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Itau’s Real Sale Shows Overseas Cost Advantage: Brazil Credit

Brazil's President Luiz Inacio Lula da Silva
Overseas real bond sales surged to a record this year after President Luiz Inacio Lula da Silva imposed a 6 percent tax on foreigners’ bond investments to curb a rally in the real. Photographer: Tomohiro Ohsumi/Bloomberg

Itau Unibanco Holding SA’s first overseas Brazilian real-denominated bond sale in more than three years is highlighting the cost advantage of borrowing abroad versus issuing debt locally.

Itau, Brazil’s largest bank by market value, sold 500 million reais ($290.8 million) of five-year international real debt last week to yield 10.5 percent, 180 basis points less than similar-maturity Brazilian government bonds offered locally.

Overseas real bond sales surged to a record this year after President Luiz Inacio Lula da Silva imposed a 6 percent tax on foreigners’ bond investments to curb a rally in the real. Local issuers of real debt abroad can use proceeds to buy the government’s higher-yielding bonds without incurring the levy. The yield gap shows how Lula’s decision to tax foreign investor dollar flows is opening up “arbitrage” possibilities for Brazilian borrowers, according to Nomura Securities Inc.

“This is what happens when governments try to do these capital controls but begin to pick and choose the flows,” Tony Volpon, a Latin America strategist at Nomura in New York, said in a telephone interview. “People just arbitrage the stuff. It’s a consequence of badly thought out government policy. You’re going to see many deals.”

Investor demand for local-currency debt sold internationally is rising as they seek higher-yielding alternatives to near-zero interest rates in the U.S., Europe and Japan. Peru sold $1.5 billion of bonds denominated in soles on Nov. 10, the biggest issue of local currency debt by a Latin American government. Colombia, the Philippines and Brazil have also sold bonds denominated in their own currencies this year, while Russia is planning an international ruble debt sale.

Tripling of Tax

Itau’s offering pushed overseas real debt sales to $10.9 billion this year, almost double the $5.5 billion issued in 2007, according to data compiled by Bloomberg. The Sao Paulo- based bank sold the bonds a month after the government tripled the tax on foreign investors’ fixed-income purchases to stem the real’s two-year, 39 percent rally and rein in a current-account deficit that swelled to an annual record of $47 billion.

At 10.5 percent, the yield on Itau’s real bonds is below Brazil’s benchmark overnight rate, known as Selic, of 10.75 percent. Itau’s press office in Sao Paulo said it couldn’t comment on the offering because the transaction hasn’t been closed. The yield on the government’s 10 percent bond due in 2015 was 12.3 percent on Nov. 19.

The tax has sparked foreign-investor demand for international real bonds because it allows them to profit from the world’s second-highest benchmark rate while sidestepping the levy. Only Croatia has higher inflation-adjusted rates among 46 countries tracked by Bloomberg.

‘Take Advantage’

“By creating these taxes and putting regulations you create segmented markets out there which allow people to take advantage of certain opportunities,” Pablo Cisilino, who helps manage $14 billion in emerging-market debt at Stone Harbor Investment in New York, said in a telephone interview. “Some guys can take the opportunity to do that. Some guys that are smaller cannot. So in reality the country’s worse off. But some guys are better off.”

Investment banks have sold a record $1.6 billion of overseas real-linked bonds this year, topping the $1.4 billion issued in all of 2007, according to Bloomberg data.

Morgan Stanley, the sixth-largest U.S. bank by assets, sold 575 million reais of 10-year bonds abroad to yield 11.5 percent, according to Bloomberg data. Mary Claire Delaney, a spokeswoman for the New York-based bank, said in an e-mail that Morgan Stanley doesn’t comment on its debt sales.

InBev Sale

Anheuser-Busch InBev NV, the world’s biggest brewer, raised 750 million reais in an overseas offering this month. The company, based in Leuven, Belgium, paid a yield of 9.75 percent on the securities.

“Given the recent developments in the Brazilian real market with respect to foreign exchange and rates, there is a good opportunity for such a transaction,” Marianne Amssoms, a spokeswoman for InBev, wrote in an e-mailed statement. The sale “is in line with a commitment to manage the maturities of our debt” and “aligning the currencies of our debt with our operating cash flows,” she wrote.

The real fell 0.4 percent to 1.7216 per dollar at 5:31 p.m. New York time.

The extra yield investors demand to hold Brazilian government dollar bonds instead of U.S. securities widened 6 basis points to 183, according to JPMorgan Chase & Co.

Default Swaps

The cost of protecting Brazilian debt against non-payment for five years with credit-default swaps climbed 3 basis points to 111, according to data compiled by CMA DataVision. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to its debt agreements.

Yields on Brazil’s interest-rate futures contract due in January 2012 rose 11 basis points to 11.77 percent.

Stone Harbor’s Cisilino said overseas real bonds sold by banks are unattractive because they yield less than local government debt.

“There’s other ways to get access to the local market,” Cisilino said in a telephone interview. “Why would you buy a corporate bond below where the sovereign trades?”

Banco Bradesco SA, Brazil’s second-largest bank by market value, withdrew an offering of five-year real-linked bonds on Nov. 16 after concern a debt crisis in Europe was worsening sparked a drop in global markets.

VTB Bank, a unit of Russia’s second-largest bank, plans to sell five-year real-linked debt overseas, according to a person familiar with the transaction who declined to be identified because terms aren’t set. BTG Pactual and VTB Capital are arranging the sale, the person said.

‘Window Open’

More real-linked offerings are likely, according to Nomura’s Volpon.

“They’ve left this other window open, and now various banks, companies, very credit-worthy institutions are going to go through that window and issue bonds to meet demand,” he said. “It’s very emblematic that Itau is issuing below Selic.”

Growing investor demand for overseas real bonds is giving companies an additional avenue to diversify funding, said Fabianna Del Canto, who works on the emerging-markets syndicate desk at Barclays Plc in London.

“It’s raised our collective awareness that this market is growing,” said Del Canto, who helped manage the InBev offering with Deutsche Bank AG and Itau. When global corporations look at financing themselves, “the real hasn’t been one of the markets that’s been part of that dialogue or thought process -- and all of a sudden it is,” she said.

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