A year after it began, Brazil’s municipal bond market has been brought to a standstill by the federal government after Credit Suisse Group AG and Bank of America Corp. provoked a backlash by collecting $140 million in fees from the first two borrowings.
The second-largest Swiss bank provided a $1.27 billion, federally guaranteed loan to the state of Minas Gerais in February and then packaged and sold the debt as securities to investors a month later at a markup of 9.2 percent, or about $116 million. Bank of America earned $24 million, or 3.6 percent, by selling $662 million of notes backed by a loan to Maranhao state last month. The profits compare with the 0.25 percent fee Brazil paid to underwriters on a $1.35 billion bond sale less than a year ago, or about $3.4 million.
Brazilian Treasury officials, who approve state financing requests and provide guarantees backing loans, are starting to demand terms to curb the profits, seeking to protect taxpayers from being exploited and to limit their own borrowing costs while alienating bankers in the process. State officials at Mato Grosso and Parana say the demands are imperiling loans they’re seeking from Credit Suisse, derailing a market the government had projected could grow to as big as $25 billion by 2014.
Federal officials have “become tougher after the Credit Suisse deal in Minas Gerais,” Vivaldo Lopes, who as deputy finance secretary of Mato Grosso has helped lead the $1 billion loan negotiations for the state. “They thought the profit margin was very high.”
Drew Benson, a spokesman for Credit Suisse in New York, declined to comment on the profits made on the Minas Gerais deal and on the status of loan talks with Mato Grosso and Parana.
Kerrie McHugh, a spokeswoman for Bank of America, declined to comment on revenue earned from its transaction with Maranhao. Officials at the Maranhao state planning and finance ministries didn’t answer telephone calls seeking comment.
Leonardo Mauricio Colombini de Lima, the finance secretary for Minas Gerais, said that while the state didn’t know that Credit Suisse was going to repackage the loan into notes, the transaction was legal and “beneficial” because the proceeds were used to pay back more expensive debt.
“These states paid a premium for their lack of experience in international markets,” Marco Aurelio de Sa, the head of fixed-income trading at Credit Agricole SA’s Miami brokerage unit, said in a telephone interview. “Investment banks can justify that premium because they’re forming a secondary market for these where none existed before.”
While Credit Suisse was structuring the deal for Minas Gerais, a mining and agricultural state lined with coffee and dairy farms to the north of Sao Paulo, Goldman Sachs Group Inc. was generating an even bigger windfall from underwriting bonds in another corner of emerging markets. Goldman Sachs made about $500 million arranging three bond sales for 1Malaysia Development Bhd., the nation’s investment fund, in the 10 months through March, said a person familiar with the matter.
Edward Naylor, a spokesman for Goldman Sachs, declined to comment on fees for specific offerings. “Clients seek us out for our ability to develop and deliver complex financing solutions,” he said in a May 2 e-mail.
Shahriza Embi, a spokeswoman for 1MDB, declined to comment on the deals in a May 9 e-mail.
In Brazil, President Dilma Rousseff’s administration is concerned by how much the banks marked up the loans when they repackaged them into notes and by the potential increase in the country’s yields from the additional supply of federally backed securities in the market, according to Lopes and Luiz Carlos Hauly, the finance secretary for Parana.
Brazil is demanding a ban on the securitization of new loans and wants to set maximum interest rates banks can charge above sovereign borrowing costs, the state officials said.
“States can take out loans, the Treasury gave its authorization and guarantees,” Paulo Valle, Brazil’s deputy treasury secretary, said in an impromptu interview at the Finance Ministry on Aug. 19. “We are not allowing securitization because this affects the bond market. It’s harmful. It affects rates.”
Treasury officials didn’t respond to additional e-mailed questions sent by Bloomberg on the loan transactions.
After giving Minas Gerais in February a 5.33 percent loan due 2028, Credit Suisse issued through a special purpose entity amortizing notes backed by the debt to yield 4.22 percent in March, still 0.96 percentage point more than similar-maturity Brazilian bonds at the time, according to data compiled by Bloomberg. Yields on the state’s notes have risen to 6.41 percent in secondary-market trading amid the three-month rout in emerging-market debt.
“The federal government didn’t like” the deal, said Lima, the Minas Gerais finance secretary. The government “provided a guarantee and Credit Suisse charged Minas Gerais state more than if Brazil would have sold sovereign bonds.”
The Minas Gerais loan was the first to be repackaged into notes since Brazil authorized 21 states last year to borrow as much as 60 billion reais ($25 billion) through 2014, ending a ban on new municipal debt that dated back to a 1997 federal bailout of local governments.
The states, facing growing investment needs ahead of the country’s hosting of the 2014 World Cup and 2016 Olympics, have been pressuring federal officials for alternative financing options to cut their interest on the 465 billion reais worth of bailout debt. Local governments are charged interest of as much as 9 percentage points over inflation, as measured by the IGP-DI index, which reached 4.8 percent in the 12 months through July.
The authorization that the Rousseff administration gave Minas Gerais to seek new financing didn’t explicitly ban the repackaging of the loans into notes, giving Credit Suisse the opportunity to carry out the sale, according to Lima.
“The banks were somewhat daring, given they didn’t have explicit authorization for this,” Carlos Thadeu de Freitas Gomes, a former central bank director who’s now chief economist at the Rio de Janeiro-based National Commerce Confederation, said in a telephone interview.
“Securitization of state debt in Brazil is complicated. We’ve had that in the past and many states got squeezed and didn’t pay their debt.”
Revenue from the deal for the Zurich-based lender amounted to about 9.2 percent of the loan’s value, according to data in the notes’ offering memorandum compiled by Bloomberg. The $116 million compares with $568 million in total fixed-income underwriting revenue in the second quarter for the bank, Bloomberg data show.
“Because of the profit, it looks bad,” said Hauly, the finance secretary for Parana, which is seeking a loan of about 1.1 billion reais. “It’s a very delicate situation for states, doing a deal and then having it be securitized immediately. If there’s a rule from the Treasury, we have to obey it.”
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