Latin America: Fair political wind could bring ‘two years in one’ for investment banks

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By:
Rob Dwyer
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2018 to outpace strong issuance volume seen last year; appetite for Brazilian risk is surging.

Capital markets activity should increase from last year’s high volumes, according to investment bankers – and some are excitedly talking about record volumes.

“If the [Brazilian presidential election] opinion polls are favourable to a market-orientated candidate by June, then we could have two years in one,” says one São Paulo-based debt capital markets (DCM) professional.

“The demand for all Brazilian risk continues to be very strong – it’s supply that’s the issue as companies are proving to be more cautious than investors and are waiting for clarity in the presidential election. But if that looks to be going well, they will begin to trigger 2019 investment plans and that will require debt – and equity.”

For the past 12 months, one of the main market themes in both the international and domestic markets has been pre-funding and asset-liability exchanges as international demand reduced premia and US treasuries remained low.

“[The] prefunding theme has been prevalent for the last 12 months and is likely to continue as the Fed is on the predictable tightening path, making refinancing exercises of the next two-to-three year maturities economically sensible,” says Max Volkov, head of LatAm DCM at Bank of America Merrill Lynch.

Optimistic

Volkov is optimistic about the year ahead, adding: “Cross-border issuance to fund local investments should result from increased economic activity in Brazil, where GDP growth is expected to reach 3%, and Argentina [which is also predicted to enjoy renewed GDP growth]. 

“Local elections in Mexico, Colombia and Brazil are likely to push more of issuance in the first quarter and first half of 2018, which is what we have been seeing so far in January 2018, which is likely to exceed all-time primary issuance record.”

Argentina and Mexico got off to a flying start with $9 billion and $2 billion deals in the first week of this year.

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Max Volkov, BAML

Volkov says that investors are not showing fatigue in credit from the region.

“Despite the volumes [in 2017], the supply was absorbed very well,” he says. “2018 has started on an even stronger note, continuing the themes of investors’ growing appetite towards emerging markets (EMs) and LatAm in particular, as it offers one of the best relative value in the EM universe.”

An expected reduction in supply in US investment-grade issuance in 2018 should also support the technical picture, and bankers report strong demand across all parts of the curve with a focus on long duration – one DCM banker says he expects 30-year deals to be a strong theme this year.

Last year’s improvement in LatAm fundamentals and the continuation of an incredibly benign environment for EM inflows saw a big pick-up in all capital markets activity in 2017.

According to data from Dealogic, international DCM volumes across the region were the highest (at $194 billion) since 2014, and were just short of that year’s record result. Equity issuance hit $27 billion – the highest since 2013 – and M&A also saw a strong result, with $113 billion in volumes (the highest since 2014’s $124 billion).

In total, investment banking fees showed a resurgence, hitting $1.7 billion, up from $1.1 billion in 2016 and just $970 million in 2015).

Expectations are for fees to increase further in 2018.

Leandro Miranda, head of investment banking at Bradesco BBI, says that the diversity in recent deals and of those in his bank’s pipeline reflect the healthy risk appetite of international investors.

Outside traditional axis

There is a particular trend for companies outside the traditional Rio de Janeiro- São Paulo axis preparing to come to the markets, with companies from other Brazilian states comprising the majority of the $10 billion-plus of deals expected to be executed in the first quarter of this year.

“We are very positive about the coming year – we are hiring,” says Miranda. “We have seen a strong start to the year and we have noticed that since 2016 international investors have begun to to increase the allocation of Brazilian assets in their EM and LatAm portfolios again.

“But they are still below the levels that they were in 2010 – there is still a lot of room for adding Brazilian exposure.”

Miranda says he believes one of the key drivers of equity issuance this year will be private equity (PE), adding: “I expect more PE funds to be selling their stakes on the stock exchange,” as well being busy throughout the PE cycle – returning funds, raising more funds and leveraging up new targets through an expected spike in acquisition finance.

Miranda acknowledges that the presidential election could inject some volatility into the market from June onwards, but argues that potential issuers have strategic flexibility to raise equity finance.

“Many companies are pursuing a dual-track process: they are preparing for an IPO but are prepared to sell controlling stakes through M&A,” he says.

“And while, theoretically, selling minority stakes get the best valuations through the equity markets and selling controlling stakes achieves the best result through M&A, interestingly this isn’t necessarily true in today’s market.”

He also argues the positive perspective on Brazilian risk will see deals continue regardless, saying: “If there is more volatility, we will have fewer IPOs and more follow-ons – they are the less risky and quicker transaction.”