Brazil’s capital markets proved exceptionally sluggish in 2014 and prospects for 2015 do not look promising either. Equity deals brought to Brazil’s stock exchange last year were less than half the previous year, a total of $6.3bn. This included a record low of just one initial public offering (IPO) – the $192m listing of animal health company Ourofino Saúde Animal.
Meanwhile, machinery rental company Ouro Verde Locação e Serviços and airline Azul announced earlier this year they had decided to postpone planned IPOs due to adverse conditions in capital markets. Furthermore, although debt issuances were of similar levels to a year earlier, volumes were largely skewed by a few exceptionally large deals by state-owned firms.
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Much of the current inactivity and withdrawals are explained by Brazil’s poor macroeconomic conditions. Gross domestic product (GDP) growth is expected to be flat for both 2014 and 2015, inflation is projected to rise to 7% in 2015 and indicators such as fiscal deficit, trade balance and public debt as a percentage of GDP have all worsened – in some cases to record levels of weakness.
Record deficit
Goldman Sachs’ chief Latin America economist, Alberto Ramos, points out that Brazil's current account and fiscal deficits combined now exceed 10% of GDP – the largest collective deficit in 15 years. This reduces the government’s ability to directly boost economic activity. Itaú Unibanco's chief economist, Ilan Goldfajn, expects not just flat but negative GDP growth this year.
“There is no room for IPOs for now,” said Jorge Simino, who manages 23bn reais ($8.1bn) as chief investment officer of Fundação Cesp, Brazil’s fourth largest pension fund, when talking to Reuters in February. “The outlook determines activity and the outlook doesn’t look good.”
To make matters worse, investors are being put off Brazil’s issuers because of a colossal corruption scandal centred around state-run oil giant Petrobras, which erupted in March last year but gathered full speed in November. Prosecutors accuse Petrobras executives of conspiring with Brazil’s largest construction companies for a decade to inflate the oil company’s contracts, stealing billions of dollars to fund lavish lifestyles, pay bribes and funnel money to politicians.
The alleged kickback scheme is said to have involved contracts worth more than $4bn. The chief executive of Petrobras, Maria das Graças Foster, who is not directly accused of any wrong-doing, eventually resigned and was replaced by Banco do Brasil’s Aldemir Bendine in February.
Foreign investment turn off
The accusations have effectively cut Petrobras off from capital markets and undermined growth for the country’s largest construction companies accused of being involved in the scheme. It has also naturally jittered the nerves of foreign investors, crashing the optimism generated only a few weeks earlier by the appointment of market-friendly Joaquim Levy as the country’s finance minister. Mr Levy is seen as an orthodox policy-maker and had announced measures to improve public finances, a move that reassured foreign investors, who have traditionally played a crucial role in Brazil’s capital markets.
"In the medium term, the market is looking for more stability on the economic front and resolution to the issues surrounding Petrobras,” says Katia Bouazza, head of Latin America capital financing at HSBC. “Once normality returns to the markets, we expect to see a pick up in the capital markets activity. The vast majority of investors believe that the new finance minister and his team have taken the right steps and there will be support from the markets if they stay the course. Although the markets are not active with Brazilian issuers at present, we believe that this could change in the second half of the year."
While some equity underwriters such as BTG Pactual, Credit Suisse and Goldman Sachs have also expressed the view that Brazilian market activity will resume in the second half of this year, others are more sceptical.
Market scepticism
Pedro Bianchi, head of debt capital markets in Brazil for Bank of America Merrill Lynch, places a higher weight on the country's poor macroeconomic background. A lack of growth has slashed businesses’ financing needs, while other external factors had encouraged corporates to store up capital in previous years. He believes that bond issuances will continue to stay low for the whole of 2015.
Expected rises in the US Federal Reserve’s interest rates were likely to attract investors away from Brazilian names, while the uncertainty of presidential elections in Brazil last year prompted issuers to take care of their financing needs well in advance of any political turbulence. Many companies raised funds in 2013, leaving 2014 as a year for managing existing liabilities and extending tenors for the majority of issuers, says Mr Bianchi – something that he believes will continue in the months to come.
Out of the $43.2bn-worth of Brazilian bonds issued last year, about one-third were raised by Petrobras, which brought to the market the first and second largest debt deals, while other large corporate issuances included state-owned lenders Banco do Brasil’s $2.5bn bond and Caixa Economic Federal’s $1.3bn notes.
“Most issuers had raised money in 2013 and to some degree in 2014,” says Mr Bianchi. “Last year was an election year, so everybody tried to anticipate funding needs in advance. Most issuances in 2014 were connected to liability management. The new money raised was not particularly large if you exclude a few large names. With the current lack of growth, we expect this to be the trend in 2015 as well.”
Reasons for optimism
Mr Bianchi is more optimistic, however, when it comes to the opening up of other sectors. Infrastructure projects are largely funded by local development bank BNDES, which can provide funds at highly subsidised interest rates. But as part of the Ministry of Finance’s plans to improve public finances, Mr Levy has already raised BNDES’s long-term financing rate for the first time in 10 years to 5.5%. Although still half the value of Brazil’s short-term benchmark rate, Selic, which is currently 12.25%, this is encouraging.
Making BNDES financing less attractive will encourage corporates to look towards the private sector for loans and the capital markets for raising infrastructure bonds. Brazil’s infrastructure spending is estimated to be $100bn per year for the next decade, according to official figures, so there should not be a lack of demand. BNDES itself had publicly supported the idea of the capital markets, complementing its activities as its president Luciano Coutinho, reiterated last November in São Paulo to an audience of deal-makers attending an event held by The Banker.
“If the government reduces financing for BNDES, which is something being discussed, we’ll start seeing opportunities for infrastructure-related deals in Brazil,” says Mr Bianchi. “This is probably not something that will materialise in the first half of the year, but it may become sizeable in the second half. You may see more projects come to the international markets – little by little, as reduced BNDES financing will be complemented by local and international capital markets deals.”
The pace of development of infrastructure bonds would of course also depend on interest rate levels. The higher the interest rate, the more likely investors will continue to flock to the safer sovereign bonds market. The Selic rate is at a three-year high as the central bank attempts to curb inflation.
Energy sector dimmed
Low growth in Brazil has slashed prospects and financing needs for businesses. Troubles in specific sectors have made things worse – oil and construction companies are suffering because of the Petrobras scandal, sugar and ethanol producers have been affected by lower sugar prices, and a drought has also severely impacted other agricultural-related activities, as well as the hydroelectricity sector.
In addition, options for corporates that need to raise financing may be limited on the banking side too, as Brazilian financial institutions continue to cut lending. This is particularly relevant for small and medium-sized companies with higher risk profiles, which, until now, benefited from credit driven by anti-cyclical policies at public sector banks such as Banco do Brasil. To contain levels of non-performing loans, which analysts fear had spiked last year, state-owned banks are expected to reduce loan flows.
Franklin Santarelli, head of Latin American financial institutions at rating agency Fitch, says: “[Over the past] two years, when banks were cautious that long-term growth [in Brazil] was very limited, you still had bank financing providing loans to the market. That helped corporate Brazil to finance their working capital needs, even if their financial profiles had deteriorated. [But now] publicly owned banks are clearly saying that they’re expected to keep decreasing the speed of new loans.” Small and medium-sized enterprises will not have the same access to working capital financing, he adds.
For larger corporates, however, which also tend to raise funds on the capital markets, the bank market remains a viable option, according to Mauricio Tancredi, head of corporate banking in Brazil for Bank of America Merrill Lynch. “What we are seeing is that the bank market is still active – more carefully, with shorter tenors, but there still is good reception of good-credit borrowers. We’re seeing some activity in the bilateral loans market and there will also be some activity in the syndicated market,” he says.
Mr Tancredi adds that a $700m syndicated loan for a large private sector issuer was being seized by lenders as The Banker went to press.
With lower corporate demand and viable bank finance alternatives, will capital markets professionals see business drastically reduced this year? Not necessarily, says Mr Bianchi, who anticipates continued growth in liability management services and expects more market share may be up for grabs.
Even with the development of the infrastructure bond market, debt market professionals may need to work on serving clients differently in 2015 and focus on providing services to existing financing, rather than seeking new capital-raising deals. Meanwhile, equity market specialists will have to continue hoping, along with everybody else, that the scandals will quieten down and the economy will pick up sooner than expected.
