The Brazilian capital markets boom arrived so quickly that several of the major investment banks were caught off guard. As a result, the US bulge bracket (major investment banks) is behind the curve in Brazil in terms of market share and it faces great challenges in catching up as there are limited acquisition options. The alternative is a slower, organic growth of the business.
“The only active US bank [in the capital markets] is Citigroup. The Swiss banks are here, there are the local banks and ABN AMRO,” says Jose de Menezes Berenguer Neto, executive vice-president and head of capital markets for Banco Real ABN AMRO. “The local presence of banks such as Goldman, Lehman, Morgan Stanley and Merrill Lynch is small and quite limited and disproportionate to their share of the global market.”
ABN AMRO bought Banco Real in 1998 and has since built up the capital markets operation. Mr Berenguer says he is unable to comment on the impact that the proposed sale of ABN to either Barclays or the Santander/ Royal Bank of Scotland/Fortis consortium would have on investment banking. But clearly if Barclays were the victor, the strengths of Barclays Capital, the investment banking arm, would bolster the Brazilian operation and make Real an even more formidable competitor.
Playing catch-up
This would make it even more difficult for the bulge-bracket houses to build their operations to a level where they have the same presence as, say, Credit Suisse – which bought Brazilian investment bank Garantia in 1998 – or UBS, which purchased Pactual for $1bn in 2006.
Why have the US banks been slower in Brazil than in other major emerging markets such as India, where Merrill has a significant presence, or China, where Morgan Stanley has been a pioneer?
There are several reasons. Key among them is the difficulties they faced during earlier Brazilian crises. Major investment banks have expanded their offices in Săo Paulo several times in the recent past, brought in expensive expatriate bankers and recruited locally, only for the economy to go into a tailspin. Then they have had to retrench and write off the costs.
While in other emerging markets the growth in the capital markets has been more protracted, in Brazil only five years ago the equity market was on its back as investors worried about the impact of policies coming from the centre-left government of newly elected president Luiz Inácio Lula da Silva. Daily stock market volumes at that time were in the $100m to $150m range. Today, by contrast, they are in the region of $2bn as Brazil has joined other emerging markets as a popular investment choice.
“We always expected that things would come right in the capital markets but we didn’t expect it to happen so fast,” says Mr Berenguer. Now Brazil is the leading emerging market after China, he says, with a huge pipeline of deals, many mid-sized companies that are raising debt for the first time and doing initial public offerings (IPOs), a wave of mergers and acquisitions (M&As) and predictably a shortage of professional staff to carry out all the work.
Smooth runnings
Fortunately, investment by the Brazilian authorities in market infrastructure and improvement in regulation means that this spike in activity has not been accompanied by the kinds of processing snarl-ups that have been evident in other markets. The boom may have caught some investment banks by surprise but not, it seems, the Brazilian authorities.
Now the problem for those banks wishing to catch up is that the major acquisition targets have been gobbled up. “There are no banks to be bought and that leaves only the route of growing organically and [by definition] more slowly,” says Mr Berenguer.
In fact there are still one or two targets left, such as Banco Fator – although its management insists it is not for sale – and there are rumours that another crop of home-grown boutiques is on its way to fruition. Some of these operations are likely to be founded by veteran bankers from the likes of the former Garantia and Patrimonio (sold to JPMorgan in 1999) that want to try their hand again, others by younger bankers who have worked a couple of years in the major houses and think they can do better on their own.
Others may come from the Brazilian development bank BNDES and would have the advantage of understanding the government situation better than private sector bankers. The aim of these start-ups would be to establish a business and then sell out to a major name.
The speed of the changes in Brazil has surprised everyone. For example, bankers at Banco Fator – established 40 years ago and involved in investment banking since the 1990s – note that IPOs were thin on the ground for most of that time.
“Now we are talking about 25 new IPOs between June 1 and the middle of July,” says Fator president Manoel Horácio F da Silva. “That’s $12bn in 45 days.” Fator itself is six times bigger in equity terms than it was in 2002 when the bank went through a major restructuring, enabling Walter Appel to become the controlling shareholder.
In Lula we trust
Mr Horácio notes that Mr Appel was always optimistic about the future of Brazil under President Lula when others had their misgivings and this spurred him on to invest in the bank. Previously, Fator had four shareholders who ran their different areas of the bank – brokerage, asset management, treasury and M&A – as almost separate institutions with contrasting cultures that reflected their individual personalities.
Mr Horácio, who has spent his career restructuring companies in Brazil and readying them for privatisation, was brought in to negotiate and bring about the changes at Fator. But he insists that even with major investment banks now impatient to increase their presence in Brazil, “Fator is not for sale” – although he does concede that an IPO might be possible at some stage. Right now the bank is busy expanding in the US so that it can better distribute the equity and debt of other Brazilian companies rather than focusing on its own capital structure.
“We have great distribution capability and capacity for research, especially in the small and medium-sized sector,” says Mr Horácio, while acknowledging that competing for the major IPOs is tough for a smaller bank.
Capital markets experts in Brazil agree, however, on two things: first that the current centre of attention is the mid-cap sector and second that the country has now reached a level of maturity whereby its markets are less volatile and prone to crises. This makes the risks involved in lending to or investing in the securities of mid-range companies more manageable.
Fator’s banking analyst Maria Laura Pessoa says: “Brazilian [commercial] banks used to make all their money by investing in government securities but now the rates have come down they are forced to lend.” She notes that lending to mid-sized companies still carries risks but that the banks have the capability to manage them.
The typical capital markets route of a mid-sized Brazilian corporate is to first allow a private equity firm to take a stake, which helps improve their systems and governance; then they do a high yield bond issue; and finally an IPO. But things are moving so fast that sometimes a foreign investor buys them out before they even get to the public markets.
Clouds on horizon
Analysts are questioning whether these rosy conditions can last forever. The recent turmoil in the US Treasury market hit Brazilian spreads, but not in the dramatic way it would have done a few years back. As Mr Horácio says: “Bad news these days only lasts for an hour.”
A major downturn in the US or China would affect Brazil as it would hit markets everywhere, but Banco Real’s Mr Berenguer believes the country is in a new paradigm. “In the past when we had this kind of volatility, the consequences were intense but now, with the new fiscal situation, things are much more stable. Debt levels are low, the balance of payments is robust and reserves are high. We felt the volatility but without the same kind of amplification that we used to get.”
If this analysis is correct, the major investment banks are going to find increasingly that they are missing out on an opportunity. They will be (and some are) upping their presence but there are now few short cuts available. They must compete in the market for scarce professional staff – some of whom have already seen their salaries double over the past 12 months. It is going to be a costly exercise.
