Brazil – The next hotspot for distressed asset investors

Brazil – The next hotspot for distressed

Brazil’s economy, which contracted by 3.8% in 2015, is expected to shrink by more than 3% again this year with the unemployment rate climbing steadily upward in the last two years to over 11%.

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Brazil’s sustained political turmoil and severe economic recession have led to the recent ejection of President Dilma Rousseff amid a background of rising unemployment and a sharp increase in corporate bankruptcy. These factors alongside recent legal reforms to attract foreign capital have combined to shape Brazil as an attractive distressed market investment over the next 3-5 years.

Brazil’s economy, which contracted by 3.8%1 in 2015, is expected to shrink by more than 3%1 again this year. The unemployment rate has been steadily increasing over the last two years, with the average in the third quarter of 2016, as reported by Banco Do Brasil statistics wasbeing 11.8%2 . In the first quarter of 2016, more than 400 companies (including Brazil’s largest Telecom company, “Oi”) filed requests for bankruptcy, which is more than double the cases from the previous year, due to the impact of low oil and commodity prices.

The previous wave of prosperity saw millions from the lower class elevated to a middle class through increased wages and an expansion of credit. This middle class are now facing a huge problem. With the country’s economic woes and the unemployment rate climbing each quarter, many of those recent arrivals to the middle class have found themselves unable to pay their bills.

In 2015, Brazil’s commercial banks non-performing loan (NPL) stock (not including the written-off loans) was c.R$105 billion. Our internal estimation is that it will continue to climb to over R$200 billion by the end of 2016. While the official default rate (for personal loans) is estimated at 6.20%3 , market discussion is that the true rate is higher across the three state -owned banks, Banco do Brasil, Brazilian Development Bank (BNDES) and Caixa Economica Federal.

Amid this background, an active market non-performing assets has emerged in Brazil with c.R$40 billion of NPLs in the last two years. The largest asset by scale has by far been consumer credit (namely credit cards, car loans, personal loans and overdrafts), as mortgage loans have not experienced the same growth, with iInterest rates among the highest in the world at - 14%4.

In response to these pressures, there have been several legal developments aimed at speeding up the recovery process, and lowering the entry hurdle for international investors looking to inject capital into the economy. The authorities have implemented several changes across the judicial system:

  • First, after a long transition period, almost all new cases are now running on an electronic platform; reducing the time spent on the administration of papers and enabling quicker decisions from judge.
  • Second, arbitration law has been modified to grant more stability, speed and sureness to decisions on cases. On one hand, this will foster an increase in the number of cases to be decided by means of arbitration. On the other hand, it will reduce the number of the cases to be decided at judicial courts.
  • Third, the Brazilian National Congress has published a new Code of Civil Procedure aimed at speeding up judicial cases. This new procedure reduces the number of appeals and the possibility of different judges issuing contradicting rulings.

As a result of the aforementioned reforms, feedback from all parties involved in judicial cases (judges, lawyers, court assistants, and public prosecutors) is that the benefits arising from the reforms will soon gather momentum in the Brazilian legal system. That should, save huge costs and shorten the time spent on litigation needed to obtain a final and un-appealable decision.

Notes

1FT report, March 3,2016

2Banco Central Do Brasil Economic Indicators as at November 9, 2016

3Bloomberg data

4BACEN interest rate as at November 11, 2016

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