Debt turned investment
The non-performing loans, which today represent R$ 400 billion in debts overdue in Brazil, are attractive for international agents in search for structured investments and may contribute to the recovery of companies and some sectors of the economyJuly-September | 2017
The Brazilian economy has experienced a period that combines recession and stagnation, with consequences that can move a large market of which investors around the world are aware: the non-performing loans. The Non-Performing Loans (NPLs) are currently over R$ 400 billion in debts overdue in Brazil, according to data from the Central Bank (BC). In the current Brazil’s economic context, NPL market can grow even more.
NPL investors around the world always monitor the countries or regions going through economic crisis, seeking for potential markets. This happened to the Asian tigers in the late 1990, then with Mexico and Argentina and, then, in Europe’s debt crisis, at the end of the last decade.
The main players of that market in the world today are Europeans, who transact hundreds of billions of euros with small, medium and large companies’ debts, and where there is a minimal part in consumer debts portfolio. For this reason, Brazil offers an enormous attraction. From the estimated R$400 billion in NPLs in the country, 80% are from consumers and are mostly in the hands of banks.
However, it is a challenge for financial institutions to manage NPLs, since this isn’t their focus. Moreover, the defaults cause a negative effect on the economy because the banks cut credits, causing impact on the market. Thus, their activity become exposed because its portfolio is defaulted. Around the world, that is the logic. Everything relates to the economic cycle, which should not change in the short term in Brazil.
Guilherme Macêdo, professor at the Business School of the Federal University of Rio Grande do Sul (UFRS), explains that after a year of default, banks can record the loss and write off these credits to clear the balance sheet. “That is when the market begins to be formed,” explains Macêdo. Who buys those credits are companies specialized in going after the defaulter, through legal proceedings or hedge funds (more focused on companies in judicial recovery).
“It is a great market, very broad and with the portfolio sale at a huge discount. The investor buys for 10 what would cost 100 and goes after to recover whatever he can. Many of them have companies specialized in the collection and use advanced technologies to prove the one in default has the resources to pay off debts. The return is very high, despite the risk, which is also very high.” Macêdo emphasizes that collection from the defaulter varies in accordance with the debt profile, the legal proceeding and the existence of assets in the proceeding.
For Luis Vasco, Deloitte’s partner who leads the Corporate Restructuring practice in Brazil, the risks can be mitigated and priced at the time of purchase of the portfolio. “Credits without proof of existence and those related to fraud must be identified and handled separately, for example. Moreover, one must observe regulatory issues and those related to the collection legal proceeding. The recovery depends a lot on the characteristics of the credit and the average portfolio age, in addition, of course, to the strategy for collection applied by investors.”
There are two large NPL markets: consumers’ and companies’ debts. In Brazil, currently the main portfolios are those from consumers and there are also some large companies in judicial recovery. “We have a large portfolio to explore, especially after the difficulties the companies from the oil and gas and infrastructure chains have faced. In this scenario, NPLs are an opportunity to create a virtuous companies and sectors recovery flow”, analyzes Marcia Yagui, Deloitte’s Corporate Restructuring director.
Good and large non-performing loan transactions must create a volume flow that encourages the active participation of large national and international investors in the recovery of companies and, consequently, of sectors and the economy as a whole., Luis Vasco, Deloitte's partner who leads the Corporate Restructuring practice in Brazil.
Vasco says that the biggest NPLs market today is Europe, estimated at €2 trillion. “In international standards, the return is 25%. In Brazil, the main transactions with volume and which follow international standards should capture the premium of entry of new investors.”
Recovery is the goal
In Brazil, the Instruction No. 444 of the Brazilian Securities and Exchange Commission (CVM) determines the specifications of this type of credit. “When a hedge fund buys debts from companies in judicial recovery, it works as a private equity fund. The investor enters the operation to change the entire structure and try to revert the scenario because it has an interest for the company to recover so he recovers his money. Therefore, these funds act as owners, in the sense of improving that structure, to then sell the NPLs for a better price or remain as shareholders of a company that has regained financial health” says Guilherme Macedo, from UFRS.
In practice, this market has another positive side. As the new creditors go after the defaulter to collect from them, there is a reversion in the debt payment, many times, as a negotiation of the form of settlement. Once this happens, the defaulter’s history is clean.
The banks in Brazil have offered a timid form of NPLs, more focused on consumers. “This has grown, but does not necessarily mean that there is a market; it is necessary to develop it. For sales of businesses loans, there are guarantees such as machinery, properties and vehicles. For the portfolio of the defaulted consumer’s credit card, overdraft account and leasing, for example, there are no guarantees” explains Marcia Yagui, from Deloitte.
The market needs to be developed to take advantage of these assets, says Marcia. “The bank creates value with its non-performing loans sold because it does business with them and goes back to its business. And the investors recover the credits because they have know-how about this. So, it is a win-win situation for the bank.”
The big question is how to start selling the NPLs in scale. The banks have begun to sell small portfolios. Some have already created businesses with a focus on this collection, however, in a business separated from the banking activity. According to Marcia, the time to sell to large investors is now. “There is much potential for the NPL business, the foreigners are expecting it. The size of the ‘pie’ in Brazil depends on how the crisis will proceed.”
Companies specialized non-performing loans extract value because they go after the assets and generate benefits for everyone., Marcia Yagui, Deloitte's Corporate Restructuring director.
Manuela Larangeira, Jive Investments managing partner, believes that the NPLs volume among large companies should continue to grow in the coming months, as reflected in the number of requests for judicial recovery, for they have been affected by the recession in the last two years. The inventory of operations of companies in financial difficulties and the impact of investigations on corruption and money laundering by the Federal Police will also continue to grow. “In general, companies are still being affected by the environment of economic activity drop, high interest rates and more conservative lending policies from the banks. Before that, Jive’s expectation is an increase in the volume of operations in this segment.”
The Central Bank’s problematic assets indicator increased from 6.15% of the total loan portfolio in December 2012 to 7.94% in the same month of 2016. “In terms of amounts, this represents an additional volume of approximately R$100 billion, which reflects an increase of 69.4% over the period”.
Manuela explains the practical difference between the types of credit. “A corporate portfolio usually has credits with higher amounts, debts above R$100,000, filed in court, and almost always with the endorsement of the company’s controlling shareholders. Before that, the recovery work of each credit should be customized, considering the individual characteristics of each debtor, the potential for recovery (existence of assets) and the execution procedure. On the other hand, in a retail portfolio, we are normally dealing with a massive volume from individuals with smaller debts (up to R$5 thousand on average), without guarantees and not filed in court. For this type of portfolio, the approach needs to be standardized, using collection agencies, discount policies and statistical bases, to maximize the portfolio recovery.”
The Argentine company Recovery opened a branch in Brazil in 2004 seeking corporate and consumers in default. Currently, the company manages over R$40 billion in loans. “If we look at the banks’ balance sheets in recent periods, we estimate that this market grows R$ 100 billion every year. Another interesting fact is that, in Brazil, there are about 60 million people with bad credit. This is a considerable portion of the Economically Active Population” explains Flávio Suchek, Grupo Recovery’s CEO. “The public has much to learn about personal finances and the conscious use of credit” says Suchek.
Even though the scenario is bad for the Brazilian economic activity, the NPLs sector, which lives in the light of defaults, presents opportunities. These credits already draw attention and, probably, attract global investors’ resources seeking for structured investments which, therefore, may contribute to the recovery of important sectors of the country’s economy. The game is on. Simply wait for the movement of large competitors.
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