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DEAL OF THE YEAR: Financing Innovation

Jan 1, 2013

Banco do Brasil $1bn Hybrid Tier I Perpetual Bond

Just how Basel III will affect banks' capital requirements in Brazil is still far from clear. So when Banco do Brasil introduced a new type of hybrid security in January 2012 that would be Basel III compliant - irrespective of what that might ultimately mean - it was thinking well ahead of its competitors.

The $1 billion hybrid tier 1 perpetual NC11 bond was the third ever Basel III-compliant bond - as well as a first in emerging markets - and has set a template for other financial institutions as they prepare to adapt to a new regulatory environment.

"This is a landmark transaction that has changed the landscape of investments available," says Marcelo Delmar, head of LatAm DCM at BNP Paribas, a bookrunner on the deal with Banco do Brasil, Citi, HSBC and Standard Chartered.

The structure was a result of the financial crisis, and is meant to help financial institutions as going concerns. Previous tier 1 perpetuals would aid borrowers during liquidation events, but were not useful for healthy banks that were going concerns (as they couldn't write off principal as long as they are a going concern).

"We dind't have an indication of how Basel III would be implimented in Brazil, but at the same time we know that Brazil is participating in the dicussions with the Basel committee," says Daniel Maria, executive director at Banco do Brasil. "We established a number of protections for the investors, and that was the key for the transaction."

The structure allows Banco do Brasil to qualify the issue as tier 1 capital under current and future regulations.

In a key innovation, the documentation includes a 'qualifying amendment' or 'floating indenture' that allows the borrower to amend conditions unilaterally once new Basel III regulations are implemented in Brazil.

"These types of provisions set a new standard relative to the other post-Basel III deals," says Chris Gilfond, co-head of LatAm debt at Citi. He says it is the first transaction with principal writedown provisions. If the bank needs capital these debt investors get written down, without a provision to get written back up. The bond was perceived as junior to the equity, with lenders taking losses before the equity is even diluted.

The BB rated bond generated a book of $6.2 billion before pricing at par to yield 9.25%, higher than the bank usually pays but below its normal 13%-14% cost of capital.

The unsecured and subordinated structure carries no step-up and offers different interest and loss absorption trigger mechanics than Banco do Brasil's previous perpetual bonds. However, buyers were drawn to the perceived value of getting the over 9% yield for exposure to the government-owned bank that would almost certainly count on a bailout from Brasília if it got into trouble.

"Investors demonstrated confidence with the structure and particularly with Banco do Brasil risk," says Rodrigo González, head of LatAm DCM at Standard Chartered. European and the Middle Eastern investors represented 41% of the distribution, Asian buyers 27%, North Americans 24% and LatAm 8%. Private banking was the top investor class, taking 49%, fund managers followed with 37%, and banks and financial institutions 14%.

With the bonds trading up above 109, Banco do Brasil followed a month later with a $750 million retap. The bank reopened at 108.50 for a 8.488% yield. The return was more evenly distributed than the original with about one-third participation coming from each of the Americas, Europe and Asia. Bankers are confident others can follow.

"This is non-dilutive tax-deductible equity," says Delmar. "Why would you raise equity if you could do this? This is not only an option for banks. Corporates will think long and hard before raising equity." LF



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