08/04/2015 - Q&A Credit Suisse-Backed Distressed Fund Expects 'Mid 20s' Return in Brazil

Distressed debt opportunities abound in Brazil's sugar, oil and iron ore sectors, according to Antonio Quintella, co-founder and CEO of Peninsula INVESTIMENTOS. Peninsula partner Rafael Fritsch expects to make returns in the mid-20 percent area from a new distressed fund. Credit Suisse holds a minority non-voting stake in Peninsula, which was founded in 2012 and manages approximately 2.9 billion reais ($930 million). Quintella, former Americas CEO at Credit Suisse, and Fritsch spoke with Bloomberg Brief reporter Hema Parmar on March 30. Their comments have been edited and condensed.

Q: What is the plan for the new fund?
Quintella: Our plan is to raise a new fund in the second half of the year. We are looking primarily into debt securities. We have engaged in discussions with lenders that want to sell portfolios or part of their portfolios. We're talking to companies that may need to restructure or are looking for debt financing at some point in the next few months.
Fritsch: We are estimating to raise 500 million reais and the fund to have a two-year investment period with a three-year divestment period.
Q: How big was your first last fund?
Fritsch: Between December 2011 and February 2012, we raised 250 million reais for a distressed debt fund which had two years of investment period and three years of divestment period.
Q: Why another now?
Fritsch: Investors understand that the opportunity now is bigger. Default rates are picking up. A lot of the bonds are held by high-grade funds. If some of these companies actually lose the high grade quality there will be some forced selling.
Quintella: In the past few years we have seen a very significant increase in overall
leverage in the Brazilian economy to approximately a 60 percent debt-to-GDP ratio. What we now see is a very sharp increase in base interest rates combined with less appetite from both private lenders as well as the state-owned banks.  
Q: What return do you expect?
Fritsch: Two hundred percent of base rates. Base rates were averaging last year 12 percent and looking forward 13 percent.  So we're expecting in the mid-20s in Brazilian currency, minus fees.
Q: Are you buying dollar-denominated or local currency debt?
Quintella: We see opportunities in both.

Q: Who would invest in this?
Fritsch: In previous years there was a taxation on foreign investors in Brazil, called IOF. At the moment there isn't, so I think we are going to be looking for qualified investors locally, and foreign investors as well. For most Brazilians still, distressed is a new product.

Q: Where are the best opportunities?
Fritsch: The worldwide price of sugar is really down. Oil-related services, given where the price of oil is. Iron ore as well. There are going to definitely be opportunities in these segments. And also as the Brazilian economy slows down I think you will see the least prepared, more leveraged companies having more issues. I do see for the next 24 months at least a lot of activity in the high-yield and distressed space in Brazil.
Quintella: [And] real estate.
Q: Which sectors are not struggling?
Quintella: The Brazilian consumer has been reasonably resilient, so companies that are basically exposed to the domestic economy so far have done well. To some extent the FOREIGN EXCHANGE devaluation helps the cash flow of competitive and low-cost Brazilian exporters. The largest Brazilian banks are also well-capitalized so they’ve done well so far.  
Q: Are you betting that companies willenter bankruptcy or escape it?
Fritsch: We're looking at situations in two
buckets. One, where it's unavoidable to enter an in-court or out-of-court restructuring. Companies above 5 to 6 times leveraged will probably need a restructuring. We're going to provide liquidity to some companies that are simply illiquid — they're solvent, but illiquid —  in order to get them through these next two years.
Q: What are some of the risks?
Fritsch: There are some assets that you can seize, and some assets that even if you have legal opinion, they're not seizable. In some situations the worst case scenario is zero. Even for secured loans.
Q: What is the default outlook?
Fritsch: Two years ago, on a 12-month run rate, 150 companies on average were defaulting a month. Today this rate is about 350 companies. I think the next 12 to 18 months are going to be very challenging. Compared to previous crises, delinquency rates could increase by as much as 40 percent.
Q: When will the cycle bottom out?
Fritsch: The next 24 months should see a bottoming on the credit cycles, the peak in terms of default rates and delinquency.
Q: How is the bankruptcy process?
Fritsch: In general, Latin American countries' bankruptcy laws are relatively new and in many cases untested. In Brazil, you have to factor process risk, which is not fully understandable, or fully price-able, and you have valuation risk. That’s why prices tend to be lower in Latin American restructurings than in U.S. restructurings. Brazil's bankruptcy law was written in 2005, and a lot of the jurisprudence and the case studies are still happening.
Q: What is the five-year outlook?
Quintella: We're likely to see more liquidity in the credit market. There will be distressed situations, but there will be knowledgeable investors. We think this is likely to play out for a very considerable period of time, at least the next five years.

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