Photographer: Dado Galdieri/Bloomberg

Brazil Bond Buyers Going Down Market After World's Biggest Rally

  • Smaller lenders and deeply subordinated debt outperform peers
  • Easing fears of surge on non-performing loans boost outlook

The junkiest bonds from Brazil’s banking sector are being scooped up by investors starved for yield after corporate debt from the country’s biggest companies surged last year.

Quesnell Capital’s global high-yield fund is one of the buyers. After beating 95 percent of its peers in the past year with an overweight position in Brazil, the fund is wagering on notes from Banco do Brasil SA that are six levels below investment grade because they’ll be worthless if the bank ever needs a large capital increase. The risky bet has returned as much as 19 percent this year -- three times the average for Brazil corporates.

“To find value, investors have had to get a bit more adventurous,” said Ian McCall, who manages $185 million in emerging-market assets at Quesnell in Geneva.

Investors are taking another look at Brazil’s worst-rated bonds after its corporate debt soared almost 30 percent last year, pushing average yields down to 6.7 percent from as high as 11 percent at the end of 2015. In search of steeper payouts, investors have gravitated to bonds from smaller lenders and deeply subordinated debt from the mega banks, betting the industry won’t suffer the surge in non-performing loans that some analysts had forecast when Brazil was in the midst of its worst recession in a century.

Bonds from Banco Mercantil do Brasil SA, a Minas Gerais-based retail lender, due in 2020 have posted a total return of more than 19 percent this year, while notes from Banco do Estado do Rio Grande do Sul SA, Banco Bonsucesso SA and Banco BMG SA -- all of which are rated at least four notches below investment grade -- have returned more than 10 percent this year. None of the senior debt from the country’s biggest private lenders, which enjoy better ratings, have posted a total return of more than 7 percent.

"The market was expecting non-performing loans on those names to go through the roof, but this hasn’t materialized," said Patrik Kauffmann, who helps manage $11 billion in assets at Solitaire Aquila Ltd. in Zurich. "Therefore the market is repricing the additional spread these names have to pay for their refinancing."

Brazilian banks are rebounding as the economy emerges from two years of recession that fueled bankruptcies and boosted bad-loan provisions. Smaller lenders are now seeing higher profits as they build out their loan portfolios.

Increasing banking concentration in Brazil has also allowed smaller lenders to increase their share of loans to the most credit worthy companies, said Claudio Gallina, senior director for financial institutions at Fitch Ratings.

"Mid-size lenders have already set aside enough for possible new loan losses, limiting the room for bad surprises for those names down the road," Gallina said.

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