Libor plus 150 basis points, with BBVA, BNP Paribas, Credit Agricole, Citi, HSBC and Inbursa the bookrunners.Brazil’s biggest deal last year was a US$1.04bn loan issued by Votorantim Group, the industrial conglomerates operating in the finance, energy, siderurgy, and steel sectors, in June. This has a maturity until June 2018 and was priced at Libor plus 225 basis points. The bookrunners were Bank of America, BBVA, Banco do Brasil, Banco Itau, Banco Santander Brasil, Citi, Deutsche Bank, HSBC, JP Morgan and Societe General.Last year, all the major loan deals received considerable attention from banks and some were up to two and half times oversubscribed.“There’s an incredible pressure on spreads,” said Jakob. “In certain instances we are seeing that spreads that companies get are lower than the funding costs of some banks participating in syndicates.”Turning a cornerDuring the international financial crisis, many banks worldwide de-leveraged, so the syndications market dried up. Demand also took a knock, as companies, feeling very cautious about the world economy amid talk of a possible depression, scaled back their investment ambitions. However, most banks have now turned the corner and have achieved the debt capital ratios they wanted, freeing them up to lend again. Companies also seem more optimistic.“Now, a confluence of events have made companies’ management confident enough to invest in expansion and the demand for bank credit is returning, although still significantly below the 2007 peak,” said Mario Espinosa, a managing director and co-head of Latin America debt markets at Citi. “Commodity prices have been high and that has helped, too.”Neither has the syndicated loans market been helped by the prowess of the bond market, which has been highly liquid and open to a broader range of companies then ever before.“Last year, the market for syndicated loans was certainly better than in 2009,” said Gonzalo Isaacs, head of Latin American loans at Bank of America Merrill Lynch.