The country’s stock index is at record levels (it broke the 106,000 level in mid-July and it is also near to a record in dollar terms), which has led to a flood of new equity issuance, most of it secondary deals. Investment banks are having a good year: according to data provider Dealogic in the first half of 2019 there were 19 deals worth a combined volume of $8,411, compared to $3,130 in the first half of last year. And the run rate is increasing. As Euromoney went to press, there had already been more than R$10 billion ($2.7 billion) in deals in a pipeline chock full of follow-on deals.
On 23 July alone, Petrobras sold R$8.6 billion worth of shares in BR Distribuidora, in what was effectively a privatization of the company, and bankers say that domestic investors remain very keen to participate in a combination of state-driven and private sales. However, some bankers report that investors are a little wary of follow-ons that are exits of investors or large-scale reductions in management ownership as they could signal inside knowledge that current valuations are frothy.
The renewed deal flow is creating an interesting tussle between local investment banks and their international competition. Brazilian Itaú BBA led the league tables into the second half of the year (up from sixth place in the first half of 2018), with a 15.6% market share, but Bank of America Merrill Lynch and Morgan Stanley came second and third (with shares of 12.0% and 10.8% respectively). Bradesco BBI was fourth (8.4%).
Resurgence
The resurgence in fees from Brazilian equity capital market (ECM) is a welcome source of revenue growth for both local and those international investment banks that have survived on meagre activity in the past four years. Combined ECM fees were $212 million in the first half of the year (up from $96 million in the first half of 2018) and expectations are that the second half will see even more income generated. Brazil is also back as the region’s driver of fee income – with more than 71% of regional ECM fee income generated by Faria Lima in 2019 (Mexico led in 2018).
Also, the fall in the country’s risk premium (the aggregated spread on Brazilian bonds over treasuries fell below the average for emerging markets in July for the first time since 2014) has re-opened interest in international debt issuance. On July 16, the spread for the Brazilian benchmark hit 246bp over Treasuries (with EM average at 257bp), having spiked up to more than 1100bp in early 2016.
Only the strong domestic markets – with local interest rates expected to keep falling – is preventing an international deluge of debt. The cost of local debt is cheaper than international when including the cost of swapping the proceeds into local currency, but international bankers are still confident that there will be a strong pipeline of deals from Brazilian issuers in the rest of 2019. Companies seeking longer-term debt to extend debt maturity profiles and diversify funding sources, those with very large funding needs (especially as M&A recovers) and those Brazilian companies with dollar financing are expected to generate more than $20 billion worth of activity.
Given the domination of local market issuance, it is unsurprising that the dominant debt capital market banks this year are the Brazilians: the first four places of the league table are comprised of Bradesco BBI (with a 14.7% share of the $23 billion issuance), Itaú BBA (13.66%), Banco Santander (10%) and BTG Pactual (9.4%).
Dislocation
However, despite the strong pick-up in activity and high levels of optimism for future deal flow there are some market observers that point to the dislocation between the financial boom and the still-stalled economy.
According to David Beker, Brazil economist for Bank of America Merrill Lynch, the pension reform was “necessary” for fiscal sustainability but not “sufficient” to bring about renewed growth. In fact, expectations for Brazilian growth have been falling and are now around just 0.8% for this year. “Alongside structural reforms, microeconomic measures are needed to enhance productivity and create a sustainable environment for growth.”
It will also require an increase in investment. In Brazil, what little investment there is has usually been led by the government but the lack of fiscal space and the new government’s desire to step back from using BNDES as a macro-prudential tool, has seen the country’s investment rate fall even further – to just 15.5% of GDP in the first quarter of 2019. That is the lowest rate for 52 years.
Bankers say the historically low interest rates, with real interest rates now hovering around 2%, could lead the private sector to become the engine of investment. With pensions reform out of the way, that is now the critical question facing Brazil, and the answer will determine whether the strong financial equities and debt performance can be sustained.
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