Brazil’s gross domestic product grew 7.5% in 2010, but the country suffers from low savings rates and investment in roads has historically been poor. As a result, it’s become common to observe that Brazil is facing a logistics crisis. But there is huge potential for new road projects throughout Brazil, says Renato Proença Lopes, executive director on the commercial board at Banco do Brasil (BB). Less than 10% of the country’s highways are currently under concession, he notes.

The giant national development bank, BNDES, has been the dominant player in financing such projects in recent years. But bankers are worried the bank’s support might flag as it is called upon to finance the 2014 World Cup, 2016 Olympics and the government’s two, highly ambitious, Growth Accel­eration Programs, covering not just roads but ports and airports, sanitation and energy, security and others. “We will need some creativity if all road projects are really to be com­pleted,” says Lopes.

Most private sector watchers think over time BNDES will have to reduce its lending commitments. BNDES will reach a limit as it has been increasing disbursements year-on-year and will have to fund many other commitments, says Sérgio Bronstein, partner at law firm Veirano Advogados. “It’s not an immediate issue, but we are likely to see it retrench in the next years,” adds Diogo Castro e Silva, executive director at Banco Caixa Geral, which has a branch in São Paulo.

BNDES says that it will continue to play a central role in road financing. Between 2010-2013, investments in roads will be at least R36 billion ($21 billion). This figure excludes additional projects envisaged under the second part of the PAC programme, says Dalmo Marchetti, manager of trans­port and logistics, infrastructure department at BNDES. “The bank will also look to catalyse existing and new financing techniques: it will continue to work closely with multilaterals and also increasingly use capital markets for long-term financing”, he says. “Road concessions in São Paulo show capital market solutions are emerging, which will spread financing,” he adds.

Currently, BNDES can finance up to 70% of capex needs in the road sector, although it is not allowed to finance concession fees nor imported equipment. Sponsors facing large concession fees or a substantial spend on imported equipment have driven the development of non-BNDES sources, whether multilaterals, bridge lending from com­mercial banks or project bonds. Even sponsors with eligible projects have tended to close – and then repeatedly roll over – commercial bridge loans while waiting for the BNDES processes to run their course.

If there is too little support from BNDES, refinancing deals may no longer be viable, says Cassio Schmitt, head of project finance at Banco Santander in São Paulo. “We need to be careful: the assets that we have in the market and which now require long-term financing assumed a scenario where the BNDES would put up at least 60% of capex,” he notes.

São Paulo’s rich concessions spark funding dash

All eyes for now are on São Paulo state. The state successfully auctioned five lots of roads, as well as the western section of the ring road round the city of São Paulo in 2007 and their refinancing through capital markets is underway.

In the auction of five lots in 2008, concessionaires com­mitted to maintain and operate 1,715km of highway with improvement work, including the expansion of 359km to four lanes, 526km of additional tracks and new shoulders and 317 bridges and viaducts, according to data from the World Bank.

Sponsors initially used commercial bridge loans, because São Paulo requires a 20% down payment for concessions and the balance in installments over 18 months. But BNDES is not allowed to fund concession fees and capital market fin­an­c­ing would be unrealistic until traffic studies were incomplete.

For the Dom Pedro 1 concession, which was awarded to Odebrecht’s Rota das Bandeiras, the concessionaire paid R1.3 billion to the government for the right to toll the section. It initially closed a R1 billion limited recourse bridge loan with a group of Brazilian commercial banks led by Santander and Banco do Brasil, and also comprising Votorantim, HSBC and Mercantil do Brasil.

“2008 was clearly not the perfect moment for liquidity and Brazilian construction companies were still digesting a wave of federal concessions,” says Schmitt. Moreover, Brazil has no more than six banks with the clout to participate in this kind of deal, he says. However, he believes the state was right to press on, as delays would have meant facing a possibly worse situ­ation. The concession’s fundamentals, including an attractive location and usage history, meant that it was able to successfully secure financing.

Over time, the bank loan market will need to grow to support road financing. There should be opportunities to bring in more banks beyond the four to six players seen today, says Lopes. The difficulty is how many banks really have the ability to under­write big ticket financings, he says. “We have lots of requests for information to understand the market and infrastructure, although so far this has not translated into active participation,” he notes.

Bouncing bonds

The Rota das Bandeiras sponsor is the only one of the five winners to have tapped capital markets so far, and is widely seen as a possible model, with modifications, for the outstanding four concessions.

The Bandeiras package, linking Jacareí to Campinas, some 90km northwest of São Paulo city, was attractive, bringing together five busy roads that already had two toll plazas, says Schmitt. The brownfield routes required widen­ing of a highway and the extension of a beltway as far as Viracopos airport, scheduled for completion by 2015, he notes.

The concessionaire applied for a R921.5 million loan from BNDES to fund capital expenditure. Initially, it considered using the tried-and-tested method of raising debt from multilaterals, which offer long-dated dollar debt, but was deterred because of currency risk.

Santander, says Schmitt, noticed that the bond market had started to improve and the roads enjoyed good traffic flow and data. Talking to local funds and agencies, it realised that there were longer tenors available, especially for inflation-linked bonds, and over eight months the structure was born, he says.

The issue consists of 12-year bonds linked to the IGPM wholesale price index, which is used by the state government to set toll increases. The deal, which raised a greater-than-expected R1.2 billion, became a landmark, says Veirano’s Bronstein, who helped put together the financing. “It show­ed there was investor appetite from pension funds to buy debentures with longer maturities, introduced the ideas of inflation-linked bonds and non-recourse project finance covenants,” he adds.

The other big innovation was security-sharing by the BNDES, says BNDES’ Marchetti. The bank has not tradi­tionally shared pledges on the rights of concessions, toll income and other assets (such as shares, other revenues and other state support), but this time agreed to split them proportionally to bring in the private sector, he notes.

However, while there’s considerable optimism the model can be repeated, the Brazilian fixed-income project finance market is still nascent and there are serious misgivings as to just how much local pension funds will be willing to invest without a properly functioning secondary market. “If five or six companies come to market with the same structure, most likely local investors will be more picky and select only the best quality at attractive prices,” notes Bronstein. The lack of a secon­dary market means that although pension funds were able to buy into Rota das Bandeiras, there is going to be a strict limit on future participation, adds Caixa Geral’s Castro e Silva.

Authorities have been struggling to stimulate markets by introducing measures to encourage market making and standardise some clauses in bonds. The recently-enacted provisional meas­ure 517 cuts taxes on revenue from long-term fixed-income instruments for local and domestic investors, says Bronstein.

Many bankers believe that the role of the state banks, BNDES, Banco do Brasil and the giant mortgage bank Caixa Econômica Federal, will be vital in stimulating the market. “We do need a more active secondary market,” says Lopes. Banco do Brasil is analysing which mature projects in its portfolio could be sold to help develop the secondary market, he says. The rate of return in the roads sector is attractive and it offers stability with tried and tested regulatory regimes, he notes.

Lopes admits that the greatest headache for foreign participation in toll roads remains their reais-based cash flows. To mitigate currency risk, Lopes believes it will be possible to use mature projects with low leverage mature and proven cash flow to issue debt with dollar payments. A programme to promote project finance bonds abroad via roadshows and communication with investors could also help bring in foreign cash, he says. Some US accounts have expressed interest in buying debt in Latin American currencies, though their opportunities have to date largely consisted of sovereign issues.

The other great hope is securitisation. Lopes and Marchetti say upcoming operations could use new securitisation-based structures. Brazil already has credit funds (FDCs) and proper­ty ones (CRIs), and it should be possible to create funds that focus on project debt. “This could create appetite and improve pricing,” Lopes notes.

Marchetti says that there are alternatives to project bonds, such as a securitisation-based fund with an external agency-provided credit rating. Using a fund structure would allow smaller-scale investors to participate, while a credit rating means these smaller buyers will not need to perform exhaustive analysis of the bonds’ structure and payment flow, he notes.

Other Sao Paulo routes

The other four routes in the second stage of the concessions from São Paulo state have also closed short-term funding and all should come to market for long-term financing over the next two years. Bankers say the concessions covering Raposo Tavares and Ayrton Senna-Carvalho Pinto are already at advanced stages.

The Concessionaria Auto Raposo Tavares, a consortium led by OAS, won the concession for the 444km highway that links São Paulo city with the central-west state of Mato Grosso. In December 2010, BNDES approved R1.05 billion to cover works that include widening and maintenance of the road, with expected investment of R2.69 billion through February 2015. The company plans to raise R400 million through debentures under­written by Santander.

Ecopistas, a subsidiary of Ecoro­dovias, won the 134.9km Ayrton Senna and Carvalho Pinto highway concession. The roads link the city of São Paulo to Caçapava on the main route to Rio de Janeiro. To finance the concession, the project company rais­ed R150 million in 2009. BNDES has agreed to finance R355.4 million. Eco­pistas will seek to raise R350 million through an issue of debentures with a possible supplementary issue of 35%

Bankers say long-term financing for the other two concessions are still at a more initial stage. Rodovias do Tiete, a consortium led by Brazilian Equipav, took over the operation of Marechal Rondon East highway in April 2009. BRVias, a consortium of Brazilian Comporte Participações and Vaud Participações, took over the operation of Marechal Rondon West highway in May 2009.

BRVias recently closed a R450 million ($268.8 million) bridge loan with Banco Espirito Santo and Banco do Brasil, attracting Banco ABC Brasil, Caixa Geral de Despoitos and HSBC as participants on the six-month financing, which is priced at 375bp over CDI. The debt, for the ViaRondon project company, would be refinanced with a bond issue. The current bridge loan, which closed in December 2010, follows two earlier financings for the concession. The first was an 18-month R340 million loan from Banco Espirito Santo, Banco do Brasil and BCI that closed in April 2009. The second, which refinanced the first, was a three-month bridge loan provided by Banco Espirito Santo and Banco do Brasil in October 2010.

Sao Paulo doubles down on Rodoanel

The other major forthcoming financing in the state’s road portfolio is the concession for the eastern and southern parts of the Sao Paulo city ring road, which was awarded last November with a fee of R400 million. “This will be a big challenge as it involves both a large award payment and is a greenfield project with compulsory purchasing of land. This is a new model and needs to be tested,” says Lopes.

The winner was Consórcio SPMar, which offered a 63.35% discount to the government’s ceiling while the two losing bidders offered discounts of just 12% and 5.11%, according to data from Artesp, the concession body for the state. SPMar will be responsible for the R4 billion con­struction of the eastern segment of the ring road to be built in 36 months. A further R1 billion will need to be invested to bring the existing southern section of the road up to scratch.

Some bankers question the viability of the winning bid, pointing out that the company behind it, Bertin, is much better known for its meatpacking business than toll road expertise. Banco do Brasil, which supported the winning bid, refutes the charge. Lopes points out that Spain’s OHL came under fire from other sponsors when it scooped a number of Federal awards, some of which had even steeper discounts. The idea for financing is to tap BNDES for the capex while non-eligible elements will be funded through capital markets and possibly a bridge loan, he says.

The western stretch of the ring road, which was awarded to CCR, has al­ready attracted financing. The group financed its R2 billion payment in part with a 15-year, $100 million loan dir­ect­ly from the Inter-American De­vel­op­ment Bank, a 15-year $200 mil­lion loan from JBIC, and a 13-year, $200 million loan from commercial banks. Bradesco provided a three-year R750 million subordinated bond issue while the sponsor contributed $530 million in equity.

Future projects

Future concessions in São Paulo will be more challenging. To date, the state programme has focused on upgrades to brownfield projects. The next round introduces roads with high capital expenditures that link the coastal ports to the main São Paulo to Rio highway through a mountainous area. The first is tipped to be a brownfield project, Tamoios, which links São José dos Campos to Caraguatatuba. The state will probably need to consider availability payment-based concessions, bankers say.

Outside of the state of São Paulo, concessions have been slower to come to market and have generally disappointed, although there have been some successes, says Castro e Silva. “PPPs remain a question mark. I don’t think the other states and Federal government have the same speed and energy and financial resources,” agrees Bronstein.

Marchetti points out that the Brazilian federal government and states have already awarded 51 concessions, accounting for 15,000km of roads. He says a third stage in the government concession program is likely, with seven new concessions. Sao Paulo is likely to push forward with its programme and broaden its range of concessions, while north-eastern states Bahia and Pernambuco are also look­ing at PPPs. He expects to see at least another 6,000km handed as toll or availability concessions in the next four years.

The political environment, however, has long acted as a bucket of cold water on PPPs at the Federal level. Under previous president Luiz Inácio Lula da Silva, short-lived plans for PPPs were snuffed out by ferocious political opposition within his Workers’ Party. Rousseff, who took power on the first of the year, seems to be made of more pragmatic stuff. However, during the election she used her party’s opposition to privatisation as a major selling point. She may come to rue that pitch. n