OREANDA-NEWS. Some small and medium Brazilian banks are seeking to repurchase debt below face value to preserve their net interest margins (NIMs) amid Brazil's challenged economic environment, says Fitch Ratings. Weakening loan demand and pressures on asset quality are depressing banks' bond prices. However, slowing loan growth is boosting banks' liquidity while expanding their capacity for debt repurchases.

Banks executing buybacks through tender offers are targeting senior and subordinated debt, with a focus on high-cost, dollar-denominated subordinated notes, partially still accounted as Tier 2 capital. On Sept. 8, Banco BMG announced that it may purchase up to USD100 million of subordinated notes due in 2019 and 2020. Banco Votorantim also announced on Sept. 8 it may repurchase about USD310 million of its 2020 subordinated notes. Both banks currently hold comfortable levels of liquidity and capitalization.

Another factor motivating banks to repurchase these legacy subordinated notes is the phase-out of their eligibility as Tier 2 capital under Brazil's Basel III convergence time line. Currently, only 70% of the legacy Tier 2 is qualified for regulatory capital purposes, according to the 10% per year step-down between 2013 and 2022, when Tier 2 is expected to be completely phased out of Brazilian banks' regulatory capital bases.

Other banks, mostly small and medium sized, have also been repurchasing senior notes directly in the secondary market. These buybacks require no regulatory approval and are simpler to execute than tender offers, but still require factoring in the bank's liquidity availability.

For most Brazilian banks, long-term foreign funding (such as eurodollar bonds) has lost attractiveness due to high hedging costs and the weak loan growth prospects. Local banks have developed a preference for domestic long-term funding instruments such as Letras Financeiras and lower cost Letras de Credito Imobiliarias (LCIs) and Letras de Credito do Agronegocio (LCAs), both of which have gained wider acceptance over the past several years.

Given the current environment for Brazilian corporates and the overall deterioration in asset quality, constrained loan growth is expected to keep pressure on many Brazilian banks' profits. However, we generally see Brazilian banks holding capital ratios at levels satisfactory for given ratings.