Renaissance Italy and modern-day Brazil might not seem to have much in common beyond sharing a majority religion. Are they also linked in the approach of their most famous financiers?
André Esteves is proud of being chairman and chief executive of an “investment bank that invests”, as he often describes BTG Pactual. He is keen to emulate famous figures from the history of finance, who, he says — like BTG — invested their own capital to back up advice to clients. He compares BTG to prominent financiers not just from Renaissance Italy, but also from Napoleonic Europe and the early industrial era of the US.
“Our business should be providing corporate clients with good advice, with credit lines, and with permanent capital when it is appropriate and required. If you go back in history, that’s what the Morgans did 100 years ago, what the Rothschilds did 200 years ago, and what the Medicis did more than 500 years ago,” he tells LatinFinance.
“We like the combination. The secret of our business is the combination of the different business units.”
The institution has come a long way since 2008, when Esteves quit his job as head of global fixed income at UBS to set up the boutique — then just BTG — with some old colleagues and former Brazilian central bank governor Persio Arida. BTG bought Pactual from UBS the following year, for slightly less than the Swiss bank had paid for the Brazilian unit in 2006, to form BTG Pactual.
Now, after BTG Pactual’s years of rapid growth since its 2012 IPO, and as Brazil’s economy continues to struggle, rivals in São Paulo privately ask whether the firm’s readiness to deploy capital is sustainable. They wonder — perhaps wishfully — whether BTG Pactual will be forced to shift to a lower-risk, lower-return business model that might bring down its investment banking market share.
“They’re getting a lot of criticism for being very bold, especially when they mix risk and investment banking,” says one banker.
Tough environment
Despite a gloomy economic background in the bank’s home country, Esteves says BTG can continue to post return on equity above 20%. He anticipates such heady results even in 2015, when most economists expect Brazil to face a year of negligible or even negative growth as long-overdue fiscal and monetary adjustments kick in.
In November, Esteves says BTG Pactual was already heading to a return-on-equity of around 20% for 2014, despite Brazil’s year of almost zero economic growth, very few IPOs, and violent swings in equities and rates. “If we can deliver 20% ROE in a year with these characteristics, it is a good signal of the strength of the franchise,” he says.
Rebalancing to more stable revenue sources, venturing into overseas markets, and reducing the proportion of earnings derived from investment banking and principal investments may help. After the completion of a $1.7 billion acquisition of Swiss private banking group BSI (expected early this year), asset and wealth management revenues will rise from around 25% to around 40% of BTG’s revenues, Esteves says.
“The contribution [to BTG’s profitability] of stable revenues will increase with the acquisition of BSI,” says Ceres Lisboa, senior credit officer at Moody’s in São Paulo. The bank has a good record in sustaining profitability, despite almost half of revenues previously coming from principal investments and investment banking, she says.
BTG’s sales and trading unit performed exceptionally well in the first nine months of 2014, with revenues of more than $900 million, 75% higher than the same period in 2012 and 2013. Esteves says it is not as volatile an earnings source as critics often assume. “The sales and trading business is quite stable, with high earnings power,” he says.
On the investment banking side, meanwhile — the business for which BTG is perhaps best known — in the year to end-November, the firm held a top five position in Dealogic’s Brazilian fee league table. BTG reported investment banking revenues of around $150 million in the first nine months of 2014, down slightly from 2013, but above 2012 figures.
The business area will grow in the next two years not just thanks to regional growth, says Guilherme Paes, head of investment banking. Hot areas include project finance and, above all, M&A. He points to “a profound reorganization going on” in Brazilian telecoms and sees “lots of potential consolidation” in education.
Yet there is no getting away from the fact that Brazil’s stock market, in contrast to developed market peers, is still well below its 2008 peak. Low valuations reflect concerns about short-term economic and corporate earnings growth potential. Political and economic uncertainty have led to large swings in the index over the past two years. For companies, raising capital in the stock market has become more difficult. Helping firms issue equity has been a core business for Esteves and his team.
The firm has come to the rescue with its own equity in some innovative ways. Funds managed by the bank have been known to buy big chunks of BTG-managed IPOs, providing heft to launch issues that might otherwise struggle. While Esteves does not hesitate to defend such arrangements, rivals voice doubts.
A senior figure at a large US investment bank allows that BTG’s ability to make quick decisions and provide capital can be good for business. “They [BTG] have their role in the market,” says the banker. Yet he says its use of equity, including backstops, could also pose dangers to the bank’s profitability and reputation.
Such criticism seemed to increase last year, as the share price of telecom firm Oi plummeted after a capital raising in April. BTG was exclusive financial advisor to Oi on its merger with Portugal Telecom. BTG also led a follow-on offering, needed to facilitate the merger and representing by far the biggest public equity issuance in Brazil in 2014, at $3.7 billion.
To help get the deal done, a fund managed by BTG Pactual subscribed to part of the transaction, equivalent to $450 million, according to an SEC filing. “There was a decision to invest some money in the company with the shareholders,” says Paes.
Not only did the shares fall 11% the day after the public offering was priced, they lost a further 40% in the following months as Portugal Telecom became caught up in the collapse of Portugal’s Banco Espírito Santo. That led senior investment bankers at other firms to assume BTG lost money on the deal.
Esteves says the Oi deal has, in fact, been profitable, although he won’t say how or whether the firm still holds shares. He says Oi renegotiated the terms of the merger with Portugal Telecom in light of its $1.2 billion exposure to a defaulted Espírito Santo unit. BTG Pactual has since been advising Oi on a possible acquisition of TIM Participações, a Brazilian telecom firm owned by Telecom Italia.
“Up to today, the relationship with Oi has been profitable,” he says.
Skin in the game
BTG’s use of its own capital in the Oi deal followed similar structures in 2013. Then, it backstopped IPOs of around $400 million each for CPFL Renováveis and Biosev, and a follow-on offering for MPX Energia, the former electricity generation unit of Eike Batista’s EBX group, now known as Eneva.
At 50% of the deal, the backstop for Biosev, a sugar firm, was so high that it required an exemption from the regulatory limits on bookrunners subscribing to their own deals, says Christian Flemming, an associate in BTG’s investment banking unit.
Ultimately, demand for Biosev stock was strong enough that BTG did not have to exercise its backstop, but it did buy just under $150 million in CPFL Renováveis’ offering. And after MPX scrapped a public deal, BTG agreed to buy shares not taken by minorities in a $340 million private offering, of which German energy firm E.ON was to take $150 million.
Bankers at other firms differ on whether BTG would have performed so well in the Brazilian investment banking league tables if it had not deployed equity in these deals. Some say the company simply has better bankers, better research, and better distribution than its competitors. “BTG has a platform that’s strong enough to win mandates on its own merits,” says one banker.
Paes is careful to point out that the Oi relationship pre-dated its merger with Portugal Telecom. The bank did not know it would back the follow-on with its own capital before it started working on the deal, he says. Similarly, the bank was already helping EBX restructure its various businesses more than six months before the MPX follow-on. “There’s no link between how we use our equity and how well we perform in investment banking,” insists Paes.
But even Paes seems keen to highlight BTG’s ability to deploy equity as a distinguishing, if by no means decisive, feature of what BTG offers. None of its competitors deploy equity in investment banking deals in this way, he says, and clients appreciate that extra tool in its arsenal.
“The way we use our equity together with our clients is very important to us,” he says. “We are not afraid to commit capital for the client when it is necessary.”
Esteves adds that the Biosev IPO, for example, would not have gone ahead without BTG’s equity support. “The client became extremely happy with that; it was the only way of doing the IPO,” he says. “It was a very creative deal, exactly the kind of thing we expect to be doing — being innovative and extremely helpful to customers.”
As such, Esteves says, BTG retains an appetite to deploy equity in investment banking, despite Brazil’s gloomy economic growth outlook and the still volatile stock market. Competitors should not rely on a change. “You could continue to expect this use of transitory balance sheet for transactions like that,” says Esteves.
Dividing risk and spoils
Insiders at BTG say a culture of sharing risks with clients like this, in part, reflects the management structure. Similar to a hedge fund or private equity firm, BTG’s bankers from director level up are partners, with a large chunk of their personal wealth invested in the firm. Pactual, which UBS bought in 2006 for $2.6 billion, had also been run on a partnership model after its foundation as a brokerage house in Rio de Janeiro, 30 years ago.
Today BTG’s stock is split between the bank — Banco BTG Pactual — and BTG Pactual Investments, a Cayman Islands vehicle for the firm’s proprietary trading, real estate, and private equity investment (or merchant banking, as BTG terms it). BTG Pactual Investments accounted for around a quarter of the group’s equity at the end of September 2014. It brought in around $250 million of revenues in 2013.
But principal investments dragged down BTG’s group revenue by around $140 million in the first nine months of 2014. Prop trading losses in the credit market in the third quarter, private equity losses in the second quarter, and real estate losses in the first quarter hit the business.
Now, just as rivals are raising increasing doubts about BTG’s use of its own equity in investment banking deals, Esteves himself admits companies held by the private equity arm will face a tough time as the Brazilian economy stutters. Will this mean a retreat from deploying equity, at least, in the merchant banking division?
A Moody’s report in July flagged BTG’s investments in non-financial companies as cause for concern. BTG had a choice between slowing the growth of its balance sheet or focusing on business demanding less of the bank’s own capital, it said. Private equity investments could bring opportunities for other business units in the future, the agency said, but cautioned that these made evaluating BTG’s longer-term creditworthiness harder.
One banker in São Paulo characterizes the merchant banking division as “the weakest part” of BTG, while another says these private equity deals were part of a misguided “macro-economic bet” on Brazil, particularly in 2011 and 2012.
Eduardo Ribas, who covers BTG at Fitch, notes that most of these holdings are still in the investment phase, so contribute little to profit. Some are listed, though, and must be marked to market. One such is BR Properties, a real estate firm, whose share price lost 40% of its stock market value in the year to November.
Another is BR Pharma, Brazil’s biggest drugstore chain. BTG controls the company, which is one of its oldest private equity investments, dating back to 2009. Its stock has lost 75% of its value over the past two years. It posted a $200 million loss in the first nine months of 2014, breaching debt covenants as it struggled to integrate acquisitions. BTG helped the firm raise $160 million in new equity in April.
Esteves says the BR Pharma investment, at its November price, had been “neutral” for BTG. Although some of the merchant bank’s investments have made money, including parking garage chain Estapar and hospital operator Rede D’Or, he admits others have not. But it is simply “the nature of this business” that some investments bring strong gains, others remain flat, and others lose money, he says.
The formula makes sense if the rewards are high enough among the winners, he says. “If in the first third you multiply [capital] by 10, the second third is flattish, and you lose everything in the last third, it means you multiply by nine at the end of the day,” he says.
New balance
Esteves does not deny that, as Moody’s suggests, BTG has a choice between slowing its growth and preserving its capital. Investing the bank’s own equity with clients will become a smaller part of the bank’s focus, he says.
“On a relative basis [merchant banking] will shrink in comparison to wealth management and asset management, or corporate lending, or sales and trading,” he says. “The direction is clear, no doubt about it. Most of our capital is used in the banking part of the business and in the future it [will be] even more.”
Calling the reduced role of principal investments “a natural evolution”, a pattern that’s already apparent over the past five years, Esteves says that does not mean merchant banking will shrink on a nominal basis.
Yet BTG is tweaking its business model to reflect the changed size of its groups, and those changes are — at the same time — helping BTG cope with the more difficult environment in Brazil. “Keeping the high return on equity that we have, on a larger capital base: that’s the challenge, and that’s what we’re delivering and will still deliver,” says Esteves.
Part of the bank’s diversification drive has been to expand outside Brazil in investment banking. After buying Chilean brokerage and asset management firm Celfin in 2012, BTG now has a top-five position in the league table in the Andean country. It bought a similar business, Bolsa y Renta, in Colombia in 2012.
Given the smaller size of the Andean markets and its natural home-market strengths, Brazil has still accounted for around three quarters of fees over the past two years, according to Paes. “The deals in Brazil are still big, especially in M&A,” he says.
Brazil will continue contributing most of BTG’s investment banking fees, but it is likely to be increasingly balanced by other markets, Paes says. The institution is seeking banking licenses in Chile and Colombia, which should help win mandates outside the home turf, Paes adds. BTG Pactual opened a broker-deal operation in Mexico in early 2014 and plans to expand in asset and wealth management.
The bank could make an acquisition in Mexico, as it did in Chile and Colombia, says Esteves: “We feel that we have more space for growth [in Mexico].”
Regulatory chance
Esteves does not plan to venture outside Latin America in investment banking “in the foreseeable future”. But in other areas, the bank is going global. Merchant banking investments in 2013 included the $1.5 billion acquisition of a 50% stake in an African oil and exploration and production venture alongside Petrobras, and the purchase of the timber division of US-based Regions Bank.
The global expansion takes advantage of being less restricted by the evolving regulations that have curtailed some activities of BTG’s US and European competitors. The bank’s expansion into physical commodities trading globally is the starkest example. As regulatory shifts pushed US and European banks to exit physical commodities trading over the past two years, BTG grabbed “the opportunity of being contrarian”, says Esteves.
But the pending acquisition of BSI is the biggest way in which BTG is moving away from principal investments, towards less volatile revenue flows — and away from Brazil. “Asset management will bring an important impact in terms of geographic distribution of our revenues and in terms of the nature of those revenues,” says Esteves.
Indeed, although Brazil will remain by far BTG’s biggest market for investment banking, more than 50% of the group’s revenues and around two thirds of staff will be outside Brazil after the BSI purchase, he says.
The acquisition is BTG’s biggest ever. The resulting hit to its capital ratio pushed the bank into to the fixed-income market last year, where it sold a $1.3 billion Basel III-compliant hybrid security to bolster its solvency ratio. Nonetheless, analysts greeted the BSI deal positively. Fitch noted “the recurring nature of wealth management fees” would not increase BTG’s profitability, but would help the bank reduce income volatility and diversify geographically.
The Swiss acquisition — as with the move into commodities — underscores the institution’s ability to jump in where others are constrained. Italy’s Generali wanted to sell BSI to bolster its equity, as European regulators push up capital requirements. “This was a deal made for a big emerging markets player to step in,” says Rogério Pessoa, BTG’s head of wealth management.
Esteves says the deal was also well timed because of Swiss regulatory changes around tax secrecy — which Pessoa says will make it tougher for Switzerland’s many smaller boutique wealth managers to survive. Although the BSI brand will remain, BTG thinks the firm, under its ownership, will outperform competitors in the new landscape.
“There’s a very interesting turning point in the Swiss market, a transition from secrecy to service. The edge will be your capability of providing service,” says Esteves. “This, combined with being at the bottom of the valuation cycle, meant [BSI represented] a very good opportunity.”
True to style
Changing US and European regulations on investment banking, also, make BTG’s strategy rare. Investment bankers at US firms in São Paulo say such regulatory hurdles are a factor in why they do not deploy their own capital.
Persio Arida, BTG Pactual’s chairman of asset management, provides a similar explanation. “All major banks are pressured because of capital requirements,” he says. “There’s pressure from the regulator to run as little risk as possible, especially in the capital markets. Because of regulatory constraints, and less-than-ideal capitalization, banks prefer to keep the investment banking platform totally separate.”
Any risk deployment should be profitable in itself, he says, before taking investment banking fees into account. “The two decisions should have logic of their own,” he says. Yet like his colleagues, Arida sees continued use of equity backstops at BTG.
From the beginning of his conversation with LatinFinance at the bank’s São Paulo headquarters, Esteves insists that, although BTG is diversifying outside Brazil and in areas like wealth management, size has not changed its culture. Nor has it, or will it, change its approach to its use of capital. “BTG continues to be a very nimble organization. We like to think of ourselves as a small place. We are less small these days, but we keep the mind-set of an entrepreneurial organization,” he says.
The use of backstops and the expansion in commodities, then, are perhaps illustrative of an institution that retains a style other investment banks have had to change, especially since 2008. BTG may still mix risk and investment banking, and attend to the needs of the super-rich, with sales and trading at its core — for as long as regulation and capital allow.
Esteves, in fact, compares BTG’s historically inspired business model, and its profitability in Brazil’s downturn, to the firms the merchant banking has bought: He expects both to thrive. “Good companies don’t need good scenarios,” he says. “They can do well in bad scenarios.” LF