Brazilian states break financing mould
NEW YORK, Jan 14 (IFR) - A recent string of loans to Brazilian states may represent the initial steps in a broader thawing of capital markets activity for the country's sub-sovereign entities, as they seek to lower funding costs to cover higher infrastructure needs ahead of the World Cup and Olympics.
Laws prohibiting such borrowers from gaining direct access to markets have stifled activity, but bankers and states are finding ways to broaden their financing options, although they still need Congressional approval to do so.
Bank of America Merrill Lynch in recent months extended around US$1.2bn in loans to Brazilian sub-sovereign entities - a US$726m 10-year loan to the State of Santa Catarina and an earlier US$479m loan to the State of Mato Grosso - in an effort to refinance more expensive debt owed to the federal government.
Credit Suisse is also funding a loan for Minas Gerais, while other banks are pitching ideas to credit heads including Rio de Janeiro, which has long voiced its desire to tap the markets.
"They are important states and they are doing well in terms of financial (ratios)," said Patricio Esnaola, an analyst at Moody's sub-sovereign group. "Social requirements for infrastructure will increase, so I expect borrowing needs to increase and they will need to get funding."
A ban on any municipality or state from issuing in the capital markets after a series of federal government bail-outs has meant that private market activity has been virtually nil.
However, this has come at a price as most states have funded themselves through debt with the federal government, which is proving expensive, especially in an environment where rates have been on the decline.
"The federal government has funded the states at rates that are quite high,' said a lawyer with knowledge of these transactions.
OFF THE BOOKS
Banks have little intention of keeping much of this debt on their books and are likely to securitise the loans, which are guaranteed by the federal government, and sell them into the market through a trust.
Should such structures work, banks are likely to find a broad swathe of investors happy to buy such paper, given its scarcity value, the likely pick-up to an already tight sovereign, and the fact that some of these states and municipalities have GDP capacity above the national average.
"You will see a number of states doing these loans and a number of securitisations of these loans as banks stop using their balance sheets," the lawyer said.
Indeed, if investors have been buyers of provincial debt in Argentina even during recent sell-offs as the federal government battles holdouts in US courts, they are likely to be more enamoured with the prospect of gaining exposure to large sub-national economies in Brazil.
"I get many calls from investors showing an increasing interest in Brazilian sub-national debt," said an analyst at a ratings agency. "Investors cannot understand why the City of Rio can't issue a bond and the Province of Buenos Aires can."
Constraints on Brazilian state funding are understandable, given the difficulties such entities have encountered in the past, but with increasing infrastructure it needs some flexibility.
According to Fitch, Santa Catarina is now able to use funds that would have otherwise gone to debt payments and put them into other investments.
"As with other states in Brazil, the investment level has been historically low and should grow in relevance," the agency said.
At the same time, states are negotiating with their federal counterparts to change how debt owed to the federal government is indexed with the aim of moving IGPM-linked rates to IPCA.
While both are inflation indices, the former is seen as too broad, capturing among other things FX fluctuations, and less relevant for states. It is also seen as unfair, as much of the inflation-linked government debt is tied to IPCA.
"A lot of states are not happy. They are paying IGPM plus 600bp or even plus 900bp," noted a Sao Paulo-based banker, who calculates that the spread differential between the government's IGPM-linked bonds and what it is charging the states is around 300bp in some cases.
(This story first appeared in the Jan 12 issue of the International Financing Review, a Thomson Reuters publication)
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