Corporate debt in Latin America has been trending upward in the last five years, in the wake of easy global liquidity underpinned by unconventional monetary policy in developed economies. In 2014 Latin American corporations issued an estimated $200 billion in debt — almost 62% of which was in US dollars. That’s up nearly 8% from 2013.
Brazilian and Mexican corporations have led the way in terms of the rising nominal value of corporate debt issued in the last half-decade. In Brazil, corporate bond issuance has increased by 15% of GDP since 2007. According to a recently published report from the International Monetary Fund (IMF), the external debt to total corporate debt ratio declined in the early 2000s. However, bond financing as a share of GDP has tripled since 2008, with equity issuance remaining relatively unchanged in emerging markets including Brazil. With higher offshore issuance, the external debt of nonfinancial corporations (NFCs) has risen from 20% in 2010 to 26% of total NFC debt in 2013.
Weak Currencies, Low Growth Push Up Corporate Default Risk
As a result, default risk probabilities are on the rise as the region grapples with weakening currencies, lower export commodity prices, and a broadly uninspiring near-term economic outlook. In Brazil, the vulnerability of NFCs that took low-interest rates and longer maturities is increasingly apparent, with corporate debt at an unprecedented high of 49.2% of GDP as of June 2014.
While the IMF paper noted that foreign exchange (FX) exposure is, to a large extent, covered by financial hedges in Brazil, investors are nevertheless jittery. Capital outflows rose by US$2.6 billion in the first week of May amid the ever-widening Petrobras scandal, economic contraction of 1.2% (D&B 2015 forecast), and government’s challenges in implementing crucial structural reforms. This has placed pressure on the already-weakened real, which traded on May 12 at BRL3.0349 against the dollar and was 37.23% weaker than one year earlier.
Not surprising, yields on Brazilian bonds have been rising. While debt issuance has risen, Brazilian firms did not increase capital spending to an equivalent level. Notably, according to the IMF report, companies instead have been using funds from new debt to increase cash reserves. While this has enabled issuers to improve their ability to deal with financial shocks, it also has been linked with lower returns on equity.
SMEs Vulnerable Too
Default risks are also higher for small and medium-sized businesses (SMEs). While the overall nonperforming ratio for corporations has so far remained at 2%, successive increases in the central bank’s benchmark lending rate (Selic) have contributed to higher defaults on loans to SMEs. Defaults on debt held by SMEs have risen from 2.7% to 4.2% since August 2013, with the most highly leveraged firms in industrial goods industries.
In April 2015 the central bank again hiked the Selic by 50 basis points to 13.25%, which is its highest level since January 2009. Borrowing costs on long-term subsidized loans also increased. To round out the gloomy picture, nonperforming loan ratios for other types of credit facilities including credit card loans, overdrafts, and working capitals range from 2% to 20%, based on data from the central bank of Brazil.
Petrobras Scandal Tied to Default Probability
Already, the Petrobras scandal has created default pressures and poses heightened near-term default risks for firms with exposure to the company. As the government moves to contain the damage, several Petrobras contractors have either had their contracts suspended and/or have been barred from doing business with the state-owned oil company. Moreover, Brazil’s government has been going after companies that benefited from the scandal to recover funds, thereby placing their subcontractors in financial jeopardy.
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Michelle Campbell is a Senior Economist on D&B’s Global Data, Insight & Analytics team. Based in the UK, she covers the Latin American region for D&B Macro Market Country Insight Products. In addition to her experience in the financial services sector, Campbell has worked as a visiting lecturer in the UK and in the Caribbean. Michelle holds a master of science degree in economics from the University of the West Indies in Trinidad.