Brazil a bright spot for debt restructuring advisors as recession bites hard
By Tatiana Bautzer and Guillermo Parra-Bernal
Debt restructuring firms are poised to pull in record amounts of business in Brazil this year as the country’s worst recession in decades and a corruption probe that has cast a shadow over dozens of companies leads to a surge in defaults.
While a slump in prices is squeezing commodities producers – from sugar mills to oil producers and miners – the “Operation Car Wash” investigation into political kickbacks at state oil firm Petroleo Brasileiro SA is also hitting many of its suppliers.
Soaring consumer delinquencies as Brazil’s interest rates hit their highest levels for nearly a decade are also putting some major retailers and homebuilders in line for painful reorganizations. Scenting an opportunity, U.S. restructuring shops including FTI Consulting Inc, Houlihan Lokey Inc, and Moelis & Co have set up shop in Brazil over the past three years to vie for mandates with local banks and independent advisors.
Last year, a record 1,287 Brazilian companies – most of them oil equipment, construction and manufacturing firms – requested court protection from creditors, about 55 percent more than in 2014. Fitch Ratings said last month that the risk of more firms facing cash crunches has risen a lot.
“This will be a record year” for debt restructuring, said Salvatore Milanese, a former head of Latin America debt restructuring at KPMG International who recently set up his own advisory firm, Pantalica Partners. “The biggest construction companies are restructuring, as are many in the oil and gas industry, and most of the ethanol sector.”
Milanese said problems extended to mining firms, medium-sized banks and even soy producers. He estimated Brazilian companies were preparing to renegotiate a total 150 billion reais ($37 billion) in debt.
To handle the workload, banks and law firms are boosting their corporate restructuring teams. Some shops are taking equity as payment, or charging higher retainers and success fees – payable when they manage to pull a client out of bankruptcy or restructure debt without having to file for bankruptcy.
The average fee for a restructuring deal in Brazil is around $10 million, bankers said. Raising capital can be particularly lucrative – the advisors can charge a fee of up to 10 percent of the new funds, experts say.
“Moelis came to Brazil partly because of restructuring mandates,” said Otavio Guazzelli, the local joint head of the boutique bank, which opened its office in Sao Paulo last year. “It’s natural that, with commodity prices going south, these companies will go through a process of readjustment.”
Ricardo Knoepfelmacher, one of Brazil’s top restructuring advisors, says he believes out-of-court reorganizations are essential to revive ailing companies and prevent the ailing economy slipping further – possibly even into a depression.
After shrinking nearly 4 percent last year, Brazil’s $2 trillion economy could contract a further 3.5 percent in 2016, according to the International Monetary Fund, putting it on track for its worst recession since 1901.
The Brazilian Corporate Recovery Institute estimates that half of the 1,287 companies that requested court protection last year may go bankrupt during their turnaround attempts. Part of the problem is the ineffectiveness of the formal bankruptcy process in Brazil for creditors and debtors alike.
A new law designed to spur faster turnarounds by emulating the Chapter 11 bankruptcy filing process in the United States was enacted in 2005, but it has not worked as expected.
Debts to the tax authorities and to workers, including wages, take priority over other obligations, and court rulings can be easily appealed, meaning a bankruptcy can drag on for years. Making matters worse is the lack of bankruptcy courts outside the states of Sao Paulo and Rio de Janeiro.
U.S. law encourages new lending to companies in bankruptcy, with so-called “debtor-in-possession” loans, by guaranteeing lenders priority over other creditors. As these safeguards are hard to enforce in Brazil, lending to firms during bankruptcy remains virtually non-existent – starving them of capital and making it far harder for them to recover.
Only a handful of the firms that have sought creditor protection under the law have managed to obtain DIP loans, said Renato Franco, founder of restructuring boutique Integra. Last month, existing creditors foiled a plan by Canada’s Brookfield Asset Management Inc to lend 800 million reais to engineering conglomerate Grupo OAS SA. The money would have allowed it to emerge faster from bankruptcy.
Knoepfelmacher, who helped negotiate Brazil’s largest ever restructuring – the 46 billion reais in debt that was owed by former billionaire Eike Batista’s Grupo EBX, said he avoids bankruptcy filings as much as possible.
“Banks, bondholders, companies are all singing the same tune: don’t to go to court,” said Knoepfelmacher, who has overseen 44 major restructurings over the past two decades. Only six of his deals ended up in court.
Bondholders of several companies that went through debt restructurings in formal bankruptcies in recent years lost almost all the value of their holdings after court rulings ordered that government-led creditors be repaid in full.
When Equatorial Energia SA acquired electricity distribution firm Celpa SA during bankruptcy proceedings in 2012, state development bank BNDES received full payment for a 234 million-real debt through an equity issue while bondholders were forced to take a 83 percent haircut.
Like many restructuring firms, Knoepfelmacher’s RK Partners is expanding. It has moved to larger premises in Sao Paulo’s upmarket Itaim neighborhood, and in the last year its workforce more than doubled to 41 from 17, with the number of partners rising by two to six. Among those it is currently advising are engineering firms UTC Engenharia SA and Galvao Engenharia SA, which had access to bank lending cut because of the Car Wash scandal.
Legal firms are also boosting their staffing. Thomas Felsberg, who has worked on more than 100 restructurings, doubled the number of lawyers in his firm dealing with restructuring to 25 over the past couple of years.
Debtors’ concerns about major banks’ potential conflicts of interest have opened the door to independent firms like Rothschild Group to oversee turnarounds. The bank clinched some of the largest mandates last year and is currently advising homebuilder PDG Realty SA and cement maker Tupi SA.
Lazard Ltd, Knoepfelmacher’s RK Partners and Virtus BR Partners have also won dozens of mandates over competition from large banks.
Fears of a full-blown crisis are encouraging banks to voluntarily rework loan terms to protect their balance sheets, bankers said.
Last year, the nation’s banking system increased loan-loss provisions by 24 percent after defaults hit their highest levels in six years, central bank data showed.
Creditors helped steelmaker Cia Siderúrgica Nacional SA refinance 6 billion reais in bank loans last year. Port operator Log-In Logística Intermodal SA and Odebrecht Agroindustrial SA, the ethanol unit of engineering conglomerate Grupo Odebrecht SA, are trying to extend their loan terms and get grace periods.
Bondholders are giving debtors a break too, worried that the highest borrowing costs in any major economy in the world may asphyxiate more companies.
Concerns about an inflation rate that is running at the fastest pace in almost 13 years, led the central bank to keep its benchmark lending rate steady at 14.25 percent this month. But with debt levels in some sectors running at 8 or 9 times operating profits, companies are fast draining their cash reserves. “We’re in uncharted territory because leverage is currently at levels not seen in prior crises,” said Luiz Muniz, head of Latin America at Rothschild Group. ($1 = 4.1066 Brazilian reais)
(Editing by Daniel Flynn and Martin Howell).