Brazil Credit Review Third Quarter 2011

Overview of Third Quarter Credit Market for Brazil
Report Summary
For a full report, download here

Latin America Structured Finance Advisors just released our comprehensive 19 page review of Brazil’s credit markets for the third quarter and the preliminary Credit Outlook for 2012. This review provides us with an opportunity to take a longer-term view of developments in Brazil’s financial markets given our recent flurry of negative reports for Brazil’s near term economic and credit outlook.

Let us, just for a moment, think of Brazil as Conan the Barbarian. Conan is trying to save the beautiful princess (played by above average growth without inflation), but he needs to pass several unique challenges. First, Conan must pass through the land guarded by the four-headed lion (Europe with problems in Greece, Portugal, Italy, and Spain), then defeat the giant dragon (China’s economic slowdown), and finally single-handedly overcome 10,000 special guards (Brazil’s own economic problems) employed by the evil sorcerer who has kidnapped the princess. Will he succeed? More than likely – he is Conan the Barbarian!!!!  Will he get a little beat up and bloody in the process? We explain in this update.

Two defining external factors put significant pressure on Brazil’s financial system during the third quarter. Standard and Poor’s reduced its credit rating of the U.S. Government and Europe’s credit crisis deepened dramatically. The Copom used these developments in their August meeting to justify a surprise reduction of SELIC, the rate used by the Central Bank to control money supply. Mr. Tombini, the Copom and central bank president, made it very clear in the minutes and statements to the press that the situation in Europe will continue to negatively affect the Brazilian economy.

Industrial Production has been declining steadily during 2011. The September 2011 number fell 2%, much weaker than expected, and was the second biggest decline since the collapse in 2008 during that global credit crisis. Vehicle sales plummeted 7.5% in October and third quarter business confidence fell dramatically. Growth has declined far below the initial estimates for the year and economists continue to reduce their forecasts.

Credit Markets

Most Analysts have changed their outlook from “there is no problem” to “Brazil is ready for the problem.” Brazil’s private banks have battened down the hatches to control exposure to the slowing economy and the deteriorating credit situation. Brazil’s public banks have, however, opened the credit spigots.  Our conclusion is that Private Banks are sending their problem loans to the Public Banks. This allows Brazil’s Private Banks to stay healthy while the Public Banks support the economy with bad loans.

According to the data pulled from the Banco Central do Brasil Database, consumer credit delinquencies over 90 days as a percent of the bank’s credit portfolio (percent non-performing loans or percent NPL for 90 days) increased 6.2% for the quarter. All the important sectors experienced increases, except for real estate. Percent NPL for 90 days for Consumer Vehicle Loans increased 17.6% and for Personal Credit 7.7%.  Percent NPL for 90 days on Consumer Loans has increased 20% since the beginning of the year, with the largest YOY increases from Vehicles and Acquisition of Goods-Other. (70% & 50% respectively)

Percent NPL for 90 days in the business sector increased only slightly in third quarter. The lone exception was in the “Hot Money” category. Hot Money credit is defined as loans up to 30 days that are extended to companies to fund their working capital needs. Hot Money jumped for the third straight month to 15.9%, a 10% increase over August. In all, Hot Money has soared from 4.9% of bank credit portfolios in June to its current level of almost 16% in September, a 3.2x increase. This trend might signal a lack of liquidity in those specific businesses that have borrowed in order to cover other cash shortfalls or cash flow timing differences, and therefore be seen as a leading indicator.

One very disturbing development has been the continuing divergence between Serasa/Experian and Banco Central data for non-performing loans.  Serasa/Experian measures NPLs based on actual reports of loan performance that are collected from semi-public bureaus for registering legal actions. The Banco Central data is gathered from monthly bank surveillance reports for provisions against bad debt. It is unclear as to why there should be such a divergence, but the Serasa/Experian data indicates large increases in NPLs, even higher than 2008.

We are even more troubled by reports that banks are dramatically increasing their provisions against bad debt because these changes do not seem to be showing up the Banco Central data. However, the Serasa/Experian data corroborates the reports from the press that NPLs are increasing dramatically for Consumer and Business Debt (see our report titled “At What Height Does a Seawall Protect from a Tsunami?).

Interest Rates and Spreads

Interest rates and spreads for Personal Credit indicate that the banks are pricing in the forthcoming problems. Average interest rates for Total Credit increased 10.29% YTD and 10.59% YOY. Interest rates for Total Personal Credit increased 12.43% YTD and 15.80% YOY. The two sectors primarily responsible for the increases are Consumer Vehicles, up 13.22% YTD and 22.25% YOY, and Consumer Acquisition of Goods, up 11.28% YTD and 17.98% YOY. Note that rates for Consumer Acquisition of Goods had been even higher and fell dramatically during the quarter.

Even with lower SELIC rates, the credit situation in Brazil will probably not get that much better as bank rates have not been falling and will probably not fall much as spreads widen out.

New Debt Issuance

The third quarter turmoil in the U.S. credit markets virtually shut down the U.S. Dollar market to Latin American issuers, and Brazil was no exception. Based on the increased local volume in the third quarter versus the first half, Brazil’s issuers turned to the local markets to make up the difference. The issuance of bonds issued under the Comissão de Valores Mobiliário’s (CVM, Brazil’s equivalent of the SEC) 476 rule also increased dramatically.

During the first half of the year the 144A was the market of choice for Brazilian issuers. However, the 144A market issuance dropped dramatically in June and disappeared in the third quarter.  It has only begun to come back in October and November.

FIDC issuance this year had kept the pace with 2010 until October. However, it is not keeping up with other sources of debt issuance, which have generally seen 20% increases in volume over last year. This can be attributed several factors. First, the CVM’s Instruction 489 went into effect on August 1, 2011 with new rules for issuing FIDCs. The new regulations significantly beef up the criteria for risk retention and risk transfer for this ABS structure.

Instruction 489 is designed to create more transparency in FIDCs and to limit the issuer’s ability to buy NPLs from the structures, and dovetail with the coming implementation of International Financial Reporting Standards. However, the added reports will place additional burdens on issuers, custodians, and administrators. News reports during the quarter indicate that issuers are confused about receiving the “true sale” treatment because of the added requirements under the new regulation.

We are also seeing an increase in competition from Letras Financeiras(LF).  These are new financial instruments that allow banks to issue debt with maturities over two years.  This form of financing has grown tremendously over the last year.

The credit performance of collateral backing FIDCs has been deteriorating over the last year, especially in a few of the higher growth credit sectors.  Provisions for Doubtful Debtors (PDD) grew more than 25% over for 2011 for 70% of the FIDCs that we evaluated.  As we saw in Bank Portfolios, the largest increases in PDD for FIDCs came from Agro-Loans, Personal Credit, and Vehicles.


Economists polled by Brazil’s central bank expect the economic slowdown to bottom out in the spring or summer of 2012; however the difference in opinion is quite dramatic. The average of all the predictions have growth slowing to 2.2% for March 2012, but the lowest forecast predicts that industrial production will fall 2% during this period. Even more telling, the Copom’s minutes from the October meeting report that the Central Bank is now using August’s less favorable “alternate scenario” as its most likely scenario.

Brazilians and the credit agencies had steadfastly held to the position “there is no problem.”  Now the analysts are warning that “Brazil is ready for the storm.”  Second, we believe that Brazil’s credit analysts and economists are confusing a credit bubble with a credit crisis.  We believe that a credit bubble does not necessarily lead to a credit crisis.  They should be separated because this perspective allows the analyst to see that Brazilian credit has been growing at unsustainable rates.

Balances for Consumer Credit experienced 25% growth YOY and Residential Real Estate knocked the ball out of the park with over 80% growth for the year.  Virtually every sector of Consumer Credit is up over 10% YOY, with the exception of the sector marked “Other.”

Total credit grew over 20% from September 2010 to September 2011. While Total Business Credit is up less than 20%, there were some very worrisome trends.  The growth in Credit for Acquisition of Goods notched 40% growth year-over-year (YOY) and growth in Commercial Real Estate Credit was truly stellar at just shy of 80% versus September 2010.

Outlook for Credit

We have reviewed the third quarter with a more general perspective of the overall credit markets in Brazil to provide a base for looking into 2012 and beyond. Our conclusion is that Brazil provides opportunities for excellent returns but the risks remain significant. Credit in Brazil cannot keep growing at the same pace. We advise readers to develop selective strategies for Brazil to take advantage of unique opportunities rather than allocating funds to an overall bullish Brazil strategy.

It is against this backdrop that we amusingly read the Barron’s article Better Times in Rio, published by Christopher Williams on November 10, 2011. Mr. Williams’ analysis provides a review that would make Alice in Wonderland happy, and makes our most recent research about the current status of credit markets in Brazil look like an Edgar Allen Poe tale.  Who is right?

We are holding to our previous reports that concluded that the credit situation will continue to dramatically deteriorate in Brazil in 2012.  Defaults and NPLs will increase with the continuing economic slowdown; this is an economic certainty that is acknowledged by even the most optimistic analysts in Brazil.  The coming reductions in interest rates will limit the damage. However, our models show that even with SELIC dropping to 9.5% the slowing economic growth will still drive credit losses even higher.

Conan will survive, but he will be battered and bloodied.


For a full report, download here

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