Who really kicked Dilma out?

The decision by the Brazilian congress to authorise the impeachment trail of President Dilma Rousseff appears to have been largely priced-in. This follows a huge rally in Brazilian financial assets in 2016 as the possibility of impeachment grew, with the Ibovespa rising by 37% since January 26 and the real rising by 11% against the dollar since the start of this year. National and international media are focused on the various political intrigues behind the impeachment process and Rousseff’s claims that it amounts to a constitutional coup, but participants in the financial markets say that the key driver of impeachment is being largely ignored.

Bankers tell Euromoney that the owners of the Brazil’s large companies and financial institutions are the main force behind the move. Politicians – financed legally and illegally (the huge scale of the latter is being uncovered by operation Lavo Jato) by corporate donations – have come under pressure from owners of companies and financial institutions to find a way to remove Rousseff as a means to arrest the country’s economic collapse. This year is widely expected to be a second consecutive one with a decline of GDP close to 4%.

One of the most important and unappreciated factors behind the impeachment process has been the growing cost of finance and refinancing risk. According to data provider Dealogic, in 2012 Brazilian corporates and financial institutions raised $46.8 billion in the international markets – a much cheaper source of finance than local banks or capital markets. By contrast, so far there has not been a single such deal in 2016, while for the whole of 2015 the total raised in the international markets was just $7.2 billion.

The lack of deals reflects both the increase in the risk premium international investors would charge Brazilian issuers due to the current political volatility – a rate they are unwilling to pay. Instead they are waiting, in many cases in an increasing state of desperation as debt refinancing risks increase, for a political solution. The local value of that debt raised in 2012 has also increased as the value of the Brazilian currency has crashed (although there has been a rally from the lowest levels of around R$4 to the dollar a couple of months ago to around R$3.60 today). Meanwhile, bankers report that they are rolling over debt facilities locally to keep their own credit portfolios healthy, but with the local cost of corporate debt at around 20%, the same bankers also report that the situation is unsustainable.

That has led to problems: 5,500 companies sought bankruptcy protection in 2015 – the most since 2008. Recent data shows that just 1% of those companies that seek protection emerge from bankruptcy in Brazil. The situation is deteriorating fast from even these levels: recent research from Boa Vista SCPC found that in the first quarter of this year requests for bankruptcy protection were 165.7% higher than in the first quarter of 2015.

Without economic recovery, bankers say that more, and bigger, companies will go bust. And the banks’ non-performing loans, which have remained impressively low and stable into the second year of a serious recession, will spike. BNP Paribas has picked up on the phenomenon of corporate defaults, which it says is being “missed”. In a report dated April 7 the bank states: “Corporate non-performing loans have already increased to new historical highs. The recession is sapping companies’ revenues and thus depleting their cash position, at the same time that a gripping credit crunch has tightened financial conditions. Some firms can survive a short-term and shallow one-year recession, but withstanding a deep and prolonged two-year downturn is proving considerably harder.”

BNPP says “a few foreign banks have exited the local market” further tightening lending conditions. So far, local banks have been willing to roll over debt that is maturing but, at around 20%, it is expensive funding for local companies, especially as they are operating in a deepening recession. The local banks’ strategy has kept NPLs in reasonable check (at 3.07% for the system in Q4 2015); without a return to growth this could rise – and provisioning has already increased.

Research by UBS found that if the downturn in Brazil performed in line with typical recessions, NPLs should peak around the middle of this year. However, UBS says: “The risk to this analysis is that the current NPL cycle in Brazil lasts longer than previous cycles, given the precarious macro outlook with the current recession being one of the deepest in history.”

It also found that the aggregated excess provisions in the banking sector of R$22.6 billion equates to 1.24% of loans – in other words NPLs could rise 124 basis points to 4.31% without further provisioning burden or risk to earnings. However, its stress scenario (a 50% increase in NPLs) would see NPLs reaching 4.60% for the system – requiring even more provisioning and further damaging banks’ earnings.  In 2015 alone, Itaú – the largest corporate lender – reported R$18.1 billion of provisions at a consolidated level. The bank does not break down this total, but sources say a huge chunk of this was related to losses in Itaú BBA – the investment and wholesale banking division. The bank’s official guidance is for a further 38% increase to R$25 billion in 2016.

BNPP warns that corporate credit defaults will lead to a vicious cycle of tighter credit conditions that will further weaken the health of Brazilian corporates. Corporate closures and cutbacks hit the wider economy, through layoffs. Unemployment rose to 10.2% in March and is predicted to be above 11% by the end of this year.

Financial market participants say this helps to explain a seeming paradox. Despite this year’s continuing dismal economic news, the leading stock index and the value of the real have been among the world’s star performers lately. The stock market has become directly correlated to the collapse of the government. A bad day for Rousseff has been a good day for asset prices and vice versa.

But, in candid moments, bankers say that what is not so well appreciated outside financial circles, domestically and internationally, is that the primary relationship is of finance creating political turbulence, rather than the other way around. Those with influence over politicians have been demanding change, say bankers. The move to impeachment is therefore about capitalizing on the president’s unpopularity to justify political change that constitutionally should come through the ballot box. Privately, some bankers (who are obviously well connected to this ownership class) say the  country does not have time to wait and cannot afford to hang on until new elections in 2018. Expediency is necessary, they say, and so a way to impeach Rousseff was sought and found.

Proof of the link may be hiding in clear sight: take, for example, on March 22 a tweet from Aécio Neves – Rousseff’s presidential challenger in 2014 and a key advocate of impeachment – that suggests a justification of political expediency for impeachment: “Impeachment is the shortest possible route to starting a new phase in the country’s history.”

This argument is backed up by the focus on impeachment related to accounting impropriety rather than the more credible route of disposing of Rousseff by asking the electoral court to annul the 2014 election result due to allegations that her campaign was (in part) financed by bribes. But that channel would take much longer – hence the focus on impeachment.

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