Brazil guide: Project finance and the infrastructure challenge

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The agenda had been written in advance, of course, but the panel discussing who would fund the gap in BNDES looked to be focusing on the wrong source: a more pressing question is who will fund the withdrawal of long-term bank debt from the international banks. Brazilian bank debt is still short term; debt securities issued in the local capital markets rarely go beyond tenors of eight years and there is still a question-mark about whether an investor base of both international and domestic capital markets will develop a risk appetite to fund projects.

The demand is there: infrastructure and power projects have long been cited as a bottleneck on the country’s growth potential and the upcoming FIFA World Cup and Olympic Games in 2014 and 2016 have just increased the urgency for investment. In anticipation, the country’s three largest airports are going through a partial privatization, with the bids expected to be announced early next year. Beyond that there are huge capital requirements for the oil and gas sector. Petrobras’s capex for the next three years is $174 billion and will create the need for huge investment from its suppliers. The country is developing its own drill ship construction project and that alone is expected to need at least $6 billion in financing.

Luckily for Brazilian-based projects, BNDES as a source is not likely to diminish any time soon. In 2010 BNDES disbursed R$549 billion, of which 42% was channelled into 195 energy and infrastructure projects. The projected increase for 2011 is 19%.

But the sheer scale of capital expenditure needed means fresh sources must be found. Diogo Casto e Silva, executive vice president of investment banking for Banco Caixa Geral - Brasil, says: "The need is there [in terms of sponsors] and the equity is there. Our biggest challenge is to open up bigger sources of funding in terms of the debt in order to get the higher returns and get the whole process going. [The aim is] to open up the whole spectrum of debt providers we have to tap into and get the institutional investors playing a role in project bonds."

Silva adds that with changing regulations – and more immediate calls on capital and capital raising, especially in Europe - the climate for project finance is going to change radically: "We are facing new regulatory issues with Basel III and how that will affect our ability to lend into long-term project financing. In the next five years all financial institutions will be facing major challenges to find the way to work together with institutional investors to have the financing available."

BNDES is a strength and weakness in terms of developing new forms of debt capital for projects. The interest rate at which BNDES lends varies (depending on perceived credit risk, for example) but according to Nelson Siffert, head of infrastructure development at BNDES, the average rate is 8.4% a year. He says that, with an assumed inflation rate of 5% (although currently it is over 7%), that equates to a 3.5% return on BNDES’s investment. However, with the country’s Selic rate at 11% (recently reduced from 12%) it is clear the commercial sector cannot match BNDES’s rates.

Subsidized rates

With the subsidized rates on offer from BNDES, project sponsors will continue to focus on BNDES debt, according to Marcelo Felberg, finance director at Odebrecht Transport: "BNDES will continue to drive the market; it is foolish to think otherwise. The important thing is that we need to look for ways to work together with the bank – they will continue to drive the market and be the main player in Brazil."

"I think the local banks are more concerned about BNDES competition than anyone else," says Karla Fernandes, director at Deutsche Bank’s Banco Alemão Trust & Securities Services. "Because for some large transactions, like the financing of the 21 drill ships for Petrobras that need to happen in the next year or so – which is large volume finance – the local banks are very concerned that BNDES will say ‘Yes I can do that’ and then there is no role for Brazilian banks."

Opening ceremony of Petrobras Brazilian Oil Rig at Angra dos Reis, 2011

"Overall the appetite to do business in Brazil is huge – in every sector and every industry – and it’s no different with the appetite of the financial industry to lend to Brazil’s project finance industry. One of the challenges we face is the role that BNDES has played in the past," says Francis Ndupuechi, director of global infrastructure finance at Scotia Capital. "But I believe in the next few years the appetite from the banks could evolve with BNDES playing a broader role, in the sense that its strength can be multiplied many times over if it can be used more as an enhancer into some projects, instead of BNDES being an immediate direct lender. If the project finance units at commercial banks work together, combining their strengths, they can multiply the capacity of the local market. This evolution should come in the next few years."

However, for Jean-Mark Daniel Aboussouan, chief of structured and corporate finance at the Inter-American Development Bank, it is the high interest rate environment, not the subsidized BNDES loans, that are preventing the local banks and capital markets getting involved in the long-term finance of Brazil’s infrastructure needs.

"I wouldn’t say BNDES is here to prevent the others coming in," says Aboussouan. "The problem is the others can’t come in yet so BNDES is, to a certain extent, the sole option. There are some fundamental reasons for this, such as the fact that interest rates in Brazil are still high and so long-term financing in reais through the banks or through the pension funds is still very high. Once you go beyond seven or eight years debt becomes very expensive. Before interest rates come down, it is going to be very hard to find an alternative."