How Brazil's project finance market is set for a radical overhaul

How Brazil's project finance market is set for a radical overhaul

Brazil Bonds M&A Funds Project & Infrastructure Finance Special Reports

What do you do if you are a national development bank and want to support a nascent industry, but your public debt load is staggering and you are running out of funds? Brazil’s BNDES is transitioning from its role as a subsidized lender to eventually match the market rate. It will partner with lenders and provide project guarantees but will less often be the lead investor in renewable energy projects.

The new approach is set to raise funding costs for Brazil’s renewable energy projects. But the hope is that the changes will encourage a deeper and more competitive project finance market. “Some people like to complain, but I think the market will get around this much quicker than you can expect,” says Elbia Gannoum, chief executive of the local wind power association ABEEólica. “Brazil is following a new path in many ways. Policies are changing, not only in the electricity sector. BNDES now needs to choose where it is going to invest because the country does not have much money. Brazil is broke.”

Starting next year, BNDES will retire the TJLP long-term corporate lending rate, which the national development bank has used for up to 70% of investments in wind and solar energy projects. The TJLP today stands at 7%, a sharp discount to the central bank benchmark rate of 10.25%. The replacement TLP rate, in contrast, will start with the IPCA consumer price index and then add a spread based on the yields on five-year inflation-linked NTN-B government bonds.

“For the first time, BNDES will not be the obvious answer,” says Marcelo Girão, head of project finance for the power sector at local investment bank Itaú BBA. “Companies will have to think outside the box and look for alternative sources for new projects.”


About time

Projects that are financed through the end of 2017 will still pay rates based on the TJLP. BNDES will begin the five-year implementation period for the new lending rate in 2018. “Renewables still have some privileges, but in the medium term they will not have them any more,” Girão says.

At least four projects made the cut in June, when BNDES granted some 2.08 billion reais ($628 million) in long-term financing for wind farms in the northeast, including 1.04 billion reais for the Ventos do Araripe III.

BNDES’ plans to overhaul its benchmark lending rate come during a lull in auctions for new renewable energy projects. The last auction for wind projects took place in 2015, and the government canceled an auction in December last year as a deep recession took a toll on electricity demand, especially from renewable projects. As it now stands, power distributors in Brazil do not need to sign new energy supply contracts for two years.

But as Brazil’s economy rebounds, builders and developers are urging the government to hold more wind power auctions before the end of the year. “If the macroeconomic scenario keeps improving, the distribution companies will probably have higher demand for power and the government will realize that it is necessary to have new auctions,” says Girão.

As BNDES loans become more expensive, developers should be able to tap project finance. Commercial lenders have played a role in financing wind projects in Brazil, often through onlending agreements with BNDES. French bank BNP Paribas, for one, has disbursed 1.3 billion reais in financing to Brazilian renewable energy projects in the past three years, while Itaú BBA dedicated around 60% of 2.6 billion reais in power project finance to renewable energy in the first five months of 2017.

“This year, we have been signing deals related to projects that were announced two years ago. But next year, we will have a decline in terms of wind power projects,” says Jean-Valéry Patin, the head of project finance for Latin America at BNP Paribas.

“On the other hand, we do have several solar energy projects that were auctioned in 2014 and 2015, which are closing now or maybe the beginning of next year. So solar energy projects may help make up for the decline in wind power,” he says.


Game changers

BNDES is not going to lose the top spot in the project finance sector anytime soon but its role could change. “We have a pipeline of 1.5 billion reais to 2 billion reais in debentures for renewable energy projects in 2017 and 2018,” says Eliane Lustosa, managing director of the capital markets department at BNDES.

The goal is to combine BNDES’ resources with those of the market. “Sometimes we can act indirectly to boost projects in the green sector. We believe that eventually differential pricing will emerge. At the moment, it does not exist, but we can help attract other investors for these kinds of projects,” Lustosa says.

With that aim in mind, BNDES is forming a 500 million real renewable energy investment fund with local asset management firm Vinci Partners. It also raised $1 billion from the sale of a seven-year green bond to more than 250 investors in early May.

“We have diversified our funding sources. In the meantime, we are supporting initiatives such as externality in the green sector,” Lustosa says. In mid-May, for example, BNDES provided guarantees for 42.4 million reais in debentures from Potami Energia, a wind farm subsidiary of Omega Geração. 

Eduardo Klepacz, the Brazilian head of Cubico Sustainable Investments, views debenture issues as an increasingly relevant source of financing for renewable energy projects. Cubico, which is owned by the Ontario Teachers’ Pension Plan and fellow Canadian pension fund PSP Investments, recently raised 300 million reais from the sale of debentures in Brazil.

“The market response was positive,” Klepacz says. “There is increasing interest from investors to seek a complement to BNDES financing. It is not a substitution. It is a complement.”


Transition plays

Meanwhile, renewable energy companies see potential in Brazil. Echoenergia, a wind power producer owned by the British private equity fund Actis, acquired two wind farms in Brazil in May and is planning more acquisitions. The company has already invested 1 billion reais in equity and intends to generate 1.5 GW in energy within three years. Echoenergia also has an IPO in its sights for the medium term, along with an issue in the local bond market.

“The growth plan is aggressive but achievable. We are looking at M&A as well as greenfield projects. The issue about greenfield is whether there are going to be auctions or not,” says Claudio Ferreira, vice president of Actis’ new business. “All our projects are being financed. All of them include infrastructure debentures. At the moment, we have to follow the rules of the game. To be competitive in an auction you need to have 50% to 70% BNDES financing and maybe 20% in debentures,” he says.

But the model is changing, and Echoenergia intends to issue infrastructure debentures on its own in the second half of the year or in the first half of 2018, Ferreira says.

BNDES will eventually become another source of financing, and not necessarily the leading one, for renewable energy projects in Brazil. “But it will be difficult to achieve without the correct incentives, as banks already have to deal with their own short-term liabilities,” Ferreira says.

Gaétan Quintard, executive manager of project finance at BNP Paribas, sees change on the way but cautions that institutional investors are not yet ready to take the lead in the Brazilian renewable energy sector. “There will be a transition period and BNDES will not pull out entirely,” he says.

Questions persist about the liquidity of infrastructure debentures and the nature of the investors themselves. Infrastructure debentures in Brazil are tax exempt for local retail and foreign investors. “But the market is currently very much restricted to a few family offices and some credit funds,” Quintard says.

Itaú BBA’s Girão says the investor pool is relatively small, and retail investors can choose from other tax-free securities, such as real estate receivable certificates and agribusiness receivables certificates. Or they can choose to buy bonds from well-known companies like Vale and Fibria. “They like the brand recognition,” he says.

“The depth of this market is still very limited. We took part in some operations for wind projects. All of them were successful, but the volume is relatively small, around 150 million reais, and the demand is typically around 200 million reais. If you have a huge project with no BNDES [financing] and 800 million reais to raise, there is no market nowadays to absorb such a huge volume in a single issue,” Girão says.

To address the lack of liquidity, the Brazilian market for infrastructure debentures must attract more institutional investors, he says.

Sergio Brandão, the head of Actis in Brazil, says BNDES and multilateral agencies could easily improve financing for renewable energy projects by providing more guarantees. He also says BNDES could ease capital requirements for developers.

“They currently restrict the use of cash that is available in special purpose entities [SPEs]. We would like to be able to reinvest part of this cash in other projects. Such reinvestment would increase the efficiency of capital, increase industrial activity and generate more jobs,” he says. “Leaving that cash stuck in SPEs is not an efficient way of using foreign capital that comes to Brazil.”

BNDES says it is open to dialogue. “We want to add our resources to those of the market,” Lustosa says.

ABEEólica’s Gannoum views the development bank’s retreat as a way for the sector to eventually stand on its own. If BNDES maintains its dominant position, private-sector lending will remain subdued and the capital markets will not emerge as a consistent source of funding for renewable energy projects, she says. 

“The idea is for BNDES to diminish its influence to allow for development of the capital markets,” Gannoum says. “We understand the changes will be healthy as long as they are implemented gradually. But there cannot be abrupt changes because, at the end of the day, you do not have a deep capital market here.” LF