SAO PAULO--(BUSINESS WIRE)--Risk within oil and construction-related loan portfolios of many Brazilian banks has risen due to corruption scandals uncovered by investigations into illegal contracts between Petrobras and multiple companies across the civil construction and oil and gas chains, says Fitch Ratings.
The scandals have elevated the challenges for the Brazilian bank sector and could result in higher past due loans, loan loss provisions and/or loan restructurings in 2015, especially for Brazil's large public banks.
Fitch's downgrade of the civil construction company OAS S.A. (OAS) Issuer Default Rating (IDR) to 'RD' from 'C' on Jan. 7 is the most recent rating action related to the corruption scandal involving Petrobras. On Nov. 19, 2014, Fitch placed all rated Brazilian construction companies on Rating Watch Negative due to the agency's concerns about the financial and business impact of the allegations.
Brazil is already contending with weak GDP growth (Fitch's expectation of 0.3% for 2014 and just 1.0% in 2015), high inflation rates (current domestic Selic at 11.75%/ year) and devaluation of the local currency (Brazilian real down 12.5% in 2014). These weak economic conditions for corporates are expected to continue in 2015. Roughly 35% of Brazilian bank loans are in the Brazilian corporate sector.
Corruption scandals can result in reduced appetites for Brazilian risk in the international capital markets and reduce local available credit, affecting the companies' liquidity, and adding to the challenging macro environment.
Brazil's public (i.e. state-owned) banks could be more prone to oil and construction-related asset quality deterioration in the near future due to their aggressive loan growth over the last four years. Public banks are also more susceptible to political interference, which can lead to larger loans (relative to private banks) to infrastructure sectors, which have been bottlenecks for the country's growth. The oil and gas, and civil construction industries fit in these categories, thus public banks are more exposed to these industries, and Fitch expects larger provision needs for public banks in 2015.
The capitalization levels of Brazil's public banks (Fitch Core Capital, or FCC, of 9.1%, as of June 2014) and default ratios (90 days past due at 2.2% as of November 2014, up from 1.8% of year-end 2012) have already shown deterioration trends relative to private peers. The lower default ratios compared with private peers are mainly justified by stronger guarantees of both BNDES and Caixa's credit portfolio. Normally IDRs on public banks are derived from sovereign support, meaning that any deterioration on these bank's financial profiles would not have a direct impact on its IDRs.
The largest Brazilian private banks have well-diversified credit portfolios and, in our view, less exposure to oil and construction sectors relative to the large public banks. Private banks in Brazil can be exposed to loan facilities and or guarantees made to large corporates. A possible reduction in Petrobras' investment plans and an environment of lower oil prices may put an additional burden on some construction companies, oil service-related companies and to individuals employed by those industries.
Although a rapid deterioration of any of the major construction companies operating in the energy sectors could lead to additional provisioning needs, private Brazilian banks currently enjoy strong capitalization (FCC: 10.4% as of Jun. 2014) and declining rates of loan delinquencies (90 days past due at 4.0% in November 2014, down from 5.3% at year-end 2012). These banks' ability to actively reprice its credit portfolios and disciplined cost controls are also positive factors. Only a severe deterioration of these banks' asset quality, profitability and capitalization would justify a negative rating action.
Small and midsize banks count on higher concentrations in their loan portfolios, including to smaller (middle market) companies that can be linked to the production chain of oil and gas and or civil construction industries. Companies that have been constituted solely for a particular project could be directly exposed to larger corporate entities involved in the scandals. If not properly formalized and adequately backed by collateral, a small or midsized bank's exposure to companies or projects in oil and construction industries could harm these banks' financial profiles.
Foreign banks are normally smaller institutions operating in Brazil and have limits on lending their local balance sheets, either due to strict credit policies or due to the size of their local balance sheets. In addition, the ratings of these banks are mostly derived from institutional support, which means that any rating action on these Brazilian subsidiaries would typically be linked to the willingness and or ability of the parent to support its Brazilian subsidiary.
The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.