It’s about time too, given the country’s stellar progress. But global credit market woes will limit the impact, writes Erika Morphy.
Petrobras. Even to the uninitiated it needs little introduction. One of the top integrated public energy companies in the world, it has increased its oil production nearly 10% every year over the last 10 years, without having to turn to the debt markets.
That is about to change, however, as the conglomerate readies for a five-year development plan that calls for a huge uptick in offshore exploration, an investment that its balance sheet will not be able to fully fund. For the remaining part of this year alone, for example, the company expects to drill more than 40 offshore exploration wells, according to statements made by executives.
Petrobras’ cashflow can handle most of that activity, says Ron Hansen, managing director of structured export finance at ING Bank.
“For the remainder, Petrobras is looking for a broad funding base, which includes the bank and the capital markets, both in Brazil and abroad,” he says, an opportunity that many global trade commodity finance banks are already anticipating in their own five-year plans.
Brazil’s recent offshore oil discoveries have roughly coincided with another milestone for the country: at the end of April, rating agencies gave Brazil its first investment grade credit rating. Typically, lower borrowing costs for local corporates follow such credit-rating upgrades, but ironically for Brazil, the exception to that rule is when larger global trends dictate otherwise. Simply put, the credit market events of the last year are still having a negative impact in most emerging markets, including its star performer, Brazil.
“Brazil’s pricing in the credit markets haven’t improved that much because of the liquidity crisis,” says Burkhard Ziegenhorn, Deutsche Bank’s head of global transaction banking for the country. “There is a huge demand for capital here, but just about everyone is still paying a liquidity premium.”
For example, primary names in the metal and energy sectors that last year were raising funds at rates significantly below 100 basis points are now paying in the one-and one-quarter range thanks to the crunch, says one banker. Smaller companies, for their part, have had to absorb lending that has increased to 300 to 400bp from 150bp one year ago. Adding further insult, the investment grade rating was already largely factored into recent pricing anyway – a testament to Brazil’s strong economy, but one that won’t deliver price relief for corporates.
But Brazil, if anything over the years, has proven it can defy lowered expectations and this post investment grade status quo will be no exception.
Starting with Petrobras, the oil conglomerate can command the best pricing, terms and covenants in the bank market, even without the backing of investment grade status. Furthermore, while there has not been, and likely won’t be unless global markets shift dramatically, a radical move in pricing because of the change, at the margins there has been some positive impact. More to the point, Brazil is continuing its programme of economic reforms, even as it reaps the rewards of its earlier measures, which, of course, is part of the reason why the rating agencies granted their benediction in the first place. “The promotion to investment grade is an affirmation of Brazil’s strong fiscal and monetary policies,” says Valentino Gallo, global head of structured trade finance at Citi.
Onward and upward
At bottom, what the change will mean in the medium term is an acceleration of trends that were already in place. What it won’t do, however, is exempt Brazil entirely from the same woes that have been hampering growth in all emerging markets, indeed, even most mature economies, since the start of last year’s credit crunch.
Still, though, it is clear that Brazil’s progress of the last few years, reflected in the investment grade status, means these woes are not nearly as painful as they are in other markets.
For instance, global trade banks had already made Brazil a top priority before the upgrade, now their comfort zone with the market is that much greater. Japanese banks were already becoming more aggressive in Brazil and are sure to develop an even bigger footprint here, says one banker. “They don’t seem to have the capital constraints that [European] banks have. When competing for deals they are more flexible.”
“We are increasing our activity in Brazil – the market is a priority for the bank,” says Florence Pourchet, head of Latin American specialised commodities at BNP Paribas. It is a decision that the bank made long before the rating agencies entered the debate. She points to the growing internationalisation of Brazilian corporates, many of which are now sourcing and exporting across borders, as just one factor behind the market’s strength.
Agency finance, as another example, will not only continue to underwrite infrastructure and energy-related transactions but probably ratchet up its support. Large corporates in Brazil, even when they haven’t needed it, would tap the ECA market as an alternative source of finance, Gallo says. “They are sure to continue to play a very critical role in many projects.”
Indeed, the country is counting on multilateral and ECA financing to support the much needed development of the infrastructure in Brazil, Hanson says. “A close cooperation among the various ECAs will be required as sourcing for many of the big projects is taking place from a number of different countries.”
Furthermore with the upgrade to investment grade status, ECA financing is sure to spread to tier two and lower corporates in the country, Nicholas Shaw, head of global trade finance for BBVA, says. “That is generally what happens when there is a move to investment grade – ECA financing becomes a viable tool for these companies.”
There also signs that pricing, while largely fixed due to scarce liquidity, is showing some wiggle room. The recent upgrades have netted lower premiums for some medium and long transactions in Brazil, Johan Schrijver, director of Atradius DSB, says. “We expect to see an increase in business flowing into Brazil as a result.”
The upgrade could also cause Brazilian banks to compete on costs for letters of credit, which are very expensive in the country, he says, thus enabling projects and transactions that were not viable before.
“Undoubtedly, Brazil’s newly gained investment rating will contribute to lower tariffs on the bond and other markets, where Brazilian sovereign and corporates are issuing paper, and attracting commercial borrowing,” says Paul Burger, senior economist with Atradius DSB.
Meanwhile, the country is continuing to liberalise its economy – particularly its export finance regulations, Deutsche Bank’s Ziegenhorn says.
At the beginning of the year Brazil exempted export financing and true sale of receivables from a tax the country applied to all forms of credit, very important initiatives to the local export community given the scarcity of working capital and the decline of the global securitisation markets, he says. Indeed, the bank has been seeing growing interest from clients in the receivables finance business for those reasons.
Also, the government has been slowly but steadily clearing the way for Brazilian corporates to adopt a more global approach to cash management. Earlier this year, a measure was passed that allows Brazilian companies to hold 100% of their export receipts abroad, up from 30% last year.
Brazil however, it hardly needs to be said, has not been immune from the credit issues of the last year – and the investment grade rating will not bestow an aura of invincibility no matter how strong the market’s performance.
Indeed, while there are many illustrations of banks’ faith in the Brazilian market, there are almost an equal number that underline the fact that ultimately it is still emerging. Some syndications are having a difficult time finding participants, one banker says, who points to a US$300mn deal in the steel industry that, as GTR goes to press, has not yet closed in part for that reason.
Also, banks are showing little sign of relaxing the security clauses and covenants they rushed to incorporate everywhere after the liquidity crisis went into full swing last year. “Brazilian corporates were getting long-term financing, up to 7-8 years, at low pricing and for little security,” Pourchet recounts. “The market has changed since those days and banks are more cautious. Lending to medium-sized companies now is only through strong structures with tight restrictions.”
Market flex, for example, is now a common staple in syndications, she says. By that, Pourchet is referring to a clause that allows a bank to increase pricing or change the structure if there is a change in market conditions. “There is no room in the market for weak pricing anymore,” she says.
The result of these conflicting trends is a, not surprisingly, complex landscape where there is a growing reliance on core relationship banks and a preference for bilateral loans on the part of borrowers while participants in the bank and bond market, for their part, prefer to focus on their core business. Senior secured debt is available but the market has become much more selective with the riskier tranches. The large caps and top tier names are doing fine, but the small and mid caps are suffering. It is the same with short versus long-term financing: the former is available, the latter is scarce.
At this junction, there is not going to be a dramatic change in the financing that is available to corporates, even with an investment grade rating, BBVA’s Shaw says. “I think the best way to look at Brazil’s finance markets is as an evolution. Brazil is diverse and there is a host of varied sectors all of which have different capital requirements and all of which are important to trade flows.” Bank appetite for these many different slices of the pie will of course ebb and flow depending on current events both locally and globally.