Brazil guide: Brazil’s credit rating strengthening while the world weakens

The latest ratings upgrade came from Standard & Poor’s, which on 17 November raised Brazil’s rating to BBB from BBB-. S&P analyst Sebastian Briozzo said that Brazil’s resilience within the global economy was the driving factor behind the ratings upgrade: "The Rousseff administration of Brazil has demonstrated its commitment to meeting fiscal targets, thereby enlarging the scope for using monetary tools to influence the domestic economy. We expect the government to pursue cautious monetary policies that, combined with the country’s growing economic resilience, should moderate the impact of potential external shocks and sustain long-term growth prospects."

The government’s tightening of fiscal policy through budget cuts – the biggest challenge President Dilma Rousseff faced at the beginning of the year, according to most Brazilian economic analysts – is expected to result in a consolidated public sector primary surplus for 2011 of 3.15%. S&P expects per capita real GDP to increase by 2.1% in 2011 and 2.4% in 2012 "barring an unexpectedly severe deterioration in external conditions". The agency also predicts that net general government debt will decline only gradually over the next three years from the 41% of GDP estimated for the end of 2011. "We expect that the current account of the balance of payments will reflect only moderate deficits of less than 2.5% of GDP in the coming three years with net foreign direct investment inflows financing a large share of these. That, along with the accumulation of international reserves that we currently estimate as covering 10 months of current account payments, is likely to sustain Brazil’s external liquidity."

The agency notes that monetary policy and macro-prudential measures are beginning to be relaxed but says that such counter-cyclical policies – when combined with continuing fiscal discipline – are not a threat to the country’s upgrade. A bigger long-term threat to further future upgrades is the low level of investment. According to the ratings action report: "Investment to GDP, estimated at 19.4% for 2011, and microeconomic rigidities in many sectors hamper its ability to increase per capita real economic growth much above 3% without running the risk of creating macroeconomic imbalances. Given the public sector’s limited, though improving, fiscal flexibility, we believe that the effort to increase private sector investment will be a key challenge for Brazil." S&P’s upgrade came less than a week after the sovereign conducted a re-tap of its 30-year bonds, in a continuation of the strategy of deepening the liquidity and narrowing the pricing of its benchmark bonds to facilitate access to the international markets for the country’s leading corporates. However, it is unlikely that the pricing would have benefited from the upgrade prior to the re-tap with the market already pricing the sovereign higher than its BBB- rating would imply. Brazil actually upsized the re-tap of its 5.625% 2041s to $1 billion from a proposed $500 million after the transaction attracted a book of more than $6 billion. With little else in the market, Brazil enjoyed pricing benefits of this oversubscription, closing at 114.700 to yield 4.694% or US Treasuries plus 160 basis points, equivalent to a concession of about 10 basis points on the outstanding notes. Brazil now has $2.8 billion of 2041s and $2.1 billion of 2021s. Bank of America Merrill Lynch and Barclays managed the transaction.

Corporate deals

The sovereign’s November re-tap will only help Brazil’s corporates access the markets, although as the end of November nears the volume of Brazilian corporate paper on the international markets has been low. At the beginning of September bankers reported a pipeline of between $5 billion and $7 billion, with many corporates readying to issue. This hasn’t happened, aside from some notable transactions, as corporates with track records are, despite low treasuries, reluctant to pay the higher new issue premiums being demanded by investors. Meanwhile the market doesn’t appear to be open for issuers of high-yield credits or first-time issuers.

Electrobras’s transaction on 20 October showed that market volatility is stifling demand from Brazilian credits. The quasi-sovereign is rated Baa2/BBB/BBB- and had set out to raise $2.5 billion but had to lower that to $1.75 billion in a trade-off for pricing over size. Despite offering a new issue premium of between 40 and 50 basis points, pricing at par with a 5.75% coupon, the company had to downsize the deal. That a quasi-sovereign is having to cut deal sizes shows the difficulty in raising the amount of capital that creates the liquidity investors are looking for in deals out of Latin America. An Odebrecht re-tap in mid-November shows how nimble Brazilian corporates are having to be to issue at good prices in the current environment. The company was approached through a reverse enquiry to re-open its 7.5% perpetual notes and sold another $250 million, with the book reportedly reaching $750 million. Odebrecht sold the re-tap at par and the deal was executed extremely quickly to ensure success amid market volatility. The deal was rated baa3/BB+/BBB- and led by BAML and HSBC.

The most recent of the four international bond deals that have closed since September was from Banco do Brasil. The bank priced a $500 million, five-year deal on 16 November. The deal wasn’t large and paid a new issue premium of about 30 basis points (the deal priced at 99.413 with a 3.875 coupon to yield 4%, or US Treasuries plus 312bp) but proved that the markets for dollar-denominated debt from Brazilian financial institutions remains open.

Beyond the dollar

Meanwhile, Brasil Telecom chose a real-denominated global structure to raise $662 million-equivalent. The telco managed to price at less than 10% - one of its key objectives – by pricing at 99.516 with a coupon of 9.75% to yield 9.875%. Brazil Telecom is a subsidiary of Telemar Norte Leste and the deal was rated Baa2/BBB-/BBB.

Global real bonds are an increasingly attractive option for Brazilian companies, with these offshore bonds denominated in reias offering both Brazilian issuers and international investors advantages over onshore local currency bonds and traditional international dollar-denominated bonds.

Brazilian issuers are attracted to global real bonds because their yield curves trade through the domestic curve. Although issuers have to pay an IOF tax if they wish to bring the proceeds onshore, the cost of funding – even with this tax – is lower than these companies can achieve in the local capital markets. And if the issuer can deploy the proceeds outside of Brazil the savings are even higher.

Despite the cost savings on offer for the issuer, international investors still receive a yield pick-up which has driven sufficient appetite to close a string of deals this year, with Banco Safra closing a global R$800 million bond in early August. Banco Safra’s deal attracted a book of more than $1.6 billion, while Brazil Telecom received orders of close to R$2 billion. Banco Votorantim, power company Coelba and Arcos Doradas have all issued global real bonds this year, with the first, Banco Votorantim, structured as inflation-linked notes.

A recent transaction by America Movil (AMX) also shows that for the stronger Brazilian credits the yen-denominated market is a possible option. In October 2011 the Mexican company potentially paved the way for other Latin American companies with the first ‘Samurai’ transaction in more than five years and the first such corporate deal that was closed without a JBIC guarantee. AMX raised $156 million equivalent (¥12 billion) in a dual-tranche issue.

Domestic growth

Despite the higher cost of the domestic debt capital markets Brazilian companies have issued more transactions so far this year than in 2010, in part because of the difficulty in executing international deals with this market’s recent market volatility. In 2011 there have already been 50 bonds sold in Brazil’s domestic capital markets compared with 33 last year, although smaller average deal sizes this year mean that total volumes stands below last year’s total of $10 billion at $9 billion. Bradesco BBI is rated the leading bookrunner for domestic bonds, with a 21.7% market share (23 deals worth $2billion), compared to fourth place last year and a market share of 12.9% (11 deals worth $1.3 billion). Last year Santander headed the domestic debt league tables and but this year falls five places to sixth with a market share of 9.4%, eight deals worth a total $884 million. Itaú climbs four places to second (15 deals with a market share of 20%) and Banco do Brasil (nine deals, market share of 15.7%) and BTG Pactual (15 deals, 11.5%) take third and fourth place respectively to keep the top four positions in the hands of domestic banks. HSBC, which retains its 2010 ranking of fifth, is the only international bank in the top five.

The international banks, for now at least, are in a stronger competitive position when it comes to international debt transactions. Santander claims first place from last year’s top-ranked HSBC, with 12 bookrunning mandates worth $4.7 billion, or a market share of 13.4%. JPMorgan drops a position from last year’s second place to round out a top three of international banks. JPMorgan’s 2011 market share is 9.4% from 12 deals. Even in this category the domestic banks are the momentum story: Itaú is now third (last year fourth), Bradesco is ranked tenth (down one position) but the eye-catching story is BTG Pactual’s appearance in the top 10. Last year, BTG Pactual ranked 17th for international bookrunning with three deals worth $474 million, or just 1.2% market share. This year the bank has been bookrunner on seven deals worth $1.6 billion, equal to a market share of 4.6%. This is turning out to be a breakthrough year for BTG Pactual in international debt transactions and a top 10 finish will go a long way towards broadening out the bank’s reputation: to date the investment bank has been thought of purely as an ECM and M&A (and asset management) house. While DCM will still clearly be weaker than its other investment banking capabilities the bank is growing its debt reputation.

Beyond BTG Pactual the other bank enjoying a good year in terms of international bond deals for Brazilian companies is Citibank. Last year Citi was ranked 13th, with a market share 2.2% on the back of four deals worth $835 million. This year the bank has already clocked up international mandates for 14 deals worth $2.5 billion and a market share of 7.2%, which puts it in sixth place. These results show that Citi’s strategy of focusing its Latin American growth on Brazil is bearing early fruit. This year the bank relocated Mariano Gaut from New York to São Paulo to be the head of Brazilian capital markets origination –both debt and equity – and Andre Kok joined the bank from Itaú to be responsible for origination of corporate and investment banking (see Euromoney’s September issue for an interview with Citi’s senior Latin American management team).

Corporates resist Latin American weakening

It is not just the sovereign that is beating the global trend and being upgraded. In September a research report by Moody’s suggested that the cycle of improving corporate ratings in the region was peaking, with downgrades expected. The second quarter of 2011 represented the eighth consecutive quarter of positive rating actions outnumbering negative ones for Latin American corporate issuers but, while it may continue in the third quarter, Moody’s believes this cycle is nearing the peak.

However, the research also shows that while credit quality within Latin America may soon begin to deteriorate, Brazilian corporates are relatively immune to the negative outlook. In 2011 all but four of the positive rating actions taken by the rating agency occurred in Brazil. The Moody’s report states: "The strong performance by the Brazilian companies, which included two crossovers to investment grade from speculative grade is particularly noteworthy and reflects the ongoing maturity of the country as a leading economic player in the region and, increasingly, on the world stage."

The two crossover companies to achieve investment grade ratings from Moody’s are chemical producer Braskem and rental car company Localiza (both Baa3 from Ba1). While the ratings inevitably involve a large element of company-specific factors the contribution of "the improved operating performance reflect the relatively strong macroeconomic environment". Another two Brazilian companies – Gerdau and Cosan – have been put under review for potential upgrade to investment grade status. Gerdau’s review was driven by the issuance of new stock to further strengthen its capital structure and financial flexibility. Cosan’s decision to enter a joint venture with Shell, creating Raizen – which will be the largest sugar ethanol producer in Brazil, was the reason it is being considered for an upgrade to investment grade.

Bankers say the volatility in the global financial markets is leading to a repricing of risk from Latin America. This repricing of risk – along with the scaling back of capex in the face of falling GDP growth worldwide – explains the falling volumes of international debt. However, ultimately bankers say this repricing of emerging market risk will be a good opportunity for higher-quality issuers in Latin America. Moody’s agrees: "We believe that for the remainder of 2011 new debt issuance will likely remain limited to established, mostly investment grade issuers" but if the crisis passes "we would expect the region to remain appealing for investors as macroeconomic fundamentals and yield differentials are likely to remain attractive on a relative basis. Under such a scenario, we would expect some companies to explore issuing BRL-linked cross border debt."