In early November senior financiers gathered in São Paulo for Project Finance magazine’s annual Brazil conference. Against the background of Italy’s government falling as markets pushed its bond yields over 7% and a technocratic government being installed in Greece, the prospect for continued long-term debt from European banks – a key provider for Brazilian projects – looks uncertain. 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."
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| 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."
Pension funds are seen as a good potential supply of liquidity for long-term infrastructure-based securities, with the long-term nature of these assets better matching in tenor the longer-term liabilities of many domestic securities. "But today you still have high interest rates and sovereign paper [and so if I was a pension fund] I will go where the interest rate is high rates and risk is low," points out Aboussouan. "As long as you don’t fix this environment, where the pension funds have the choice of high interest rates and low risk, there won’t be an appetite for greater risk."
Aboussouan also points to the current lack of secondary trading – and therefore liquidity in these assets - as another structural disincentive for institutional investors to start funding long-term infrastructure risk.
Odebrecht’s Felberg is also looking to another type of institutional investor as a potential supplier of project debt: insurance companies. "We know that recently insurance companies in Brazil were allowed to buy long-term bank paper for their technical reserves and [that equals] between R$35 billion and R$40 billion. There is a lot of money sitting there on the sideline that would be available for funding infrastructure projects. In developed countries infrastructure is financed by that kind of investor – Canada is a good example – a lot of institutional investors’ money and insurance money flows into infrastructure. If the insurance companies in Brazil start buying long-term bank paper for their technical reserves then we have potentially just opened an interesting market."
European banks
But just how dramatic will the European bank withdrawal from the project financing market in Brazil be? Fuensanta Diaz Cobacho, head of infrastructure for the Americas at WestLB, admits that the European crisis will create a strain on the ability of European banks to deploy capital in the region: "You won’t be seeing a lot of banks coming with new business because of funding and liquidity issues but I don’t necessarily see a dramatic change, at least in Brazil. Banks will become more opportunistic but any European-based player who has a large presence in Brazil will view Brazil as the market that will weather them through crisis so I don’t see things changing for Brazil."
Cobacho is less upbeat about the likelihood of European banks’ commitment to deploy capital in the rest of Latin America, but says that Brazil is too important a market for the European banks to exit. "If we don’t want to lose market share in Brazil and we want to continue to have a market share we have to be here despite the cost and despite the fact that from a portfolio basis the return is less," says Cobacho. "Banks with a global scope have to be here. There is no question – we have to be here despite the cost because today it represents more than 40% of the region and now Brazil’s domestic companies are global players and they are looking into other regions and we need to be here to go with them."
