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
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
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
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
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
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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