Brazilian bankruptcies create opportunities for debt investors

From apartments and cars to coffins, liposuction and toilet paper, there are few things that cannot be bought in installments in Brazil – a legacy, in part, of the country’s past fight against the coronavirus. hyperinflation.

As Brazilian buyers have taken advantage of this credit culture to take on debt over the past decade, companies in the country have also borrowed heavily, encouraged by state-owned banks and the state development lender BNDES.

As Brazil slips into its deepest and longest recession on record, the country’s credit windfall has come to a dramatic end, sparking a wave of bankruptcies but also creating some of the best opportunities yet for investors. distressed debt investors.

Last week, telecommunications operator Oi filed for bankruptcy, the largest ever filed in Brazil. The Rio de Janeiro-based company, Brazil’s largest fixed-line operator, was forced to seek creditor protection over a 65 billion reais ($19 billion) debt after restructuring talks broke down ahead of the impending maturity of a €231 million euro-denominated bond. .

“Oi’s filing was a watershed moment because a lot of its suppliers are going to get in trouble,” says Guilherme Ferreira, partner at Jive Investments, the largest independent buyer of distressed assets in Brazil, ranking Oi as one of the “fallen” of Brazil. blue fries”.

Born of a government-backed merger, Oi was encouraged to accept overambitious deals by the recently overthrown Workers’ Party (PT) to make it a “national champion”, capable of taking on the largely foreign players in the sector.

Oi says he is operating normally and is confident his receivership plan will be successful – a view shared by some analysts who say bondholders and shareholders have more to gain from reaching a deal. Other analysts say they think the company will either be sold or broken up.

Once the darling of emerging markets, Brazil’s fall from grace has been staggering. After shrinking by 3.8% in 2015, the Brazilian economy is expected to contract by more than 3% again this year. In September last year, the country’s credit rating was downgraded by Standard & Poor’s to junk status, making it even more difficult for Brazilian companies to access international debt markets. The worsening political crisis in Brazil, which led to the suspension of Dilma Rousseff in May pending impeachment, has made this nearly impossible.

“Without a sustained economic recovery and a reversal of political conditions, access to credit is likely to prove difficult,” Fitch Ratings analysts wrote in a report. “In Brazil, companies with lower ratings should face the greatest obstacles to refinance themselves with appropriate conditions, if at all.”

For many companies, it is already too late. According to the latest data from credit research firm Serasa Experian, Brazilian companies filed 409 bankruptcy protection applications in the first quarter of this year, more than double the number from the previous year.

The in-depth investigation into corruption at Petrobras has also put pressure on the oil sector as well as construction companies involved in the bribery and kickback system. Although interim President Michel Temer’s government may step in to capitalize Petrobras, it is unlikely to offer financial support to private sector companies, says PwC’s José Braga.

“All of this has had an effect on the banks as well,” says Ferreira de Jive. “Every company that goes down leaves another imprint on banks’ balance sheets,” he says, adding that for mid-sized banks in particular, it’s been a “terror story.”

According to Moody’s, the rating agency, Oi owes a total of R$13 billion to BNDES and state banks Caixa Econômica Federal and Banco do Brasil.

On Monday, the central bank said defaults on consumer and business loans reached 5.9% of outstanding unaffected credit last month – a new record high. Defaults would be even higher if it weren’t for banks’ efforts to dramatically raise renegotiation rates, analysts say.

They have also turned to funds such as Jive to offload non-performing loans. Last year, Jive raised 500 million reais – about 70% from Credit Suisse private banking clients – for the country’s largest distressed asset fund. Mr Ferreira says they have already gone through 85% of the fund, which is also buying property assets.

However, as Brazil’s new interim government begins efforts to push through long-awaited labor and pension reforms, there are signs that the country’s crisis may be easing. According to data from Bloomberg, the cost of insuring against losses on Brazilian bonds with credit default swaps has fallen by almost a third in the past six months – the biggest drop among the world’s major economies. world.

Still, Brazil should brace for even bigger bankruptcy filings in the meantime as companies in the country continue to feel the effects of the economic and political crisis, says Fábio Rosas, a restructuring specialist at the Brazilian law firm Souza, Cescon, Barrieu & Flesch Advogados. .

“Over the next year to 18 months, we’ll likely see deposits the same size as Oi, if not even bigger.”

Carol M. Barragan