Brazil’s announcement of a R66 billion infrastructure programme, and indications that more projects will follow, have again focused attention on what has proved a frustrating market. The programme calls for the construction of 10,000km of new railways, together with building or upgrading 7,500km of roads. The federal government is also expected to put forward a package of investment in ports and waterways imminently.

Brazil has lagged behind on infrastructure investment and failed to engage the private sector. Paulo Oliveira, chief executive officer at São Paulo-based Brazil Investments and Business, says Brazil needs $300 billion per year to sustain 5% annual growth. “We are competing for this money with the other Bric countries. The money is not going to come from government or banks, which face capital restrictions thanks to Basel 3 rules,” he says.

Key elements in the new programme have captured the attention of investors, says Marcelo Felberg, finance director at Odebrecht Transport. The government’s determination to plan and commit to this large programme should ensure a smoother flow of projects. The explicit statement that the private sector will be a key player is very encouraging, and the timing is good for foreigners, with the Real having dropped from R1.50 to just over R2 to the dollar, he says. Local debt markets are increasingly promising: Brazil’s overnight interest rate has come down 5% in the last 12 months to stand at a record low of 7.5%.

Transport bonanza

The government says improvements to Brazil’s railway network will attract R91 billion in spending. New lines should be ready within five years of signing contracts, slated to take place next year. Some, such as the rail ring for São Paulo, the Ferroanel, are already well advanced. But the separate contract for the R33 billion Rio de Janeiro-São Paulo-Campinas bullet train has not yet been revamped after the government failed to award the concession on 11 July.

Felberg says that Odebrecht will look at that project again when it is reintroduced. “We have to wait and see what the model looks like and what kind of guarantees are on offer. A whole series of questions from demand predictions, technical specifications, environmental issues and expropriation will be taken into account,” he says.

Roads come second in the programme, with a planned R42 billion in spending that will see 7,500km of federal roads passed to the private sector, of which 5,700km should be ready within five years of contact signing. The government is already working on concessions for two major highways. The first is a 937km stretch of the BR-040 from Brasilia to Juiz Fora to the border of Minas Gerais and Rio de Janeiro states, and the other an 817km section of BR-116 which goes from the border of Bahia state through Minas Gerais to the border with Rio de Janeiro. The concessions contracts are set to sign in March or April of next year. Other road concessions are likely to be announced by the end of the year, says Felberg.

Although not included in the programme, a second round of airport privatisations is likely to come to market. Galeão, the international airport for Rio de Janeiro, and Confins, the main airport for Belo Horizonte, are obvious candidates, and Salvador and Manaus are tipped as likely as well.

Concessions for these federal airports will compete for sponsor attention not only with international projects but also with local ones. Alberto Zoffman, director of the project finance department at Banco Itaú in São Paulo, notes that his clients are interested in the São Paulo state airport privatisations, which feature a possible 31 concessions. There is particular interest in the coastal Guarujá airport, which has a 1,400m runway and needs R85 million in investment, as it looks to upgrade to handle 1m passengers in 2014. The airport will also be key to handling personnel working in the pre-salt oil and gas exploration area.

Doubts over execution

Brazil will need to work hard to woo foreign investors, and initial reaction to the programme has been mixed. “There is little consensus yet from overseas clients that we have spoken to,” says one banker in São Paulo. Former President Luiz Inácio Lula da Silva sought to push infrastructure using two giant Growth Acceleration Programmes (PACs), while the World Cup and Olympics seemed to offer a chance for the private sector to gain traction. Both are behind schedule and private participation has amounted to very little, bankers agree.

Moreover, the second round of Federal roads and the recently-completed first round of airports featured some poorly designed concessions. The road concessions did achieve low tolls for road users, but concession holders have failed to stick to the timelines for capital expenditure stipulated in concession contracts, while the airport concessions attracted sponsors with little experience of running large, complex airports.

The question is whether this time round things will be different. Zoffman is optimistic. He points to the use of the Empresa Brasileiro de Projetos (EBP), which should bring more objectivity to studies. Large banks are well represented at the company, which will vet government infrastructure projects and undertake feasibility studies, with its costs borne by the eventual concessionaire.

On roads, Felberg believes the government has learned its lesson. It will pay more attention to ensuring investment plans are followed through by using enforceability clauses, he says, and sanctions are likely to take the form of fines and penalties. The Minister of Transport, Paulo Sérgio Passos, has already said that new contracts will stipulate no toll can be levied until at least 10% of works are complete.

The government is already rethinking airport concessions. The first round saw three relatively small fry win concessions for some of Brazil’s largest airports. In February, when the winners were announced, the government revealed it had netted a fat R24.5 billion, nearly 350% over the minimum bid level. But there is considerable market scepticism about how these concessionaires will now make money and invest given the high upfront concession fees they have promised to pay.
 
Brazil’s senate has already set up a commission on infrastructure services, which has sounded a scathing note on the concession process. The head of the commission, senator Francisco Dornelles, recently said he will investigate: “how it will be possible to reach the quality of service desired with the resources that will be left after the payment to the government.”
“There are very legitimate questions about the existing concessions and technical qualifications and you have to tread very carefully in the airport sector,” says Eduardo Farhat, manager of the Brazil Mezzanine Infrastructure Fund at Darby Overseas Investments in São Paulo. He reasons that the relatively inexperienced operators will use sub-contracting substantially. “They will look at everything from air conditioning, energy generation, ground handling and catering services,” he says.

Felberg adds that the government will seek a structure that nets the top operators. “In my view, if they introduce a small number of changes in the tender, they will bring in leading operators. Just raising the bar on size and making sure would-be concessionaires present business plans ex-ante will achieve these goals,” he says.

Another possibility, says Darby’s Farhat, is that the government puts Infraero, the state company that still holds 49% of privatised airports, back in the driving seat for future concessions, with some private participation. Local reports suggested that the idea of Infraero, which has a reputation for being susceptible to political interference, running the airports went down badly with foreign investors during a foreign roadshow that included Luciano Coutinho, the president of Brazil’s national development bank, BNDES.

The port sector is more complex still, and will experience a major review within 12 months. The sector needs a legislative overhaul to clarify the status of private ports and mixed ports, where private companies have terminals within public ports, amid complaints of unfair competition. “These projects require a lot of capital, especially as the port infrastructure is old in Brazil and you don’t have a take-or-pay contract. They are not easy to finance,” thinks Zoffmann. Farhat too is sceptical, particularly about the hype surrounding the container business at Brazil’s premier port, Santos. There are already three large container projects and companies have been operating below capacity for some time. “It’s hard to justify new container ports in Brazil with projects across the country and especially in the south,” he says. He sees more opportunities in bulk liquids handling facilities, driven by the oil and gas, chemical and ethanol industries.

Cold financing fronts

But potential sponsors also have two key questions about the financing backdrop to this infrastructure activity. Firstly will BNDES leave room for capital markets to emerge? Secondly, what kind of financial instruments will predominate if it does? Otávio Lobão Vianna, head of the capital markets department at BNDES, says that the bank knows that: “alone, we cannot support all the financing. We spent R56 billion in the sector last year and that’s lots but not nearly enough for all the projects”. He believes that a number of financing techniques will flourish and that the bank can help catalyse these. Simple debentures and securitised bonds, called credit rights investment funds (FIDCs), will be the two main debt instruments, and the bank will encourage the development of a secondary bond market. It will also engage in direct equity participation and private equity funds, he says.

Banks are optimistic about the role for capital markets Itaú is looking to add more people as it explores opportunities in the logistics space, partly as a result of the program, says Zoffmann. The bank has three executives covering logistics working under Zoffmann now and is looking to increase that with one or two more hires, he notes. “Once the regulation is announced we intend to visit our clients abroad interested in project finance in Brazil through roadshows,” Zoffmann says.

The role of BNDES will change and while the bank will remain a key debt provider it will also act in helping to structure debentures that will share project collateral with a BNDES direct loan, as well as in directly buying debentures that will be offered to a broad base of investors, thinks Daniel Vaz, head of debt capital markets at BTG Pactual. The development of fixed-income capital markets, especially through long-dated instruments, will allow sponsors to increase leverage and reduce the amount of sponsor equity over the medium term, he notes. Large institutional investors, including pension funds and insurance companies will participate early on and as the secondary market develops liquidity, other investors, including foreign ones, will join, he says.

Boutique managers have already set up funds and now even the largest asset managers, such as giant state bank Caixa Econômica Federal, are starting funds to invest in infrastructure. Domestic  players are also optimistic that the non-recourse project finance bond market will expand. Specific deals have already closed, as Odebrecht’s Felberg notes. “We are starting to see real project finance bonds. Two years ago, we closed the first non-recourse debenture, raising R1.1 billion.” But Felberg admits that for now the domestic base for this remains confined to just the most sophisticated pension funds and institutional investors. The top 10 pension funds in Brazil control nearly 90% of the market, he estimates.

It has not been smooth sailing for project bonds. The Concessionaria Rodovias do Tiete toll road in São Paulo, sponsored by Cibe and Ascendi, was unable to issue R650 million in bonds earlier this year and was obliged to roll over and increase a R600 million bridge loan with BTG Pactual for another 360 days. Barclays had been mandated to lead the bond issue.

One senior banker noted that the issuer had tried to bring the debentures to market before there was full clarity surrounding legislation, and another said that Barclays did not have sufficient local experience for such a complex operation. Both are confident that the deal is possible. The deciding factor will be key changes to the legislative framework. Attractive conditions already exist for project finance bonds on paper. Last year, Congress passed law 12.431, which is designed to boost the long-term market, covering bonds of at least four years tenor. These bonds are tax-exempt for domestic and international investors and have the further benefit of being exempt from the financial transactions tax (IOF) applicable to foreign investors.

Investors are now waiting for refinements to the law that will define the role of BNDES properly. If the refinements go through BNDES and the special purpose vehicle that issues the bonds will be able to share collateral, and cross-default clauses that apply to BNDES’ own loans and bonds will be written into financing agreements.  The proposed modifications would also increase the percentage of each issue that BNDES will be able to buy from between 5-20% to between 15-30% of public offers. There will also be more flexibility on how money raised from an issue is spent, with issuers able to pay down debt raised at the start of the project.
 
These changes are in line with BNDES’ owns capital markets aims. Zoffmann sees tenors lengthening, with intelligent, customised amortisation schedules that suit the bank and investors. “If you put together good, well-structured deals, BNDES is very open to guarantee sharing,” he says. Itaú is discussing a guarantee sharing structure for a bond financing for a hydroelectric power plant alongside BNDES.

The first bonds will be for energy transmission and generation assets and road projects, including the Rodovias do Tiete concession, will soon after be able to access this market, Vaz predicts. These two sectors have clear legislation and a track record, he notes. Ports, airports, railway and logistics could follow, but will take longer.

Bankers agree that initially pricing will be difficult and the bonds will be expensive as investors get used to them. But prices should drop over time and tenors lengthen. Vaz predicts initially, tenors will be capped at 12 to 15 years but that within one to two years, 20 years will be possible. The structure of the bonds will be key, thinks Vaz. They will be structured with a longer grace period so that a project meets the debt service coverage ratios required on a BNDES direct loan in the first years.

Striking a balance

Brazil’s federal infrastructure programme has often disappointed foreign investors. High interest rates, an inconsistent pipeline, poorly written contracts and an institutional reluctance to attract private money have hamstrung what should be a highly attractive market. This time round, more of the ingredients are in place for the market to take off. Local bankers are convinced that the government is serious in getting the private sector involved and will undertake changes to the concession process. They hope BNDES works with the private sector rather than competes with it.