There is only one way banks and companies can hope to raise money these days and that is to provide lenders with as many robust risk mitigation features as they can. This means issuers need to back their bonds with a flow of hard currency offshore payments that are immune to Brazil risk. However, even this is often no longer enough for some high-grade investors, which has forced issuers to buy political risk insurance (PRI) from US providers such as Sovereing Risk Insurance, or financial guarantee insurance from insurers like AMBAC Assurance. This means that the issuer can raise funds at comparatively low rates, while the investor gets a high-yielding, high-rated security. These structures reduce the risk of an interruption in a company’s exports or a bank’s dollar payments flows, or of the low probability of a major insurer failing or refusing to honor a policy.
High Demand
All major Brazilian banks are now using these structures to raise funds. State-owned Banco do Brasil, the country’s biggest commercial bank, is the leading issuer of asset-backed paper. It raised $1.05 billion in asset-backed and PRI-wrapped securities in the last year at a fraction of what it would cost to issue clean paper, now that the spread on Brazilian sovereign bonds is well over 2,000 basis points. The bank handles about $5.5 billion to $6 billion a year in incoming dollar payments alone. This means it still has room to issue another $500 million in asset-backed, dollar-denominated paper, since insurers and rating agencies require that these notes be heavily over-collateralized. The bank also has about $3.5 billion-worth of incoming flows in European currencies, which it has not yet tapped.
Délcio Blajfeder, executive general manager at Banco do Brasil, says the bank in June raised $300 million with a second tranche of a $450 million December 2001 transaction backed by payment streams from the US, structured by Merrill Lynch. The seven-year bonds Banco do Brasil issued in June were priced at 60 basis points over Libor to an annual yield to maturity of 5%. The paper, launched by ING Barings, received a AAA-rating thanks to insurance from AMBAC Assurance. At that time, Brazilian bonds were trading at 1,500 basis points over US Treasurys and the country had a B rating from Standard&Poor’s. Gordon Kingsley, managing direct at ING Financial Markets, says the bonds were rated BBB before adding the insurance. The bank has also securitized $300 million-worth of dollar remittances from Brazilian workers in Japan.
Exporting companies have long used their hard currency receivables to back their bonds. For instance, Aracruz, Brazil’s biggest exporter of pulp used by the paper industry, in 1995 issued $112 million in bonds collateralized by export receivables. Salomon Smith Barney has structured another export-backed program worth $1 billion for Aracruz and the company issued the first $250 million tranche in February.
Receding SupplyHowever, there are several drawbacks to issuance of asset-backed paper and PRI or financial guaranty insurance. First, it is limited by the willingness of insurers to take on Brazil risk. As turbulence has intensified, insurers and their re-insurance companies have pulled back. Blajfeder says ING attracted $500 million for Banco do Brasil’s last bond, but insufficient insurance capacity limited its size to $300 million. Insurers are only likely to begin increasing coverage once market and political instability have quieted down. The market will probably be subdued for at least the next six months. Furthermore, only a small number of companies and banks can issue these bonds since issuers must be exporters or have access to hard currency flows, and have a domestic investment grade rating.
Secondly, although the principle behind these structures is quite simple, they are complex and time consuming to put together, and require the participation of lawyers, rating agencies and insurers. An issuer must set up a vehicle in an offshore jurisdiction, which has the right to receive a portion of the payment flows to the bank or company in Brazil. The vehicle then issues the bonds and makes payments to investors.
The good news, so far, is that well-designed structures are very robust and even the few bonds issued with similar structures in Argentina have continued to perform satisfactorily.