Brazil’s government bonds have proven such an unprofitable investment for Rio de Janeiro retirees the state’s pension fund is taking the unprecedented step of borrowing money overseas to plug its shortfall.
Rioprevidencia wants to issue $1 billion of debt backed by oil royalties, Fitch Ratings said June 2, in what will be the first-ever bond sale by a Brazilian pension, according to data compiled by Bloomberg. The bonds, marketed to potential investors in San Francisco, New York and London in the past week, may be rated two levels above junk at BBB by Fitch. Emerging-market notes with the same rating yield 4.7 percent on average, data compiled by Bloomberg show.
The move comes after Brazilian bonds, which account for almost half of Rioprevidencia’s assets, posted their biggest losses last year since 2004 as the Latin American economy slowed and the real plunged. While the bonds have rebounded this year, Brazilian pension funds suffered a record deficit of 22 billion reais ($9.9 billion) in 2013. To avoid a repeat, Rioprevidencia plans to use royalties that Rio de Janeiro receives mostly from state-run oil producer Petroleo Brasileiro SA to guarantee payments in its bond sale.
“Rioprevidencia is seeking ways to cover their actuarial deficit in an innovative format for Brazilian funds,” Mirian Abe, an analyst at Fitch, said in a telephone interview from Sao Paulo. “That amount should be good to cover their deficit in the next three to four years.”
Natalia Oliveira, a press officer at Rioprevidencia, directed questions on the bond sale to Rio de Janeiro’s Planning and Management Secretary. The Secretary’s press office said in an e-mailed response to questions that the fund hired banks for a potential offer of bonds backed by oil royalties.
Rioprevidencia hired BB Securities and BNP Paribas to arrange the offering, said a person familiar with the matter.
The pension fund’s assets shrank 14 percent last year as Brazil’s inflation-linked bonds lost 11 percent. Brazilian local bonds have returned 7.5 percent so far this year, compared with a 5.2 percent gain from other emerging markets.
While the bonds have recovered, a measure of inflation that last month reached the highest level since July has kept Rioprevidencia from meeting its actuarial target of 6 percent over price increases.
The real declined 0.4 percent to 2.2340 per U.S. dollar at 2:15 p.m. in New York.
Rioprevidencia is turning to the debt market after relying on cash proceeds from redemptions of bonds issued by the federal government in 1999 to finance its cash shortfall. The last of those notes, issued to the pension fund as part of the state’s debt renegotiation, were redeemed in 2012.
To meet its funding obligations last year, Rioprevidencia sold oil-revenue rights to state-controlled banks Caixa Economica Federal and to Banco do Brasil SA for 2.2 billion reais and 1 billion reais, respectively. Caixa and Banco do Brasil will sell the revenue rights they own back to Rio Finance Oil Trust, the special-purpose vehicle created to sell Rioprevidencia bonds. In turn, the banks will receive 2.7 billion reais in local bonds backed by the oil royalty flows.
“Pension funds from different parts of the country are struggling with considerable deficits,” said Ricardo Mollo, a corporate finance professor at Insper Institute of Education and Research in Sao Paulo. “Rioprevidencia is seeking to fill its actuarial gap counting on money mostly coming from Petrobras production.”
A decline in the amount of assigned oil revenue received by Rioprevidencia may “materially adversely impair its ability to pay principal, interest and additional amounts, if any,” according to bond’s prospectus. Petrobras’s production has declined for two straight years, falling short of the 9.4 percent annual increase estimated since 2010, when it started developing the so-called pre-salt reserves off Rio’s coast.
“Petrobras is undergoing a transformational process that has required significant capital expenditures to boost its production and cash flow, possibly delaying efficiency and timely production,” Eric Gretch, an analyst at Standard & Poor’s, said in a June 6 report.
Rioprevidencia’s oil royalties totaled almost 4.9 billion reais in 2013, equal to about 40 percent of total revenue.
“It doesn’t look good to see a pension fund issuing debt,” Ulisses de Oliveira, a money manager at Galloway Capital Management LLC, which oversees $400 million in emerging-market debt, said in an e-mailed response to questions. “The royalty installment payment method exists for a reason, so there are no lump sums paid at once.”
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