01 Dec 2010

Randolph Walerius

The Brazilian Development Bank is the traditional source of finance for infrastructure projects. But the country′s massive need, both to close the existing gap as well as to sustain its high growth rates, means Brazil will have to find ways to bring private-sector capital into the sector. InfraAmericas and Machado Meyer Advogados brought infrastructure experts together for a discussion in Sao Paulo, broadcast on the web, about how to fill the funding gap. Antonio Meyer, right, a founding partner of Machado Meyer, moderated the discussion.

For a snapshot of why Brazil’s government-backed financial institutions aren’t going to be able to fund the country’s future infrastructure needs, look at a few headline numbers.

Brazil’s 2008 GDP was about BRL3.415bn. After a stagnant 2009, the economy is growing about 7% in 2010, lifting GDP to about BRL3.654bn. If 4% of GDP is a marker of how much ought to go to infrastructure investment, Brazil should be investing BRL136m in 2010, and then more as the economy grows.

The Brazilian Development Bank (BNDES) said it disbursed BRL41.5bn to infrastructure from January to October of 2010.

The gap, in short, is a big one.

InfraAmericas invited six Brazilian infrastructure experts to a seminar in Sao Paulo on Nov. 24, hosted by Machado Meyer Advogados, to discuss alternatives to BNDES funding. The meeting was attended by 60 Brazilian infrastructure developers, investors and funders, and broadcast via audio webcast to participants in 10 countries.  

Desperately Seeking BRL150bn
“We will invest around BRL150bn per year in sectors like oil and gas, shipping, energy, logistics, and PPPs,” said Schmitt, pictured right. “That’s my number. I really do not believe they [BNDES] are capable of this huge financing. They would certainly need to prioritize. We are just talking about infrastructure. BNDES has other deals as well.”

Indeed, BNDES said almost 60% of its disbursements in the first 10 months of 2010 went to sectors such as industry and agriculture. The government could plough more money into BNDES, but the webinar participants doubted it could sustain the funding that is necessary.  And there are other ways to tap that capital.

“We need commercial banks,” said Schmitt. “We need capital markets. Not just national capital markets. We would have to have financing from abroad.”

Brazil’s infrastructure financing is handicapped by several factors. BNDES’s subsidized loans make it difficult for commercial lenders to compete and BNDES’s lending practices add to the crowding out phenomenon. Many domestic pension funds – like many pension funds around the world – don’t have infrastructure expertise. Taxes discourage some types of investing and regulatory regimes discourage others. Debt capital markets aren’t deep enough. Foreign investors face currency risk that is expensive to hedge. And construction risk scares many investors away.

The stakes in a country growing as fast as Brazil are huge. The economy has been a model of economic growth for a decade and still has an infrastructure gap to close. More infrastructure investment is needed to sustain high growth rates that Brazilians take for granted. Participants in the InfraAmericas’ webinar saw 5% growth as the minimal number on which to build calculations.

Sustaining 5% growth would require 4% to 6% of GDP going into infrastructure, said Pinto Almeida, left, adding that the country is today investing 2.3% of GDP into infrastructure. “If you compare it to Latin America as a whole – 2.6% - we’re below average,” he said.

Identifying potential sources of capital is easy.

“Our local investors have always been the great anchor to those projects and those investments,” said Schmitt. “International investors are looking at Brazil for infrastructure as well. Infrastructure funds abroad – from Europe and the US – are very interested in coming to Brazil. Maybe not for greenfield projects, but to acquire assets. That offers liquidity, which makes it possible for local investors to sell and put equity into new greenfield projects.”

Brazilian pension funds have an estimated BRL500bn in assets, of which about 60% is allocated to fixed income and 30% to equity. Structured assets, which include infrastructure, take about 2%, with some talk that they could go as high as 5%. If all of such an increase went into infrastructure, it would contribute BRL15bn, or 10% of Brazil’s annual investment need.

Weaning the country from its dependence on BNDES will be one of the key steps to draw on that capital. The bank not only provides loans at a long-term rate that is below the market, but it has traditionally resisted sharing its standing with other senior lenders. Commercial banks can’t compete on price and can’t get security.  Commercial banks, however, can compete on a range of investments, including acquisitions of existing assets, where BNDES doesn’t participate.

For the first time, BNDES accepted a pari passu sort of guarantee in relation to project bond holders.

Dom Pedro Tests Some Options
Brazil tested some solutions in August with a 12-year, BRL1.1bn project bond to refinance bridge loans on Odebrecht’s Dom Pedro highway concession in São Paulo state, the first use of project bonds for long-term financing of a highway concession (
click here for InfraAmericas article).  Santander and Banco do Brasil led the deal. The issue was significant because BNDES agreed to allow other creditors to stand equal to it in seniority and because Brazilian pension funds were willing to buy the bonds.

For the first time, BNDES accepted a pari passu sort of guarantee in relation to project bond holders.

Schmitt, at Santander, said the deal was structured to help overcome BNDES’ unwillingness to share security with investors providing shorter tenors.
“We were able to issue 12 years and the amortization was back-ended,” he said. “This type of structure is not easy to put in place. It’s not going to work on all projects.”

The Dom Pedro bond issue illustrates the potential of pension funds. They can be sources not just of direct equity or loan capital, but also of fixed-income debt. Cleaver, left, says his experience is that projects are available, that InfraBrasil has invested successfully in sectors from energy to sanitation to logistics.

“The issue is not so much how to invest the fund, but how to raise the fund,” he said. “You have a small group of very large pension funds who are very sophisticated. Maybe 10. You have an enormous amount of smaller funds who don’t have the capacity to analyze these sorts of transactions. They are pretty comfortable with returns in government [debt].  The challenge we face as a fund manager is to come up with a structure which will be attractive for these smaller funds.”

Schmitt said the Dom Pedro bond issue shows how time-consuming it still is to bring investors such as pension funds on board and to resolve issues with BNDES, but he said Santander wants to stimulate investment into projects.

“It took some time for them to analyze,” he said. “It took us a year to explain this and to negotiate with BNDES. There are very good opportunities, but they do need to prepare themselves for this change.”

Bank Tenors Lengthening

Santander likes to get involved in projects very early, Schmitt said. “We tend to work first as advisers. We try to join sponsors as soon as possible. We are a kind of support that there will be financing when they need it. We can offer bridge loans. This has been very important for these projects in the last 5, 10 years.”

Banks, too, are starting to offer tenors that are reaching 7 to 9 years. “The cost is higher. But banks are carrying the long-term risks,” said Schmitt.

BNDES offers long-term loans at 6%, plus a spread on top of that. Commercial banks pay almost 11% for their funding and have to add their spread. Interest rates in the 14% range start to look as costly as equity.

One solution, of course, would be for the government to lower interest rates. The yields on government debt are high enough to discourage some institutional investors from even looking at infrastructure investment. It’s not worth the effort and cost if it’s only going to add 50bps or 100bps to the return.

Handling Completion Risk
Brazil still struggles to handle the completion risk on projects, particularly on big ones – often in the hydropower sector – that have environmental challenges that can stop construction. Banks may demand guarantees from sponsors who aren’t in a position to provide them.

Mellis, right, said banks are willing to take on the risk when it understands the risks of the business well enough. Wind power, thermal power, toll roads are well enough known for banks to take the risk, he said. “Where we understand the risks, we can finance this with non-recourse project finance, with the appropriate solution.” Completion bonds aren’t structured well enough to reassure, he added. “Lenders here are not satisfied with the product. We are discussing how to improve it.”

One way to deal with such risk is contract structures to soften it, or at least allow thorough monitoring of the risk through the construction phase.

“The completion risk in a greenfield project is always a challenge,” Novaes said. “The risk of a project completion is still a challenge for some investors. After completion, there seems to be a bigger appetite, although in fact there should be no such difference, if there is a good EPC contract with a strong sponsor.”

The government can play a role, and in some cases is starting to, he said. A very good example is the arenas for the World Cup in 2014 and the Olympics in 2016. They have been auctioned as PPPs, where the private partner is responsible for raising the investment proceeds based on future government payments and guarantees.

Odebrecht, one of the country’s leading construction companies, has become a practiced hand at bringing equity into deals or into businesses that it sets up around concessions.

“People will consider investing with well-known players in specific markets,” said Novaes, left. “We still lack the adequate funding structures for debt to come in in size and quality, and the requirements for project finance-oriented funding.”

Competing with BNDES and overcoming the completion risk aren’t Brazil’s only obstacles to tapping additional capital.

“Even if Brazil was to find a pot of gold – if we had BRL150bn to invest – I doubt that we would be able to invest it,” said Cleaver. “You have some sectors that have a much more friendly regulatory environment while others have a much more cumbersome regulatory environment, which does not make it easy for investment.”

Ports, he said, are crucial to maintaining growth, but are a “big mess” in terms of regulatory framework. “In airports, you’re not even allowed into the sector.”

Brazil’s National Civil Aviation Agency (ANAC) is currently seeking a concessionaire for the Sao Goncalo do Amarante airport, near Natal in the state of Rio Grande do Norte. The concession, involving an estimated BRL650m in investment, is the first of its kind in the airport sector. The procurement, which could be a test of how to structure such a concession, has been taken out of the hands of Infraero, the state-owned operator of 67 airports. Invitations to bid are expected in early 2011.

“It seems to be a step in the right direction,” said Cleaver. “But do we have the time to see if this experience is going to work, and then apply it to other sectors?”

Tax Changes Could Unleash Capital
The government could change tax laws to unleash the flow of capital, comparable to what it did in the real estate sector in the past. Take some of the taxes out of long-term financing and BNDES would find competition, said Mellis. “I think it’s a good step.”

The real estate sector benefited from CRIs, a type of real-estate-asset backed security that carried a tax incentive. “Since we have to develop capital markets, why not offer an incentive to buy this type of bond,” said Schmitt. Instead of offering cheap funds to BNDES, use the resources as tax incentives to stimulate investment.

Taxes also distort the market.  BNDES provides subsidized loans on energy projects, but the taxes imposed between the electricity producer and consumer eliminate that subsidy. Cleaver said the government could eliminate the taxes, remove the subsidized BNDES loan, and commercial lenders would be in a position to lend at commercial rates with no effect on consumer prices.

Brazil may even have access to an unquantifiable volume of capital held abroad by its own citizens. The government could try – and is thought to be considering whether – to attract some of that back home with an amnesty. Argentinians are said to have brought USD60bn home under a similar amnesty. Brazilians bringing their own money home wouldn’t just add to the liquidity pool. It would be a strong indication that the new government can be trusted.

(InfraAmericas | www.infra-americas.com 01.12.2010)

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