One step ahead

One wonders how your average Latin American policymaker has avoided developing a squint, having to keep one eye firmly on domestic markets while the other is fixed so intensely on Europe’s unfolding Greek tragedy. Yet it is a measure of how LatAm financial markets have bolstered their resilience to foreign shocks that at this juncture a squint is likely to be the worst byproduct of the eurozone crisis. Nonetheless, ripples from Europe will still wash upon LatAm’s shores. That is a recurrent theme in this report – despite the inevitable temptation in official circles to view the Old World’s troubles with a certain Schadenfreude. After all, the continent has weathered its own fair share of sovereign debt problems in the past, and has responded with waves of reform and restructuring so radical they would leave Europe’s finance ministers as dizzy as a trader unseated by the tequila effect. The 1982 debt crisis in Mexico mired in a “lost decade” of limping growth and painful restructuring. Argentina’s 2001 crash was only resolved at a high political and social price. One result of the turmoil in Europe is that European banks are also retrenching and observers predict fewer syndicated loans this year. Historically, European banks have been an eager source of syndicated loans for project finance. But the debt crisis and new liquidity requirements under Basel III are likely to change how large projects will be financed in the medium term. Prices are also heading north. Mexican companies have already been finding it harder to access the loans market because of European and US retrenchment. Brazil’s IPO-drought that began last year seems set to persist in a climate of risk aversion. As strategic outbound M&A activity accelerates sharply at the same time as bank liquidity dries up, bonds offer an obvious alternative to syndicated finance in the medium term. Besides, corporations in LatAm are spreading risk and taking up the mantra of diversification. The natural path, therefore, are the debt capital markets. LatAm corporates are responding in kind and the year to February 15 saw record bond issuance. The retrenchment also enhances the role of domestic banks as sources of finance and has raised the profile of multilateral agencies such as the IDB in financing the ambitious infrastructure agenda of countries such as Colombia, buoyed last year by its achievement of investment grade, and across LatAm more generally. While these European ripples, both negative and positive, confirm that LatAm remains considerably exposed to a deteriorating world economy, the region’s fundamentals and policy momentum are now protecting it against turbulence that in previous eras might have hammered it. Unlike in past crises, now policymakers can use macroeconomic measures to limit their countries’ exposure to outside turbulence. They are also benefiting from a decade of stable politics that is in significant measure a response to the taming of inflation. So while the eyesight of zealous policymakers south of the Rio Grande may have been strained from watching Europe’s drama with nervous anticipation, all the signs are that it is unlikely to give them too much of a headache. To view the digital version of this report, please <a onclick="window.open(this.href);return false;" onkeypress="window.open(this.href);return false;" href="http://edition.pagesuite-professional.co.uk/Launch.aspx?EID=2db79904-530f-40b7-bdb6-a998b0692ca4">click here</a>. To purchase printed copies or a PDF of this report, please email gloria.balbastro@thomsonreuters.com

Latin America is grappling with a US$1trn problem. That is the estimated sum the region’s governments are planning to invest in infrastructure over the next decade as they try to convert massive economic potential into reality. The problem comes from how the region will finance its ambitious goals at a time when one of its most reliable sources of funding is drying up. Historically, European banks have acted as the go-to providers of syndicated loans for project finance, providing more than half the supply in 2011. However, the European sovereign debt crisis and the changing regulatory landscape are causing a shake-up in the competitive landscape – and the way large-scale projects will be financed in the future. Nasser Malik, head of global project and infrastructure finance at Citigroup said: “The US dollar funding pressures on some European banks are having an impact on project financings in LatAm, where the bulk of financings are denominated in US dollars.” For example, recently it emerged that BNP Paribas had put a portfolio of US$11bn of loans to oil and gas companies up for sale as it seeks to offload dollar assets and shrink its balance sheet. Some of the loans related to project finance, and the sector is falling in the cross-hairs of deleveraging because its loans are long term, illiquid and subject to considerable execution risk which makes statistics misleading. In 2011 the volume of syndicated loans provided for project finance in LatAm hit US$13bn, more than a threefold increase on the previous year and the best year for issuance since 2008. John Greenwood, a director in the project & infrastructure finance group at Citigroup in New York said: “While on paper 2011 seemed like a good year for project finance loans, volumes were related to commitments that pre-dated last year.” In other words, the funding challenge for project finance in Latin America, has not yet hit home. Malik said: “The next five years will be all about finding innovative solutions to solve for project sponsor objectives within a new market reality. Local investors will also be key to unlocking more infrastructure funding going forward.”Identifying investors Banks that are not pulling back from the market hope that the next generation of financing solutions will provide the projects with the financing they need. That means identifying international investors willing to invest in the region’s projects through the capital markets. “With some banks being more frugal with their balance sheets in project and export financing, sponsors will need to find a more plentiful supply of capital. In the long-term investment-grade bonds would be the best solution,” said Duncan Caird, head of project and export finance for the Americas at HSBC. “The next five years will be all about finding innovative solutions to solve for project sponsor objectives within a new market reality. Local investors will also be key to unlocking more infrastructure funding” “We are seeing more refinancings with a bond, and also bridge-to-bond financing structures, or term loans to investors that include a consideration of a project bond. Importantly, increasingly sponsors like the idea of bonds because they provide a means of recycling capital, thereby allowing banks with their lending limits, to lend into new projects. The bonds thus provide new sources of capital, oft post-construction, with the benefits of duration and competitive fixed rates matching project cashflows.”Brazil: worth its salt? The Rio Carnival is a staple in the tourist guides to show Brazil’s party-loving face to the world, but even the “host with the most” might be wishing it could take a break. According to analysis by HSBC, the main infrastructure sectors in Brazil are expected to invest around US$200bn between now and 2014, when the country hosts the Football World Cup. Two years later, it will host the Olympics and bankers say there will be a massive investment in “social infrastructure”. In addition, t

For years, emerging market nations across the world have aspired to create fully functioning, deep and liquid local bond markets – markets that can easily finance the medium and long-term funding needs of domestic companies with the support of a solid domestic investor base, and can also prove attractive enough as an investment opportunity to foreign investors. Yet achieving this goal has just not been easy for a multitude of reasons, and emerging market countries that have tried to develop their local corporate bond markets have failed. Now Brazil stands a chance of succeeding where others have not. With the launch of a new programme, the Novo Mercado de Renda Fixa (or the New Market for Fixed Income) that is designed to catalyse the country’s domestic corporate bond market, Brazil may finally be on the road to creating a long-term, sustainable local corporate bond market. Sponsored by Anbima (the Brazilian Financial and Capital Markets Association), the country’s central bank and the Banco Nacional de Desenvolvimento (BNDES), the programme aims essentially to mobilise credit for much-needed infrastructure investment in Brazil by providing a set of standard issuance procedures and certain codes of conduct. Bond issues that comply with the rules set out in the code will obtain Anbima’s Novo Mercado seal of support, which, proponents hope, will help to attract increased domestic as well as foreign investor interest. Sustainability Ultimately, the programme would help provide the regulatory framework and confidence needed to bring about liquidity in Brazil’s secondary market for corporate bonds. If it works, Brazil would prove itself a trailblazer for emerging market nations that, albeit well established on the international capital markets, have just not been able to put in place the necessary measures to successfully launch and sustain healthy domestic markets, says Richard Segal, an emerging markets strategist at Jefferies in London. “Although this is a very long-term project that’s not going to show any results in the immediate future, it would be a landmark achievement for Brazil and serve as a template for the other emerging market countries that have tried to do the same and failed,” Segal said. In essence, the Novo Mercado de Renda Fixa was created to meet Brazilian corporates’ need for both medium and long-term capital market funding, both of which are in very limited supply, said Ruy Piza, head of domestic sales at BLR Trust Investimentos, the Sao Paulo-based asset management arm of Banco BVA. “Except for pension funds, insurance companies and development banks, very few investors are used to and have the appetite to invest in longer-term issues,” Piza said. There are many historical reasons for this, not least the staggering rate of inflation that existed in Brazil until the mid-1990s. The high interest rates paid by Brazilian Treasury bonds – the benchmark Selic rate is still at 10.5% per year, one of the highest levels anywhere – as well as the floating component that is used on most debt issues, and may result in coupon changes throughout the tenor of a deal, have also contributed towards the unpopularity of medium to long-term debt instruments, Piza said. There’s little doubt, though, that the need for longer-term funding is strong, particularly when it comes to infrastructure development – a huge necessity for all the BRIC countries. According to Piza, Brazil has the lowest ratio of infrastructure investments-to-GDP of the BRIC countries. Yet BNDES has an infrastructure lending portfolio that is far bigger than that of the Inter-American Development Bank, and it is just not going to be able to increase its lending pace to finance everything on the list. Indeed, in 2010, BNDES disbursed a whopping R$52.4bn to infrastructure projects alone, and this represented around 31% of its total disbursements for the year. The Novo Mercado de Renda Fixa will help ease the pressure on BNDES because it calls for the creation o

Latin America has suffered relative underinvestment in infrastructure over the past 20 years, compared with other emerging markets regions, according to RBS, in its paper, The Roots of Growth: Projecting EM Infrastructure Demand to 2030. Total infrastructure investment in LatAm reached only US$681bn between 1991 and 2010, according to RBS. Brazil and Mexico dominate that spending, with 40.8% and 26.5%, respectively, of that total. For the smaller markets, such as Colombia, the underinvestment has been chronic. What infrastructure has been financed throughout the region has largely depended on national governments and regional development banks. “The private sector will not be there without [the public sector],” said Gaston Astesiano, infrastructure and environment sector adviser at the Inter-American Development Bank. Once synonymous with guerrilla war and drug trafficking gangs, in recent years Colombia has done much to alleviate the concerns of would-be investors. Alongside Peru, it is now among a second tier of trustworthy, investable LatAm countries, behind economic stalwarts Brazil, Mexico and Chile. Successive governments have made economic progress and the creation of a business-friendly environment a top priority. Where once a lack of continuity between governments undermined long-term planning, there is now a greater level of agreement between political parties about the need to invest in infrastructure. For example, the decision by a Colombian government more than a decade ago to develop gas infrastructure and promote gas utilisation survived multiple changes of government. Investors can therefore be confident that infrastructure concessions awarded today will be honoured by the governments of tomorrow. LatAm as a whole has demonstrated a commitment to infrastructure spending in coming years, as a vital element of improving its own economic prospects. “Total infrastructure investment is expected to reach US$1.2trn in 2011–30, with the highest growth expected in Peru, from US$25bn to US$58bn,” stated RBS. The smaller economies, like Peru and Colombia, will require an even greater commitment than the continental average they are to achieve their potential. And Colombia has shown evidence of its ambition, with commitments to infrastructure spending totalling US$25bn in five years from 2010. That will encompass projects of all different types, though Colombia’s most pressing projects are modernising its road network and its power capacity. The road less travelled Roads are a particular concern in Colombia, owing to its geography and the danger posed by guerrillas when transporting goods across the country. To demonstrate the country’s need for improved roads, research by the IDB found Colombian transport costs add more to the cost of exporting to the US than the import tariffs that were removed by the bilateral free trade agreement Colombia signed with the US in October 2011. “The implicit tax on Colombian exports to the US arising from transportation costs is almost equal to the burden imposed upon Chinese exports to the US, despite the much greater distance between China and the US,” said Standard and Poor’s in a paper on Colombia written in January. For other East Asian countries the cost is much lower, it added. “The cost of sending cargo from Bogota to the coast typically exceeds the cost of shipping from the port to the final foreign destination, reflecting Colombia’s poor road network.” Colombia already has a lot of projects in the pipeline, many of which are rated by a ratings agency and financed in the capital markets. It can be a challenge to attract investment, both local and foreign, to projects in a country like Colombia, said Eduardo Uribe, an analyst at S&P in Mexico. But the country is in a strong position relative to some neighbours, for example Venezuela or Ecuador: it boasts a developed domestic banking system and relatively mature capital markets, clear natural advantages for any prospective infra

After having been pronounced dead, the LatAm offshore local currency bond market may soon be revived, bankers and investors are betting. The belief is based on the renewed appetite for risk and yield seen in the market since the beginning of 2012 and as volatility returns to levels seen prior to the downgrade of the US by S&P. At the same time, the few global local currency bonds issued last year, which had suffered severely during the roller-coaster of the second half of 2011, are back above reoffer. One such example is the five-year bond issued by Brasil Telecom on September 15 2011. That was the largest and the last global corporate Reg S/144a bond denominated in Reais. Hence, it also hit hardest by the volatility seen late last year as a result of the euro crisis and the US downgrade. Priced with one of the tightest coupons ever for an offshore Brazilian Real-denominated bond, the 9.75% note was sold originally at 99.516 to yield 9.875%. It touched a low of 95.00 at one point but in mid-February was being quoted again at 99.65. It’s a similar story for the five-year 10.25% Real-denominated global bond issued by Banco Safra in August at par. It was nearing 101.00 in February. The five-year issued by Arcos Dorados in July 2011 was doing even better, trading in February US$3 above reoffer quoted at 103.00. With the secondary market improving, investors are no longer feeling burnt as they did late last year, when the idea of a new global local currency bond sounded outrageous to any credit committee. Besides that, the local currencies in LatAm are nearing the stronger levels they enjoyed early last year before market instability increased. “They [investors] want the foreign currency exposure, especially now that Bernanke has signalled that he wants a weaker dollar,” said a portfolio manager in the UK. Still, the memory of significant losses because of a sudden spike in volatility remains fresh in investor memories. To make matters worse, the spike in volatility seen last year skewed the models that funds use to evaluate potential return on these bonds. An EM fund manager in London explains that volatility is one of the key factors used to analyse risk premiums on local currency global bonds. With the secondary market improving, investors are no longer feeling burnt as they did late last year, when the idea of a new global local currency bond sounded outrageous to any credit committee Basically, she explains, a return model on an offshore local currency bond has to add the currency risk to all the other normal fixed-income variables. To determine what kind of premium a currency warrants, she said, investors use volatility to determine a potential band of variation and see what kind of yield carry will mitigate potential losses. Until July last year, that was not such a tough task. Most of the EM currencies had maintained a very low level of volatility, between January 2009 and July 2011. For instance, the OHLC volatility in the Brazilian Real remained below 20 most of the time. In October last year, that measure touched 40. If the historical numbers – which are key to calculate premiums – are still skewed by the spike, the good news is that volatility has subsided significantly (see chart). In mid-February, the Real was safely trading with a 10.6 OHLC volatility. The way we are going, said a portfolio manager for a large fund in the New York area, “give it a month before it comes back”. The LatAm currencies have also been on a clear appreciation trend (see charts), which could translate into additional returns on offshore local currency bonds. Volatility apart, investors still have the same incentives they had before to invest in offshore local currency bonds from Latin America. “The dollar is toast sooner or later,” said a portfolio manager for a large fund in London. Another portfolio manager in the West Coast of the US concurred, saying that at some point investors will have to turn their eyes to EM currency assets again

“Twin peaks” is a description that might best be applied to the Nevados de Payachata – the impressively symmetrical twin volcanoes of Pomerape and Parinacota in the arid far north of Chile. But the phrase in fact has come to symbolise the reform of capital markets in the country spearheaded by the finance ministry that passed a landmark in November with the first full working meeting of a powerful new financial stability council. The Payachata twins offer a metaphor for one vision that regulation should take if it is to balance the need to be dynamic – the volcanoes remain active – yet to provide a stable bedrock for the towering ambition of the country’s financial sector. Chile is worthy of scrutiny because it was welcomed into the Organisation for Economic Co-operation and Development in late 2009 and has become a model of South American membership following loyally – if not always fully – the organisation’s prescriptions. Its capital market is one of the largest relative to its size among emerging economies, and capitalisation of the equity market by the end of December 2011 stood at US$270bn. The financial system is well-developed, buoyed by the long maturities available in the fixed-income market. From 1990 until January 2012 the market value of Santiago’s IGPA stock market index, which tracks large companies based in Chile, averaged 7,788.16 points, reaching an historic high of 23,465.63 points in January 2011. Almost 90% of the fixed-income market is inflation-indexed, meaning that local instruments have yielded strong returns, reducing the allure of equities, and the insurance sector, if still small, has grown steadily with assets at 18% of GDP (compared with 51% for pensions). Chile’s reforms have arguably reached their zenith under President Sebastián Piñera who came to power in 2010. He hit the ground running, but in June 2011 was given a salutary reminder of the potential cost of failure by the worst credit scandal in years when La Polar, Chile’s fourth- largest retailer, admitted to nearly US$900m in bad credit card loans. In September 2011 it was reported that a criminal investigation had been launched into the company’s accounting and lending practices. The La Polar case The La Polar case has highlighted the imperative Chile – and the OECD – are now placing on regulatory themes, and has become a major test of the consumer protection agency Sernac, which is now spearheading a class action by a million consumers. The case is likely to impact on plans to strengthen a consolidated credit register for bank and retail credit to households. Household indebtedness is a faultline in Chile, doubling over the past 10 years and now hovering at 70% of disposable income. The challenges facing La Polar are the first sign of strains in a demand-driven boom that has pushed a rapidly expanding retail sector to compete for customers with tempting credit offers that take advantage of record-low interest rates. La Polar has also exposed the potential fragility of Chile’s bond market and caused jitters among international issuers about rules being tightened. The benchmark IGPA (which includes La Polar) and IPSA index of most heavily traded stocks bombed in July. There are other reasons reform of supervision has become a priority in Chile, not least to propel reconstruction after the devastating earthquake just weeks before Piñera took office. Insurance losses from this earthquake were the second largest ever recorded anywhere in the world. Leaner and fitter Underlying the reform process has also been a loftier ambition to transform Santiago into a financial powerhouse. It is not unrealistic: Chile emerged from the “lost decade” of the 1980s leaner and fitter than its neighbours thanks to macroeconomic stability, robust pension funds, and growth driven by conglomerates that have become the exoskeleton of the capital markets. Chile’s pension expertise, and the size of its copper-related sovereign wealth funds, give the country advantag

A senior ECM banker in New York said: “It’s going to be another tough year. There’s no way of getting around the risk aversion people are still feeling, along with the wrong companies trying to come to market at the wrong time.” The turnround in Brazil’s IPO market, without a doubt, has been dramatic. In 2007 there were 70 new listings; last year there were just 11, with many priced below the indicative range. It has indeed been a chilly start to the year in LatAm’s largest economy, as two IPOs were pulled, extending a seven-month drought of issuance until sometime around April when a quarterly blackout period ends. Travel services company Brasil Travel Turismo and its shareholders dropped plans to sell shares in an IPO in February. The plan floundered due to lack of investor demand and unfriendly market conditions, according to people with knowledge of the situation. “It really is a pity, not because of the company per se, but because it represented a reopening of a market that was on fire just a few years ago,” said a senior ECM banker in New York. The deal’s failure signals that investors, who last year steered clear of local IPOs as Europe’s debt crisis worsened, will continue to shun companies that have an insufficient track record, poor earnings visibility or that could be vulnerable to a downturn. Meanwhile, Norwegian offshore driller Seadrill postponed its plans in early February to unlock value in its Brazilian operations with a spin-off of the unit in an IPO. The company had planned to list the unit, Seabras, through a sale of 48m shares at a target price of R$20–R$26, but has now pushed that to April, according to a lead. “In a bull market, there would not be nearly as many problems,” said an ECM banker in Brazil. “What people want right now are plain vanilla deals, and companies with stories they know instead of these obscure stories.” The last Brazilian IPO was a R$371m deal from Abril Educacao in late July. “What people want right now are plain vanilla deals, and companies with stories they know”BTG Pactual IPO speculation But ECM professionals received a boost in late February when news broke that BTG Pactual is the next jumbo set to hit the market, after Goldman Sachs and JP Morgan were mandated to lead the float in February. The two international banks will work alongside the emerging market specialist’s in-house team on a deal that is expected to value the bank at US$13bn–$14bn and price in the second quarter, possibly in April. The float has been long anticipated as billionaire backer Andre Esteves has a long history of buying assets when they are cheap just to sell them later at a profit. Founder Esteves famously sold Pactual to UBS for six times book value in 2006 only to buy it back in 2009 for 1.5 times book – US$2.5bn. Brazilian meatpacker JBS recently announced plans via Brazil’s SEC to sell shares of its dairy unit, Vigor. JBS hopes to list it on the Sao Paulo Stock Exchange. In a valuation report put out by Bradesco, there was mention of a range of R$11.35–R$12.48 per share. Edemir Pinto, CEO of BM&F Bovespa, said he expected as many as 40 IPOs to make it this year. Others aren’t so sure. “I truly believe there will be at most 15 [IPOs] this year,” said a senior ECM banker in New York.Eyes on the Andean region In 2010 issuances out of Brazil totalled 78.6% of the LatAm total, with only 22.4% in other LatAm countries, while last year Brazil made up 52.3% of total equity-related issuances, versus 48.7% ex-Brazil. “If you weren’t on deals outside Brazil [in 2011], you weren’t working enough,” said one ECM banker. “I see this continuing to be a trend, especially with the recent booms in other countries.” One such boom took place in Colombia last year, though it’s been slow to start this year. “I don’t see the market having as many huge offering as last year,” said an ECM banker in Bogota. “We saw a lot of investor fatigue at the end of last year.” That said, equity offerings out of the Andean natio

Merger and acquisition activity in Latin America got off to a very strong start this year with debt bankers enjoying the benefits with corporate shopping helping to drive record levels of corporate bond issuance. By February 8, year-to-date total M&A activity amounted to US$29.856bn from 158 separate deals, according to Thomson Reuters. Most of the activity is from Brazil, with a total volume of US$23.71bn (62 deals), followed by Chile with US$5.15bn (29 deals) and Costa Rica with US$801m (three deals). The acceleration in issuance is also expected to continue across countries and sectors in LatAm and into other regions. “We are expecting this to be a very strong year again for M&A activity in the region,” says Udi Marguiles, head of LatAm M&A at Barclays Capital. “There is a lot of cross-Europe and cross-Asia transaction flow out of LatAm. The mining and oil and gas sectors in particular are very buoyant. There is a great deal of international interest in the region’s commodity or natural resource assets. We are also seeing Latin American groups acquire in Europe and the US. Throughout LatAm we are seeing consolidation in the consumer, retail, food and beverage, and banking markets but it’s true that most of the activity is coming out of Brazil. We expect to see a pick-up in the volume of deals out of Mexico.” A record amount of bond issuance by Latin American corporates accompanied the deal flow with total issuance of US$23.3bn (29 deals) by February 15. Brazil’s corporates have been the biggest issuers in the international markets this year, with 15 deals valued at US$14.77bn, followed by Mexican companies with five transactions valued at US$3.86bn. “M&A activity throughout Latin America has accelerated sharply during the past two years,” says Christopher Gilfond, co-head of LatAm credit markets at Citi. “I think it’s fair to say that we have started to see a lot more outbound M&A activity from the region than inbound. I would say two-thirds of deals these days are outbound, one-third inbound. It’s becoming common for a Latin American group to make a purchase in the US or Europe, where corporate valuations tend to be lower today.” Mario Espinosa, co-head of LatAm credit markets at Citigroup, adds: “Many acquisitions are of a strategic nature and, at least at first, some portion of the acquisition financing is likely to come from bridging loans. The acquirer will have in place debt covenants with its principal bankers. However, within a relatively short period of up to 18 months, it will want to have in place permanent lending, which could involve a syndication or a bond issued in the domestic or international markets.” “It’s becoming common for a Latin American group to make a purchase in the US or Europe, where corporate valuations tend to be lower today” Last year, total M&A activity in the region added up by US$147.88bn (1,904 deals) against US$193.68bn (1,771 transactions) in 2010. Brazilian companies were the biggest issuers of debt internationally, surpassing US$32.7bn (45 deals), followed by Mexican corporates with US$15.13bn (24 deals). Peruvian firms were ranked number three for international DCM activity last year, with a total deal volume of US$1.7bn (five deals). Setting a trend Bimbo, the Mexican bakery group, is a prime example of a company breaking out of the region with acquisitions that are quickly refinanced through debt markets. In November 2011, Bimbo completed the purchase of the North American fresh bakery of Sara Lee, the global consumer-goods company, for US$709m. A month earlier Bimbo also announced plans to acquire Sara Lee’s fresh bakery businesses in Spain and Portugal for €115m (US$158.3m). In April, the Mexican group took out a five-year syndicated loan for US$1.3bn from 10 financial institutions, to refinance existing debt on better terms as well as to fund partially the Sara Lee deal (Bimbo originally announced the deal in November 2010 but it took one year for the U

Amid soaring enthusiasm for Latin American debt, Votorantim's five-year note was one of the largest local currency corporate deals in recent years, eventually raising R$1bn (US$582m) for the Brazilian borrower. Such was the warmth of its welcome, the deal was hailed as a gateway deal that would awaken the LatAm corporate linker market from its four-year slumber. In the event, no sooner had the market awoken than it went back to sleep. Syndicate desks reported investor enquiries for inflation deals through mid-year, but before any were able to hit the road concern over euro region sovereign debt spiralled, sparking a back-up in spreads and wholesale retreat from risky investments. One of the funds to get a piece of the Votorantim deal was Aviva Investment’s EM inflation-linked bond fund, which turned a quick profit as the linker marched higher in the secondary market. “We were very happy to be involved in that deal because it performed spectacularly well,” said the fund’s co-manager Kieran Curtis. “In the end it got so expensive that we could not justify holding it any longer and we sold it.” Given the positive result Curtis and his team were quick to get on the phone to syndicate desks to ask for more inflation-linked paper. “We definitely had more appetite for this stuff, but in August and September the market went south and the new issuance space effectively shut down.” One of the reasons behind the exceptional demand for the Banco Votorantim deal was that it represented a diversification play for emerging market inflation-linked funds, which rely almost entirely on LatAm’s thriving government linker market to satisfy investor demand for inflation exposure. Of the roughly US$440bn worth of emerging market inflation-linked bonds globally outstanding, LatAm has about US$400bn, with Brazil and Mexico alone accounting for US$300bn, almost entirely emanating from sovereign programmes. Some 29% of Brazil’s government debt comprises so-called NTN-B notes, linked to the IPCA inflation measure. Investor demand for the bonds is high, both locally and internationally, and emerging market inflation-linked securities have outperformed their fixed-rate counterparts, returning some 97% over the past five years, according to HSBC, nearly the double the return on nominal bonds. Given the excellent fundamentals it would seem to make sense for LatAm corporates to imitate their sovereign Treasury counterparts by rolling out yield curves in indexed securities. That has to some extent been seen in the on-shore market (the HSBC-led Elektro Eletricidade E Servicos R$300m dual-tranche five and seven-year transaction being one example last year), but the international space has been left almost entirely bereft. “The local market has been developing quite nicely and there are important deals that are getting access and execution with pretty good maturities, which would not have been possible five years ago,” said Katia Bouazza, co-head of global capital markets for the Americas at HSBC Securities (US). “When banks issue inflation-linked bonds they may be very well looking at pure arbitrage between where they can place the bonds in the international market and how that would swap into CDI” “You are getting excellent third party distribution, with pension funds, insurance companies and banks coming in and buying. However, in the international market there are dynamic elements like the cost of the swap or investor appetite, and you need to align all of these for the deal to get done.” Finger on the pulse A key consideration for Latin American corporates looking to issue inflation-linked off-shore is the availability of hedges. Following its inflation-linked sale last year Banco Votorantim bought the money onshore and swapped into a fixed rate, according to sources close the situation. However, the offshore inflation swap market is by no means a guaranteed liquid proposition. “When banks issue inflation-linked bonds they may be very well looking at pu

The increased cost of funding is hampering the ability of banks to lend at attractive levels which will probably mean a fall-off in syndicated loans this year, as companies shy away from the higher borrowing costs in the bank market – and turn to bonds instead. It has already been a slow start to the year for loans, with only a handful of deals announced. Banks are charging more than 100bp than they did this time last year, and faced with shorter tenors and higher prices, many borrowers will be making the flight to bonds. In February Brazilian oil giant Petrobras had been looking at both the loan and bond market before going for the latter route and issuing its biggest ever bond, a US$7bn four-tranche deal. “They have huge infrastructure spending and had been considering the loans market, but chose to go the bond market. They were not going to do a three-year tranche, as they would normally get this sort of tenor in the bank market, but it turned out to be more attractive,” one banker said. The higher pricing for syndicated loans, which started in the second half of last year, is not going away any time soon. In addition to higher funding costs, the new capital requirements banks are facing under Basel III will also be weighing on liquidity. “It is very quiet in the loans space. Banks are retrenching – especially European banks – and we expect to see fewer syndicated loans this year, though there could be an increase in club deals involving Japanese and Canadian banks compared to 2011,” said one syndicated loans banker at a European bank. The five-year CDS for US banks is at least in the low 200s, for Japanese banks it is in the mid 200s, and for the European banks it is at least in the mid 300s. These were around 100bp lower around this time last year. “We expect to see fewer syndicated loans this year, though there could be an increase in club deals involving Japanese and Canadian banks” In December Banco de Bogota priced a three-year term loan at 225bp over Libor spread. A similar lender, Banco de Credito de Peru, priced a term loan with the same maturity at Libor plus 175bp just nine months earlier. One of the first companies to come to the market for a syndicated loan this year, Confab, had to revise pricing upwards for general syndication from the price that was offered to relationship banks. The Brazilian subsidiary of steel pipe maker Tenaris is looking for a US$350m five-year amortising loan. At the bank meetings in New York and Sao Paulo it offered a price of 210bp over Libor out of the box, moving up to Libor plus 288bp on a leveraged grid. The pricing was 35bp higher than the range of Libor plus 175bp–250bp that had initially been given to relationship banks. While this showed that higher spreads will be needed to attract banks to participate in loans, it also demonstrated that Japanese banks are expected to be among the most active. Bank of Tokyo-Mitsubishi was the only institution to put in an MLA ticket before the meetings even took place. Japanese banks, however, are also faced with the same general constraints. “Even Japanese banks are not lending at such tight spreads as last year. Their cost of funding has gone up too,” said one banker. “I don’t think any bank can justify lending at lower than their cost of funding based on ancillary business.” Among the new deals being syndicated, regional banks and multilaterals have been involved – a trend which is also expected to continue in 2012. Brazilian coffee co-operative Cooxupe is seeking a three-year pre-export credit facility for US$150m, according to market participants. Itau is the lead bank, and bank meetings were only held in Sao Paolo. Meanwhile, Peruvian cosmetics brand Belcorp is looking for an A/B loan, which the IFC is leading. The US$130m loan, with the B Tranche for US$80m, is offering banks six, seven and eight-year tenors. The syndication process launched in mid-January, and proceeds will be used to expand the company’s operations to other parts

In Brazil, for example, the region’s largest financial institutions had an average Tier 1 capital ratio of 12.8% in the third quarter of last year, just shy of the 13% hurdle required under the new capital accords but significantly better than the 8.9% European average recorded by the European Banking Authority stress tests in August. Although investors were happy to buy Banco do Brasil’s recent Tier 1 perpetual as public-sector risk with a 9.25% coupon, it’s not clear that other LatAm banks will adopt the controversial structure to raise Basel III compliant capital. While retail accounts lapped it up, institutional investors are demanding more certain structures and higher risk premiums to play ball. Indeed, the luxury of generally well-capitalised banks last year encouraged Banco Central do Brasil to accelerate its Basel III schedule and it expects to have key components of the new regime in place by July, two years ahead of the Basel committee’s own timeline. Significant uncertainty, however, still remains over how the central bank will interpret the new accords and whether key sources of capital relief available under the present domestic Brazilian regime will be permitted. “We need more clarity from the central bank on how it will interpret Basel III in the light of important local differences before we can talk about how much additional capital Brazilian banks will need to issue in 2012,” says Marco Pierry, LatAm bank analyst at Deutsche Bank in Sao Paulo. “LatAm banks are well reserved with little leverage. In this relatively safe banking environment, the significant oversubscription on the BdB perpetual shows you that there is strong appetite for this paper” For instance, existing rules allow banks to count deferred tax credits associated with bad loan provisions as part of Tier 1 capital, which is currently worth about R$20bn, equivalent to 40% of Brazilian banks’ total equity base, according to Deutsche. BCdB said last year it would make a final decision on whether deferred tax credits would qualify for Tier 1 treatment under Basel III by December 2011, but the market was still awaiting confirmation. Meanwhile, BCdB is also poised to remove domestic banks’ ability to recognise revenues from loan sales upfront, forcing them to wait until final maturity. Although this will probably not be a huge concern for the three largest lenders, which have leveraged their scale to generate loan and ROE growth of some 20% per year, the smaller lenders who recycle capital by off-loading loans to bigger banks may find themselves more constrained. “There is a huge pool of LatAm dedicated money out there, and financial institutions are among the largest constituents in the regional equity indices. LatAm banks are well reserved with little leverage. In this relatively safe banking environment, the significant oversubscription on the BdB perpetual shows you that there is strong appetite for this paper,” Pierry said. After several years of 20% loan book growth, a string of large ticket acquisitions and a mandatory dividend payout ratio of 40%, government-controlled BdB ended 2011 with the lowest Tier 1 capital ratio of the large Brazilian banks at 11.1%, according to Moody’s. The agency also highlighted BdB’s R$22bn of subordinated debt classified as Tier 2 instruments, which accounted for 39.1% of Tier 1 equity, and R$2.3bn of perpetual hybrid debt instruments, the eligibility of which as Tier 1 capital components is expected to change under Basel III. Unsurprisingly, it was the first regional bank into the market this year with a structure to test market appetite for regulatory capital before the regulations are finalised. Special challenge “Structuring a deal like this in the face of regulatory uncertainty is a special challenge and the outcome represents more of an interim solution than a template for future issuance. We know how Brazil adopted the first two Basel accords, but we don’t yet know how Basel III will be implemented. Thi