LatAm bond markets: Brazil’s local markets brace to take the strain

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The troubles at Petrobras have hurt all of Brazil’s borrowers but bankers in the country think the worst is now over and that the bad news has been priced in. The proof will come when issuers return to the markets, but who wants to go first – and can the local markets produce the goods?

By Rob Dwyer

"The local market needs to step up now that the international market has closed," says Rodrigo Gonzalez, head of DCM for the Americas at Standard Chartered Bank. "The local market has historically been a short-term but big market that has absorbed the majority of local needs. The question is, for all those corporates that have capex and longer-term financing – to what extent will the local market take over?"

Leandro Miranda
  We are in a period of such volatility regarding interest rates and premium for specific risks that market participants are discussing what will be the right pricing for companies from now on

Leandro Miranda,
Bradesco BBI

The effective freeze-out of Brazilian issuers from the international markets since the corruption at Petrobras came to light, coupled with its inability to file audited 3Q2014 results, has shifted the focus on to Brazil’s local debt capital markets. According to Dealogic, Brazilian issuers placed 51 deals worth over $42 billion in the international markets in 2014, which is a lot of money to now be sourced in the local markets.

However, refinancing requirements this year are low and Petrobras, a $10 billion-plus annual issuer in the international markets, is unlikely to be raising any fresh funds for a while. With a recession forecast in 2015, many Brazilian companies will be rethinking their capex needs. Also, at some point the Petrobras issue will be resolved – one way or another – and Brazilian issuers will have access to the international markets again. So the actual amount to be absorbed is likely to be much less – some expect under $10 billion – and last year, according to Anbima, Brazil’s Financial Capital Markets Association, the local market’s fixed income volumes topped R$140 billion ($49 billion), of which debentures, the local bonds, were R$70.5 billion.

If Brazilian companies can, therefore, be optimistic about seeking the volumes they need from the local markets there is less good news about the tenors available. Brazil’s local debentures are structured much like loans. Banks fully underwrite the deals and therefore have to take paper onto their books if there is a lack of appetite from investors (there are very rare examples of 'best-efforts’ arrangements). In the past many of these debentures weren’t at all distributed but were simply passed along to the asset management arm of the bank. Some still are, although this is rarer today. Tenors are short – averaging around five years, with 3.5 years the average life. Deals were getting longer when the Selic base rate was forced down a couple of years ago to 7.25% but as it has rebounded to 12.25% the lengths of debentures shortened.

In 2009 the Brazilian Securities Commission (CVM) launched Regulation 476, which is designed to speed up debt issuance in the local markets. The specifics changed recently, but the concept is that these deals can be marketed to a select number of investors (now 75) and sold to a sub-set of them (up to 50). Also, as opposed to the formal offering regulation (400) there is no need for prior notification or a deal prospectus given to the CVM – although 400 deals can be marketed and sold to an unlimited number of qualified investors (those with more than R$1 million in liquid assets). Also, with 476 deals, the bank can distribute to an unlimited number of investors through secondary distribution after 90 days.

The effect of 476 was to create a nimbler debt-raising tool for companies, which is particularly useful in times of volatility. This can impact on the longer 400 transactions. Leandro Miranda, head of investment banking at Bradesco BBI, says Brazil is in a 476 moment: "We still have huge liquidity, nevertheless we are in a period of such volatility regarding interest rates and premium for specific risks that market participants are discussing what will be the right pricing for companies from now on."

'New benchmark'

The local markets are restricted to the strong investment-grade rated companies in normal times, and the contagion has spread from Petrobras to affect the local market (albeit to a much lesser extent than the international markets). But Miranda says he is working on a new Regulation 400 deal that will come to market in March and will re-establish a solid local benchmark, with which to reprice all local investment grade credits.

"We are about to experience a shift in the risk premium," he says. "This will be a major transaction from one of the top Brazilian private companies that will bring everyone together, create momentum and fix the pricing issue. It will set a new benchmark that other private companies can use and from this point the market will pick up."

Miranda believes that Brazil is close to an inflection point, with the barrage of bad news about to bottom out and the outlook set to take a more positive tone. Even if power and water rationing are introduced, he argues investors will shrug this off as "all the positive downsides are already priced in". However, even if international investors – and many domestic investors – share this optimistic reading of the outlook for the Brazilian macro-economy they won’t be participating in this upcoming 400 transaction. Simply put, sovereign paper pays too well. With the base rate at 12.25% investors can pick up very high yields almost risk-free and so there is absolutely no incentive to add credit risk and pick up 100 or 200 basis points. Plus the sovereign investment is tax free.