Goldman Sachs and JP Morgan have clinched the prized mandate to lead a benchmark sized, 10 year global deal in reais next week.
The news follows almost a year of speculation and months of denials from Brazil that a global transaction in reais was on the way.
The issue will be a landmark for a new asset class among Latin American bonds. After Colombia's peso global last year, bankers began predicting a rash of sovereign and corporate Eurobond offerings denominated in Latin American currencies, including a major deal by Brazil.
But although Uruguay emulated Colombia and there have been several smallish deals by Brazilian banks and companies, the market has lacked liquidity — a problem Brazil's long-desired arrival may help to rectify.
But the true significance of these deals is as stepping stones. Latin American governments are eager to lengthen the maturity of their debt and reduce exposure to currency movements, but their domestic investors are unwilling to go longer dated.
The only way to improve their debt profiles is for governments to persuade foreign investors to buy longer dated bonds in their domestic currencies. Thanks to Latin America's improving credit quality and the shortage of yield elsewhere, overseas funds are ready and willing.
"[Brazil has] been asked to do this for months. But they've insisted that they would prefer to bring investors into the domestic market," said one sovereign coverage banker in New York. "Now it looks like they have changed their mind. There was more appetite for a real sovereign deal six months ago, when the real was at 2.60 to the dollar. But even so, there is still a good carry trade here and people are chasing yield."
The real has since strengthened to R$2.30/$. But with an expected yield of 14%-14.5%, the deal should still be a blowout. It will be at least $500m in size, to give it the secondary market liquidity that Colombia's pioneering peso global last year has lacked.
The market was beginning to lose hope of a Brazilian sovereign deal, since funding officials refused to discuss the idea of doing a global real issue.
"We are not concerned about new issuance in Europe in reais," said José Antonio Gragnani, director of external credit at the National Treasury, in August. "Our strategy is to bring the foreign investor to the local market."
Gragnani wants to issue a 10 year fixed rate domestic bond. But bankers seem now to have convinced the Treasury financing team that issuing a large and liquid 10 year global reais deal inside its interpolated 10 year local yield curve would set a great benchmark for that project.
"One of the benefits that any country gets in doing these local currency global deals is that it helps enhance the local market," said a manager of emerging market debt syndicate at a bank in New York.
"What we have seen in a lot of local Latin American markets is that external investors have been more bullish than local investors on the direction of interest rates, so external investors were ready to buy longer dated maturities in Mexico, Brazil, Colombia and Peru long before the local investors," the banker said. "It's a case of leading the domestic market with the external market."
Mexico is the best example of a country that has made this transition — though, like Peru, it took the alternative route of removing barriers to investment in its domestic market. Mexico has no need to issue peso globals, since foreign investors are now happy to hold 80% of its longer dated domestic debt.
Extending the yield curve
The administration of President Luiz Inácio Lula has made huge progress in extending its fixed rate government bond yield curve out to seven years — from just nine months in 2003.
Even so, its five and seven year fixed rate bonds in reais are small and were sold to a handful of foreign institutions. They were reopened only when there was reverse inquiry from international investors.
"There is a huge amount of short tenor liquidity provided by local investors, but after three years the liquidity for fixed rate government bonds starts drying up," said a banker in New York.
Foreign investor interest in Brazilian reais denominated bonds is enormous, but punitive withholding taxes, financial transaction taxes and red tape have stunted direct investment in Brazil's local currency market.
A global reais bond that is clearable through Euroclear and settled in dollars will avoid all those barriers.
"This is perfect for investors that cannot access the local yield curve," said a syndicate manager in London. "It will give them exposure to reais at more or less the level of local rates."
A new liquid deal will also help investors hedge their exposure to the smaller Brazilian corporate reais Eurobonds.
If it prices below 14%, Brazil's global will come inside an interpolated 10 year point on Brazil's domestic bond curve.
Brazil has an inverted yield curve. Its fixed rate 2010s trade at around 15.11% and its 2012s at 14.69%.
Pricing will be difficult. The global real bond will not incur taxes; there is a difference in the number of business days in Brazil versus the international 30 days a month/360 days a year convention; and the deal will lack liquidity.
Brazil's decision to issue a global reais deal now rather than earlier this year might be linked to this week's 25bp rate cut by Copom, the Brazilian equivalent of the US's FOMC, taking the Selic rate down to 19.5%.
That is the first of what may be a series of rate cuts in Brazil.
Banco Central do Brasil has kept rates higher than needed to purge its financial markets of inflation indexation. This was once rampant in Brazil and a prime reason why the country suffered years of hyperinflation.
Danielle Robinson
