Bofa Battles Credit Suisse for 50% Markups on State Loans

Credit Suisse AG and Bank of America Corp. are exploiting guarantees from Brazil to help its states refinance $200 billion of bailout debt at interest rates that are 1.5 times higher than the nation’s own borrowing costs.

The firms are among at least five lenders in talks to loan five states $6.5 billion this year -- more than double last year’s total -- as local governments seek to chop debt costs by replacing loans from a 1997 federal bailout that average 14.4 percent in reais. Credit Suisse is lending Mato Grosso, an agricultural state in western Brazil, $1 billion for 15 years. The loan, with a rate equal to about 11.2 percent in reais and guaranteed by Brazil if Mato Grosso defaults, compares with 7.35 percent for yields of similar-maturity government debt.

Municipalities are seeking to refinance bailout debt and take on more loans to compensate for lower tax transfers, after Brazil authorized 21 states in August to borrow a total of 60 billion reais ($30.4 billion) through 2014 with government guarantees. Joining the foreign lenders are local banks, which raised a record $19.5 billion abroad last year and are looking for alternatives to government debt after the most-aggressive rate cuts among Group of 20 nations damped returns.

“Two years ago nobody had the money, neither state nor private banks,” Luiz Carlos Hauly, the finance secretary for Parana state, said in a telephone interview from the capital city of Curitiba. “Six months ago they started running after us, realizing it’s a low-risk deal.”

Market Opening

Average overseas borrowing costs for Brazilian banks plunged 116 basis points last year, or 1.16 percentage points, to 3.87 percent, according to Credit Suisse indexes. Brazilian banks’ dollar issuance last year was the most since Bloomberg began tracking the data in 1999.

The combination of near-zero benchmark rates abroad and record low borrowing costs at home, where the benchmark rate was cut 5.25 percentage points since August 2011 to 7.25 percent, have stoked private banks’ interest in lending to states, according to Aod Cunha, the director responsible for public sector banking at JPMorgan Chase & Co.’s Brazilian unit.

“This market only opened up with a more accentuated drop in interest rates,” Cunha said in a telephone interview from Sao Paulo. “When interest rates were much higher, it was difficult to make this type of transaction happen.”

While JPMorgan hasn’t lent to any states, it is “looking at the market,” he said.

Improving Finances

Privately owned lenders are also being drawn to state lending now because stronger total tax revenue, even as the federal government cuts back on transfers, has improved their finances, according to Marcio Tunholi, the executive manager for government relations at Banco do Brasil SA.

The ratio of states’ net debt to revenue has been declining and probably fell below 1 in 2012, according to a Feb. 22 report by Fitch Ratings on state borrowing. States had a total of 408 billion reais of debt in 2011, 88 percent of which was owed to the federal government, according to the report.

Brazilian states and cities haven’t been able to take advantage of the unprecedented decline in interest rates because they have been restricted from selling bonds since the 1997 bailout, leaving the country without a municipal bond market. States ran into financial difficulties in the early 1990s after years of mismanagement and hyperinflation.

State Payments

States’ interest payments have exceeded the size of the original federal bailout loans, which carry an interest rate of 6 percent plus inflation as calculated by the IGP-DI index, currently at 8.24 percent. Parana, which originally borrowed 5.7 billion reais, has already paid 10.2 billion reais and still owes 9.3 billion,

“No father treats his son like this,” Hauly said.

Parana state, in the south of Brazil, is seeking approval for a 1.1 billion-real loan from Credit Suisse to repay debt owed to the state-owned electric utility, according to Hauly. It also wants to refinance an additional 2.5 billion reais of federal bailout debt.

Bank of America, Itau Unibanco Holding SA, Banco Santander Brasil SA and Banco BTG Pactual SA have all offered credit to help refinance the federal debt, he said.

Bank of America, Banco BTG, Credit Suisse, Itau and Santander declined to comment on their lending activities.

Overdue Payments

Mato Grosso do Sul is negotiating a loan with several banks, including Santander, to amortize 3.2 billion reais in overdue payments on its total 7.3 billion reais debt, Jader Julianelli, the state’s finance minister, said by phone. The cost of the new loans, when converted to local currency, shouldn’t exceed 7 percent, he said.

The state of Rondonia, which borders Bolivia, is seeking to refinance 1.7 billion reais of federal debt with private banks, according to a notice in its official gazette on Feb. 22.

Goias, in central Brazil, is also seeking to refinance federal bailout debt, according to Vivaldo Lopes, the deputy finance secretary of Mato Grosso. Attempts to reach the finance secretary in Goias by telephone were unsuccessful.

Under pressure from governors, the federal government has sent a bill to Congress that would ease the terms of the bailout loans. The proposal would reduce the rate to 4 percent plus the IPCA inflation index.

“The government has been more sensitive toward restructuring debt because it’s good for the states to amortize their debt and have more money to invest in Brazil’s infrastructure,” Julianelli said.

‘Transparency’ View

The federal government has supported requests by states and municipalities for debt exchange operations “as long as the financial conditions are more advantageous than those of their contracts with the” federal government, the Finance Ministry said in an e-mailed response to questions.

The time it would take to collect from the federal government should a state default is unknown and the factors used to evaluate states’ fiscal conditions isn’t public, according to the Fitch report. Grace periods on private loans could also tempt states to loosen fiscal discipline by pushing back payments to their political successors.

“The more transparency in this process, the better,” Paulo Fugulin, a Fitch analyst and author of the report on state borrowing, said in a telephone interview from Sao Paulo.

Yield Spread

The extra yield investors demand to own Brazilian government dollar bonds instead of U.S. Treasuries dropped five basis points, or 0.05 percentage point, to 171 basis points at 3:30 p.m. in New York, according to JPMorgan indexes.

The cost of protecting Brazilian bonds against default for five years rose three basis points to 126 basis points, according to data compiled by Bloomberg. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent if a borrower fails to adhere to its debt agreements.

The real fell 0.2 percent to 1.9754 per dollar.

Even if the federal government agrees to lower the rates charged on bailout debt, states will still have an interest in taking loans from private banks to raise money for investments, according to Hauly.

“Even with a new law, private banks will continue to be an interesting alternative,” he said.

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