People wait in line in front of a public bank to try to receive emergency aid given by the federal government to the most vulnerable, amid the Covid-19 outbreak in Rio de Janeiro last week
When the coronavirus crisis arrived in Brazil it hit fast, it hit hard and it reignited the debate about the merits of having a banking market dominated by just a handful of big firms.
Having an oligopoly, as one senior investment banker in São Paulo describes the Brazilian banking sector, hasn’t been so contentious in recent years. With the national interest rate environment transformed – controlled inflation and a Selic rate of 3.75% – companies have been raising cheap capital in the domestic markets.
This was the context as 2020 opened and all seemed set fair for a record year of issuance. January’s financial markets featured a pipeline of more than 25 primary equity deals (four IPOs were printed between February 3 and 11, 2020), as well as lots of local and international debt.
Even as investors had one eye on the coronavirus news coming out of Asia and market volatility soared, Brazilian companies kept moving forwards with listings: Alphaville Urbanismo and Prima Foods both announced their intention to list as late as March 4.
However, on March 11 Caixa Economica confirmed that the markets were heading to a shutdown by pulling the $2.9 billion IPO of its insurance division. The Ibovespa fell 14.8% that day – on top of the previous day’s 7.6% decline.
In all, the stock exchange’s circuit breaker was triggered a record six times in the following week.
Corporates were much better prepared for this pandemic crisis than they were going into the 2015/16 recession in Brazil- Hans Lin, Bank of America
As the seriousness of the situation became evident, corporates created ‘war rooms’ to respond. The first priority was to protect their own and their employees’ financial health. This meant shoring up liquidity.
With the local and international debt markets closed, the queue formed at the banks’ doors.
“Corporates were much better prepared for this pandemic crisis than they were going into the 2015/16 recession in Brazil,” says Hans Lin, head of investment banking at Bank of America in Brazil. “They were much more deleveraged and more efficient. They had been making capex plans, but given the spare capacity left, they hadn’t yet initiated these investments.”
However liquid they were, companies still felt a pressing need to maximize their cash positions.
Bankers talk about a reverse bank run, with every contingent credit facility and revolver accessed immediately. BRF, for example, pulled down its R$1.5 billion ($282 million) facility from Banco do Brasil, despite sitting on cash reserves of R$5 billion.
“Most of the large companies moved to create the biggest possible war chest,” says Andre Cury, co-head of corporate banking at Citi in Brazil, who points out that Brazilian companies typically hold large cash positions on their balance sheet because of experience with previous cycles.
Andre Cury, co-head of corporate banking at Citi in Brazil
“Given the much lower cost of debt in Brazil when compared to the previous crisis, there are no concerns about the cost of keeping liquidity high through the coming crisis,” says Cury. “Almost all the large corporations made this move, also knowing that excess cash down the line might be a competitive advantage if the crisis creates opportunities for consolidation.”
And so pre-arranged credit facilities were drawn down. Those were available to a lucky few, but almost all companies wanted to boost their liquidity. The queue formed and the banks reacted by raising the cost of credit.
“Spreads went through the roof,” says one banker. “Previously the local banks were charging local triple-As CDI-plus 100 basis points for R$500 million five-year loans. Now they are offering those same companies R$150 million for 12 or 24 months for CDI plus 500bp.”
The companies are finding it very hard to find new money from their traditional relationship banks,” says one, “especially those companies outside the top tier, blue chips- Investment banker
Some investment bankers report witnessing shock and anger among corporate treasurers and CFOs.
“The companies are finding it very hard to find new money from their traditional relationship banks,” says one, “especially those companies outside the top tier, blue chips.
“This is just another example of why there is increasing scepticism about the concept of relationship banking: when clients most need credit, the banks increase their spreads dramatically. That’s what happens when you have 85% of the system’s assets concentrated in four or five banks.”
Candido Bracher, chief executive of Itaú, points out that he is well placed to comment on the issue, given that he has been in corporate and wholesale banking for nearly 40 years.
“Being a relationship bank means being present for your clients – in this case to your corporate clients – to take their calls and whenever possible have credit lines open for them,” he tells Euromoney.
“In the past two to four years, these companies have gone to the capital markets rather than take out bilateral loans with banks,” he says. “And we felt very good – the capital markets in Brazil have flourished – they have supplied the cash needs for these large corporates, especially the first-class companies.
“At the beginning of March we saw the spreads in the corporate bonds increasing tremendously. We ourselves have a perpetual bond, which was yielding about 5% before the crisis. With the onset it moved to 15% and now it’s about 9%.”
Bracher points out that the same thing happened with bonds from Petrobras and Vale, and almost every important corporate issuer.
“So in the first moment of the crisis most of the companies wanted to increase liquidity, and we were there to help them do it. We increased spreads – on a case-by-case basis – but this was but a fraction of the risk perceived in the capital markets that was transparent in [the pricing of these] bonds. So I am very confident that all these companies see in Itaú a relationship bank that will keep on being a partner for the times to come.”
So far, the banks remain solid and the central bank and the government have been using the stability of both the large private- and public-sector banks to disburse liquidity into the system.
A corporate finance crisis shouldn’t become a systemic issue.
Eduardo Rosman, financial institutions analyst with BTG Pactual, updated his forecasts for the banks in mid April – once the initial volatility had washed through – and he still expected positive loan growth of 5% (down from 10%).
He says non-performing loans will rise – although they will be “postponed” by the banks’ grace repayment periods and by re-negotiations. Provisions will also increase, as will the cost of equity, meaning that earnings per share and return on equity will fall, but not greatly.
That small strong banking sector might be expensive, but it provides a strong foundation that helps the country weather crises.
But can that foundation be enough?
Everything that is being done is the right thing, in the right way, by the authorities... The question is, will it be enough?- Ricardo Lacerda, BR Partners
Pedro Mesquita, head of investment banking at XP Inc, says companies are closely monitoring the secondary markets for hints about when the primary markets will re-open.
“The biggest companies in Brazil have cash, and they will be able to pass this moment because they have liquidity and they have credit lines with the banks,” he says. “Of course we have just two [large private] banks, and they are charging a very high price. They give credit to those companies that will pay to stay alive. The problem is the medium and small companies – they will have a problem, especially those in some [heavily hit] sectors.”
The central bank is trying to extend liquidity to these companies and has announced a total package of liquidity measures worth R$1.2 trillion, or 16.7% of GDP, and capital measures worth 15.8% of GDP. These are big numbers, but questions remain.
Ricardo Lacerda, BR Partners
“Everything that is being done is the right thing, in the right way, by the authorities,” says Ricardo Lacerda, chief executive of BR Partners. “The question is, will it be enough? And in Brazil there is also a question about the last mile: will this relief get to the population that needs it. Or will it get lost in bureaucracy and in other things like corruption? We don’t have full certainty that it will reach where it needs to reach.”
Bankers rightly talk about the moral obligation of the immediate healthcare challenge to save lives as being more important than the future cost. But there are already growing fears about turning on the fiscal tap.
Lacerda says the government is absolutely right to be prioritizing the population’s health over fiscal dynamics but, nevertheless, says there are concerns.
“The question in Brazil is that you have a lot of groups that are very well structured and lobby for their own interests and against the interest of the state,” he says. “They will try and take advantage of this crisis to get a bigger share of the funds that are flowing to help the economy.
“So that’s where we run a big risk. Yes, it’s OK to have to spend an additional 7% to 10% of GDP to combat the crisis, but this can’t turn into 15% to 20%.”
BTG Pactual estimates that the government’s fiscal deficit could hit R$1 trillion if the lockdown extends towards the end of 2020 – or more likely about R$600 billion, or 8.3% of GDP. Goldman Sachs predicts the debt-to-GDP ratio to be around 90% by the end of this year.
Carlos Hamilton Vasconcelos Araújo, CFO of Banco do Brasil, tells Euromoney that this macro risk is critical.
“How is the sovereign debt going to evolve, given that the [fiscal] measures announced by the government until now represent around 5% of GDP and the fiscal deficit was something that the government was working very strongly to reduce in the coming years?” he asks.
“We expect that the government and congress will work closely in the approval of reforms that were already being discussed in congress, like tax reform and the law to help states that are facing difficulties – movements that would help to soften the impacts of the higher debt, given the implementation of measures to fight the coronavirus.”