São Paulo: Brazil’s position in the global market for contingent convertible bonds (CoCos) is faltering, with lenders favoring local financing amid rising demand worldwide. The once-thriving market has experienced a significant decline, with the country’s hard-currency issuing shrinking to just one bond after Itau Unibanco redeems its Additional Tier 1 bonds. In contrast, countries like Colombia and Mexico are expanding their CoCo offerings, capitalizing on favorable market conditions.
Brazil’s Dwindling CoCo Market
Brazil’s share in the global contingent convertible bonds (CoCos) market, once valued at $10 billion and second only to China among developing nations, has seen a drastic decline. The last sale of international CoCos from Brazil dates back over four years, and as Itau Unibanco prepares to redeem its two perpetual Additional Tier 1 bonds, the nation will be left with only one remaining hard-currency AT1 note—issued by state-owned Banco do Brasil. Once a strong player in the international market, Brazil now finds itself vastly outperformed by its regional neighbors.
For instance, Colombia and Mexico have been actively selling CoCos, having issued a robust $1.5 billion in this financial instrument over just this year. This pickup in activity contrasts sharply with Brazil’s stagnation, raising questions about the sustainability of its CoCo market amidst a growing preference for local financing.
The Shift to Local Financing
The diminishing international appetite for Brazilian CoCos reflects broader trends across emerging markets, where a notable shift towards local currency instruments is underway. Brazil’s domestic credit market has experienced explosive growth in recent years, and the local currency corporate bonds, known as debentures, now significantly outsize the market for hard-currency debt. Companies from various sectors are seizing the opportunity to access a new pool of institutional investors, effectively gaining cheaper financing while sidestepping the currency risks associated with borrowing in dollars.
Major banks, including Itau and BTG Pactual SA, are tapping into local demand by issuing CoCo bonds denominated in reais while simultaneously seeking to buy back their hard-currency notes. “The supply has shrunk significantly because the local market remains very strong,” explains Eduardo Alhadeff, a credit portfolio manager at Ibiuna Investimentos in São Paulo. His observation highlights an undeniable trend—Brazilian banks can now issue future securities at extremely tight spreads in the local market.
Financial Dynamics at Play
The ongoing transition raises essential questions about the attractiveness of international versus domestic financing. For Tier 2 bank notes, which can absorb losses only if a bank approaches insolvency, notable mentions include Itau and Banco do Estado do Rio Grande do Sul SA (Banrisul). The latter plans to issue Tier 2 notes locally with a spread of 165 basis points over the benchmark DI rate, a stark contrast to the 400-450 basis points expected for similar offshore sales. Such favorable conditions create a compelling argument for banks to engage in domestic issuance rather than international markets.
For instance, Itau took advantage of the thriving Brazilian market during the first half of the year. Its CEO, Milton Maluhy, shared that the bank successfully sold nearly 10 billion reais in AT1s, attributing it to “a deep market in very good conditions.” By managing its liabilities strategically, Itau aims to repay its dollar notes and remain agile in its local market pursuits.
The Future of CoCos in Brazil
As the dwindling supply of Brazilian CoCos becomes apparent, the combined value of the global AT1 and Tier 2 bonds issued by Brazilian companies has dropped from roughly $10.5 billion in 2021 to around $4 billion today. This number is projected to further reduce to $2.5 billion following Itau’s bond redemptions. For offshore investors, the sole option left for AT1 investments will be a $1.72 billion bond from Banco do Brasil, which was once part of a vast $9.6 billion issuance.
Despite challenges, concerns regarding Brazilian CoCos can be somewhat overstated. Analysts like Natalia Corfield from JPMorgan Chase emphasized that Itau’s decision to redeem its low-spread bonds was unexpected given their previous appeal. Nevertheless, the underlying strength of Brazilian banks allows for continued international funding should they choose to access it. “For the lender, it’s an economic decision: ‘Where do I have volume at a good price?’” notes Nikolau Muller, a portfolio manager at JGP Asset Management. Despite the prevailing conditions favoring local issuance, the global markets remain available for these institutions.
As the banking landscape evolves in Brazil, the decisions made today will shape the country’s future financing strategies. While the preference for local currency debts appears beneficial for Brazilian institutions, navigating the international waters may still present valuable advantages in due time. For now, Brazilian banks are demonstrating agility and adaptability within a challenging yet exhilarating financial environment, leaving room for future growth and innovation.
Bankerpedia’s Insight💡
The shift away from international bank debt towards local financing by Brazilian lenders signals a significant trend in emerging markets. For India, this emphasizes the need for banks to strengthen local capital markets, fostering resilience and reducing dependency on foreign currency exposure. As domestic markets expand, Indian banks should prioritize local instruments to enhance funding strategies. Investors should stay informed about local bond opportunities, considering their potential for lower risks compared to international debt. Embracing this trend could bolster both stability and growth within India’s banking sector.
What Does This Mean for Me?🤔
- Salaried Person → Local financing may offer lower borrowing costs.
- Business Owner → Limited access to international funding options for borrowing.
- Student → Local financing options may reduce student loan costs.
- Self-employed → Local financing options may become more affordable.
- Homemaker → Less access to affordable loans affects household budgeting.
- Retiree / Senior Citizen → Potential risk to retirement savings from decreased global bonds.
- Job Seeker → Reduced international financing options may limit job creation.
- Farmer / Rural Citizen → Local financing reduces currency risk and improves credit access.
Research References📚
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