The banking industry in Brazil thought another four years of Dilma Rousseff would be a disaster. Now she has been re-elected, have they changed their mind?
The sight of a pro-opposition march down Faria Lima will live long in the memory of those well-heeled manifestações who took part. Bankers, CEOs and CFOs joined a popular protest against the incumbent President Dilmma Rousseff that made its way slowly down the avenue, which is flanked by the shiny new glass headquarters that make up Brazil’s new financial heartland. The short elevator-journey from business suite to street illustrated just how much resentment festers within the business community against the ruling PT party – as well as how much more money they thought they could make under an Aécio Neves presidency.
But then Rousseff won, albeit it closely. The markets braced for the impact from the warnings of financial and economic Armageddon to come. But the pre-election volatility subsided. The FX devalued, but slowly and orderly. The stock market bounced around but less than anticipated. In finance, hope of optimism springs eternal and bankers and traders began to convince themselves that the closeness of the election and the admission, in her victory speech, of failures and Rousseff’s promises to be a better president in her second term (despite no conciliatory mention of either of the two leading defeated candidates of the bitter campaign) meant that ‘Dilma Mark II’ would be OK after all. Now it became all about the finance minister. A market-friendly appointment would lead to renewed confidence: corporates would dust-off capex plans and give a renewed spur to growth. Credit would begin flowing and cascade through the economy. Rains would come and avert power-rationing.
Of course, all bankers will reasonably say that who the next finance minister is matters. If he (there are no leading female candidates for the post) and his team are credible to the markets and industry then it will make for better sentiment and for a higher investment rate. However, the level of import is contested: some argue President Rousseff will always be her own Finance Minister and she is convinced of her interventionist and government-spending-led approach to her goal of maximizing employment. Some say the fiscal challenge requires structural reform that is unlikely given the riven political environment and – beyond such deep measures – whoever is Finance Minister will be minimizing the current administration’s economic damage and maximizing growth at around 2% at best. Others take a more up-beat assessment of a potential investment-led rebound if corporate Brazil finds its mojo – led by infrastructure investments and a reinvigorated export sector that rediscovers its competitive edge as the real finds its way to a fair exchange rate.
All this matters: capital markets bankers need to have a feel for likely 2015 issuance from Latin America’s largest market in order to anticipate revenues and allocate teams and resources accordingly – in terms of international versus domestic transactions – and by products and currencies.
2015’s rollover requirements are relatively modest – at about $12 billion of private and public debt to be refinanced next year, and some of that may have already been pre-funded in what has been another very strong year of international issuance out of Brazil. If 2015 is to see volumes anywhere near this year (YTD in the middle of November had seen $42 billion of volumes) – or indeed any year since 2010 – then there will need to be a solid demand for fresh capital. Is this likely, given a scenario of low GDP growth? The consensus forecast for 2015 is for less than 1% after this year’s expected 0.4%.
“In order for us to see greater supply we would need companies that have held back long-term investment plans to review and unlock them,” says Alexei Remizov, Managing Director of Capital Financing for Brazil at HSBC in New York City. “And that would only happen if there is confidence in corrective measures being taken by the economic team to be appointed. Only in that event would you see a significant pick-up in capex, and therefore, need for long-term financing. So the pipeline will depend on that.”
However, Remizov does see sources for optimism based largely on the ongoing devaluation of the real. “The weaker exchange rate could potentially make it more plausible that exporters will issue fresh transactions – for example steel producers or food producers – because the currency could make these sectors more competitive and they could potentially require capex to add capacity,” says Remizov. “There may also be some demand for M&A-related funding due to consolidation in some industries. Nonetheless, to reach cross border issuance volumes that we have seen recent years we would need broader capex plans going forward – which, in turn, would also precipitate the need for financial institutions to access fresh capital. However, we have little visibility about this broader, positive scenario at this point – a lot will depend on the government’s ability to support investor and business confidence in the coming weeks and months.”
Chris Gilfond, co-head of debt and equity capital markets origination for Latin America at Citi, predicts fixed income new issue volumes will slow next year, albeit from a record base: “We are expecting a reasonably active year [in 2015] – probably not as active in Brazil or the region as this year, which is on pace to be another record year despite a significant slowdown in the third quarter. The extraordinarily strong volumes in Latin America in the first half of 2014 have been somewhat tempered by the economic slowdown and Brazil hasn’t been an exception.”
Gilfond puts Brazil’s slowdown into the local – and EM – context: “Given what is going on with commodity prices and expectations about global monetary policy – in part around possible appreciation of the US dollar – then my feeling is that large scale investments are not going to be as proactive or as aggressive as we have seen in the last two to three years.”
In the main, DCM bankers appear relaxed about the likely levels of investor appetite for the lower volume of transactions from Brazilian issuers. Leandro Miranda, managing director and head of fixed income at Bradesco BBI, says that he expects demand for Brazilian fixed income securities will remain strong for a variety of reasons – not least there is a relatively small pipeline to be placed at the moment: “Most of the frequent issuers are excellent credit risks with conservative managements and issuers are conservative with their capex and so financing needs won’t be high,” he says. “EM funds are also very liquid and are eagerly seeking exposure to good credit risks – Latam and Brazil should continue to represent a reasonable part of their portfolio for historical and index reasons and there is still an attractive arbitrage in Brazilian bonds when you compare them to bonds with similar ratings from different regions.” Leandro also agrees with HSBC in that devaluation could spark fresh capex requirements: “Most of the Brazilian frequent issuers are large exporters whose revenues will benefit from BRL depreciation as their products become more competitive. Investors are aware of that and, as such, a BRL depreciation should not represent a concern, but rather a credit enhancement.”
This technical demand that is derived from fixed income portfolio managers and investors tracking indices that almost impels them to buy Brazilian bonds (albeit sometimes with small ‘tracking errors’) coupled with the likely more modest volume from the country gives most bankers who are tasked with selling these deals comfort for 2015. Even when asked about a possible downgrade (and the conversations switch to ‘un-attributable’ for fear of entering a political minefield – or even simply loathe to appear downbeat on one of the region’s core markets) there is a striking lack of fear evident in tone. Most suggest it probably won’t happen (while conceding it is becoming a material risk) and they argue that Brazilian issuers managed to sell bonds before they had investment grade ratings. They contend that while the pool of investors will shrink – and there will be volatility while those with investment rules require forced divestitures of Brazilian paper; the pricing mechanism of the market will enable continued access through a higher spread. “Spreads would widen and access would be more difficult to manage and navigate but with 80% of the volume in Latin America now investment grade there would be plenty of room for non-investment grade transactions,” is a typical response. “Ten years ago it was the other way around – only about 20% of deals were investment grade and so even if a big credit like Brazil was to go, it wouldn’t be the end of the world as we know it. Certainly it would be an important change but the market would cope and would continue to provide financing alternatives to the Brazilian complex of issuers.”
But some are not so sanguine. The market has already re-priced to an extent: Brazil’s credit default swap was around 170bp in early November, well outside 83bp for Mexico and Colombia and Paraguay both under the 100bp threshold.
Daniel Tenengauzer, Head of EM & Global FX Strategy at RBC Capital Markets in New York, says that shift could continue: “The main risk is sovereign risk – in the sense that the fiscal situation is concerning and we could see CDS widening, which implies that everything widens in line with that. So that’s one key consideration. The next consideration is even bigger: what is going on with Petrobras? It’s a very large issuer – there is now an investigation into the company by the SEC and it could have a big impact on the broad corporate issuance in dollars from Brazil by dragging the cost of funding for the entire private sector up and down – depending on how the investigations continue from here. It’s definitely something that is something that other issuers need to pay attention to when they think about issuance outside Brazil.”
Others see Petrobras as a source of optimism for Brazil’s ability to attract liquidity in difficult moments: “I am reminded of the time that we did the transaction for Petrobras” says one banker who declined to comment publicly on Petrobras at this time but who was involved in one of the quasi-sovereign’s 2014 international transactions. “At that time there were a lot of question marks around Brazil and the deal – as a proxy for Brazil Inc – was a massive affirmation that, notwithstanding some challenges, there was a huge amount of interest to absorb another very large funding. It reminds me that although Brazil may not be viewed as the darling of the market it was 24-36 months ago, it is still an incredibly important real economy, with a very robust private sector that has global connectivity across several industries.”
But those who argue that Brazilian issuers could tap the international markets with a small premium should there be a downgrade – because they did in the past – are (possibly deliberately) missing the point that markets work on trajectory as much as the ratings themselves. While ‘Brazil Inc’ attracted good liquidity as a high yield credit it was an improving credit and investors saw the likelihood of yield compression. “It’s the direction of the pendulum that is most important,” says one banker, explaining why the markets are putting so much emotional energy in the announcement of the new economic team and its articulation of strategy. “That expectation about whether they are implementing the right measures will really dictate the tone and the relative appetite for success that investors will have in terms of coming to the market. Is the pendulum swinging back to positive or will we find in a year from now that we have continued to swing in the wrong direction?”
While the volumes of issuance in the international markets are uncertain, the local markets are expected to fare well. Issuance volumes should meet –or if not exceed – 2014 levels based on a continued local needs, a growth in infrastructure-related debentures and possible acquisition capital needs. Also, with access to the international markets uncertain for the less strong Brazilian credits, bankers predict an increase in securitizations in Brazil next year (unsecured transactions remain just for the best credits in the Brazilian local markets).
Our view is that the local markets will remain open and very receptive for local issuers,” says Antonio Oliveira, Executive of Capital Markets at HSBC in Sao Paulo. “The government has just promoted a new round of concessions, in addition to airports we have seen transmission lines, power plants, water and sewage works so we have a lot of projects that are still in the construction phase.” These projects typically get financed through short-term paper such as Commercial Paper as buyers before being recycled into longer-term debentures as investors in the latter don’t like taking construction risks. Oliveira also expects an increase in FIDC securitization structures, particularly from issuers such as the energy and distribution companies that have suffered local downgrades in recent times due to the stress on the industry. “There is also the potential for the ‘elephant’ transactions that are in connection to the large acquisition financing that has the potential to happen as local industries consolidate.”
While there is optimism about supply, there is confidence about the demand side to the equation. The very high local interest rates – the Central Bank raised the base rate to 11.25% just after the election and further rises are expected. “There is a captive liquidity in Brazil,” says Oliveira. “There are almost no other products or markets that pay the rate of return of Brazilian fixed income and there is a large liquid local investor base now – especially for floating rate corporate transactions since the federal government has cut its floating debt profile from around 80% to around 50%.”
And it’s not just local investors who see the obvious appeal of the interest rates on offer in Brazil’s local market. A Bank of America Merrill Lynch report said than in September foreign investors increased their local fixed income holdings in Brazil by $4.7 billion – more than any single country in the last three months and 42% of the total monthly increase.
However, interestingly the international investors target a different local market trade to the Brazilian investors, according to Tenengauzer. “The international investors are receiving the very long bonds – the Jan 2021s for example. This is the one trade where they still feel comfortable that even if inflation goes to 7% or 7.5% there is enough cushion at the back end. The approach of the locals is dramatically different because they are a lot more cautious about the risks of sharp increases in interest rates. The short-end is incredibly volatile but if you look at some of the large local investors – they are saying this position might cost us in the short term but they have to stay defensive and alive to the fact that rates could leap to anywhere up to 20% in the coming months and they don’t want to be exposed to that possibility.”