With rising interest rates, real estate fund posts worst October on record

As conditions worsen, fund managers offload assets and boost cash reserves

11/06/2024

Real estate funds (FIIs) experienced their worst October on record, with the Ifix—the sector’s benchmark index—plummeting by 3.06%. This marks the largest monthly decline since November 2022, leaving share values nearing historic lows last seen in March last year. The analysis, conducted by Clube FII’s research team at Valor’s request, covered both “brick funds,” which invest directly in real estate, and “paper funds,” which invest in debt securities.

In response to the challenging landscape, fund managers are adjusting strategies, halting transactions, and selling stakes to bolster cash reserves as capital raising has become increasingly difficult.

“Until late August, our outlook was positive, and we were gearing up for a new issuance with promising deals in the pipeline,” said Gabriel Barbosa, manager of TRX Real Estate (TRXF11), one of the largest funds with R$2.15 billion in assets and 184,000 shareholders. “Since September, the scenario has collapsed.” Both issuance plans and negotiations have been suspended. “It’s better to wait for market stabilization because, right now, visibility is limited,” he adds.

The funds’ devaluation stems from rising interest rates in the futures market amid fiscal and inflation concerns. Long-term rates on B-Series National Treasury Notes (NTN-B) bonds, which serve as sector benchmarks and are theoretically risk-free, have reached yearly highs, surpassing 6.5% of Brazil’s benchmark inflation index (IPCA). These rates are luring investors away from FIIs, said Danilo Barbosa, partner and head of research at Clube FII. “Long-term NTN-B rates are far more correlated with FIIs than the Selic rate,” he notes.

According to the Clube FII study, paper fund shares are trading at an average 7% discount to asset values as of October 31, slightly above the 10% record in March 2023. Brick fund shares show a deeper 16% discount, close to the 17% historic low from March last year, while Ifix sits at a 12% discount (its record was 13% in 2023).

Corporate office buildings are the hardest hit among real estate types, with a 33% discount, followed by shopping centers at 18%, logistics warehouses at 11%, and urban rental properties (such as pharmacies and supermarkets) at 7%. For shopping malls, the discounts are even higher than in November 2021 during the pandemic, when the average discount hit 20%.

According to Clube FII’s Danilo Barbosa, the market may still face further declines, given that long-term NTN-B rates are currently higher than they were at past lows. “The 2035-maturity NTN-B now offers IPCA plus 6.64%, compared to 6.48% in March 2023. If this were the sole factor, it could suggest further downside for fund values.” However, he believes share values are now attractive to buyers.

TRXF11, which holds 53 properties across 11 states—primarily large retail stores—secured a major deal in July with a R$621 million contract to build a “built-to-suit” hospital for the Albert Einstein chain, a landmark 20-year lease for the fund. In the first half of the year, TRXF11 successfully raised R$250 million, twice the anticipated amount. Now, with limited prospects for additional funding, Mr. Barbosa has decided to boost the fund’s cash position, which currently stands at R$400 million.

To capitalize on strong investor demand in the private credit market—where high interest has driven down rates on corporate debt securities—TRXF11 is issuing R$224 million in 15-year real estate receivables certificates (CRIs) at IPCA plus 6.9%. “When public offerings aren’t favorable, we raise capital through debt securities to maintain liquidity and secure quality investments. When the environment improves, we’ll issue shares to balance the books,” the fund’s representative said.

Known for its portfolio rotation, TRXF11 sold ten properties this year, generating R$750 million. Although the fund employs a multi-strategy approach, its primary focus remains on real estate assets (“brick” investments), holding just R$120 million in CRIs. Currently trading at a 2% discount, the fund has mostly stayed above its asset value throughout its history. This recent dip has pushed its dividend yield to 11%, above its historical average of 9%.

“Retail investors tend to have a short-term view, which doesn’t align with real estate’s long-term nature,” said Felipe Gaiad, managing partner of HSI Fundos Imobiliários, highlighting that around 75% of FII investors are individuals. “When interest rates rise, investors shift from FIIs to government bonds, causing quotas to drop excessively. However, the fundamentals remain unchanged.”

Earlier in the year, HSI raised R$450 million for its HSI Malls (HSML11) fund, which it used to prepay debt and strengthen cash reserves. “Initially, we focused on organic growth, but with reduced liquidity, we’ve redirected investments.” The fund now emphasizes acquiring minority stakes and expanding assets, including mall developments, with a 25% discount on asset value and an 11.5% dividend yield.

RBR Asset has strengthened its cash position, allocating 15% of its largest listed fund, RBR High Grade (RBRF11), to real estate credit bills (LCI). This fund, with R$1.2 billion in net assets, is a strategic move, according to Bruno Nardo, the company’s partner and multi-strategy manager. “We leveraged the favorable market conditions in March to build cash reserves and ensure liquidity. Since we haven’t yet made substantial use of these funds, we’re comfortable holding and waiting,” he explains.

The fund invests in other funds and in CRIs, the core focus of the manager’s strategy. According to Mr. Nardo, the bleak outlook has prompted banks to pull back, though companies still have a strong demand for credit. “As expectations have soured, interest rates have worsened rapidly over the past four weeks, and high cash flow is a helpful buffer,” he explains. Currently, RBRF11 shares trade at a roughly 22% discount, with an annual dividend yield of 10%.

The RBR Plus Multiestratégia (RBRX11) fund, with the flexibility to invest in FIIs, CRIs, and equities, originally planned to allocate R$100 million from its March public offering to other funds. However, facing a more challenging market, its focus has shifted to CRIs and preferred equity. Currently, its shares trade at a 15% discount, with a 12% annual dividend yield. The portfolio maintains a more defensive stance in RBR’s exclusive funds for pension and multifamily offices. “We view this period as an opportunity to acquire quality assets at attractive prices,” says Mr. Nardo.

In August, amid challenging market conditions, Inter Asset launched a fundraising effort for its logistics fund, INLG11, which holds R$450 million in shareholder equity. Targeting R$100 million, the offering secured R$82 million. Currently, the fund trades at a 20% discount with an annual dividend yield of 11.6%. “Share prices are one thing, and real estate assets are another. It’s a long-term play,” remarks Mauro Lima, a partner and director of real estate investments, who joined Inter Asset last year to expand the FIIs segment, develop new funds, and reposition existing ones.

According to Flávio Pires, an FII analyst at Santander, the market is unlikely to see recovery in the immediate term. He anticipates continued volatility through November, followed by a traditional December rally seen in FIIs since 2019, with individual investors reinvesting their thirteenth salaries and managers repurchasing shares of their FIIs through other funds. However, he foresees potential instability continuing until at least the second quarter of 2025. “Shares are currently undervalued and present a good entry point,” he observes.

Mr. Pires adds that investors are not entirely exiting their funds but are trimming positions to shift toward fixed income. He notes there are resilient segments within FIIs, particularly urban income. “Few funds warrant an exit solely due to adverse macroeconomic conditions. Most have solid portfolios, sound management, and sufficient liquidity,” he said.

*By Liane Thedim — Rio de Janeiro

Source: Valor International

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Companies sell minority stakes to fund expansion

Deals account for 35% of M&A activity this year through October, up from 6% in 2021

11/06/2024

With the Brazilian stock market closed to new listings for over three years, a group of companies is resorting to selling minority stakes to raise funds for expansion. As of October this year, minority transactions accounted for 35% of mergers and acquisitions (M&As), compared to 23% in 2023 and 16% in 2022.

In 2020 and 2021, when the market was fully open due to ample liquidity, even for smaller deals, the percentage was 7% and 6%, respectively, according to a study carried out by Seneca Evercore for Valor.

According to experts, some companies are also seeking a preliminary valuation before going public, anticipating a reopening of initial public offerings (IPOs), which is currently projected for 2025. Others aim to improve their capital structure, as was the case with steel maker CSN, which decided to sell a stake in its subsidiary CSN Mineração.

Among the cases in progress, pharmaceutical company Cimed has hired J.P. Morgan to find a buyer for a minority stake, expected to attract private equity funds, according to market sources. Brazilian chocolate brand Trento, owned by Peccin, has appointed UBS BB to facilitate the sale of a stake, as reported by Valor. The companies declined to comment.

Another notable case is Compass, the gas division of sugar and energy company Cosan, which was in line for a public offering and also plans to sell a minority stake. Rubens Ometto, founder and chairman of the conglomerate, told Valor there is investor interest.

The trend is also seen among fintechs. Act Digital is seeking a partner for expansion. Contabilizei sold a stake to Warburg Pincus, and MeuTudo is also looking for an investor with a bank involved in the process, according to sources. Agibank, waiting for a market window for an IPO, is working with Goldman Sachs on a minority sale. The companies declined to comment.

Daniel Wainstein, a partner at Seneca Evercore, noted that the rise in minority transactions is also due to shareholders deciding to sell their companies. However, with asset values down, they are currently opting to sell only a stake. “The current market perspective is that transactions initially considered for full control have shifted to minority stake sales, partially meeting shareholder desires and reserving a 100% sale for a more favorable market moment.”

Anderson Brito, director at UBS BB, said that the bank currently has about 10 transactions involving minority stake sales in its pipeline, including fintechs, consumer sector companies, software companies, data centers, and firms related to energy transition. “We also see companies that could enter the capital markets now needing to scale up. Others need to see a recovery in multiples and are conducting pre-IPO rounds,” he said.

Mr. Brito noted that companies are also seeking funds to continue expansion plans. In other cases, minority stake sales involve funds that have reached the maturity stage of their investments and need to divest.

Private equity funds and foreign groups are traditionally viewed as investors for companies seeking partners to grow their businesses, said Guilherme Monteiro, a capital markets partner at law firm Pinheiro Neto Advogados.

“Without IPOs, private placements, common in the U.S., gain traction in this scenario. Companies strengthen by bringing a significant partner into their shareholder base,” Mr. Monteiro said. With these private placements, he adds, companies tend to be seen as having a more sophisticated capital structure, even for future IPOs.

For Guilherme Bueno Malouf, an M&A partner at Machado Meyer, private equity funds are the most obvious route, as this format allows for primary investment—capital directed to the company. “These resources enable companies to prepare for larger ventures,” Mr. Malouf said.

He noted, however, that private equity funds have reduced these types of transactions due to the ongoing high-interest rates and geopolitical tensions. “In this context, investments become more conservative, with shifts towards fixed income.”

“There’s also a challenging scenario for companies seeking these investments, with the domestic environment still fraught with fiscal uncertainties,” he added.

Ricardo Thomazinho, a partner at Urbano Vitalino Advogados, confirms that such transactions are reaching the firm, often involving funds as buyers since strategic investors mostly prefer acquiring control.

He noted that strategic investors might initially acquire a minority stake but often with a pre-arranged agreement for future control purchase.

Currently, Mr. Thomazinho said, minority stake sales are also being pursued by companies needing to balance their books. “Many companies are seeking solutions after enduring high interest rates for an extended period,” he said.

Maintaining control of these deals is also crucial for business owners. Renato Stuart, a partner at RGS, said that when a company goes public, one of the goals is to retain control. “That’s why, when they opt against an IPO, they generally prefer selling to a minority fund,” he said.

*By Fernanda Guimarães, Mônica Scaramuzzo — São Paulo

Source: Valor International

https://valorinternational.globo.com/
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Brazil-U.S. trade likely to see election impact

Concerns rise over Trump’s victory and increase in import tariffs

11/06/2024

Bilateral trade between Brazil and the United States is expected to face potential challenges as Donald Trump returns to power. Experts believe that while specific measures against Brazil are unlikely under a new U.S. administration next year, Mr. Trump’s victory could drive up import tariffs overall. A key concern with the former president’s campaign is his proposal to raise tariffs, which could impact global trade volumes or trigger currency devaluations. Some fear a “spiral of tariffs and retaliations,” though it remains uncertain what parts of Mr. Trump’s platform are campaign rhetoric versus actual policy intentions.

Experts believe the U.S.-China relationship will remain marked by intense geopolitical competition, with Brazil striving to balance relations. While trade protectionism could harm intra-company exports due to U.S. investments in Brazil—the largest among foreign investors—the U.S.-China rivalry could continue to benefit Brazil’s agricultural exports, though increased protectionism is not viewed as ideal for global trade.

“Politically, it would be preferable for the Lula administration if Kamala Harris won, given the president’s previous endorsements of her,” said José Augusto de Castro, president of the Brazilian Foreign Trade Association (AEB). From a trade perspective, he points to Mr. Trump’s campaign pledge to raise import tariffs by at least 10% across the board and 60% on Chinese goods. “Such measures could curb global growth, impacting commodity consumption and reducing trade. But we must remember that the world is transitioning, and many factors will need adjusting.”

Sergio Vale, chief economist at MB Associados, suggests that a blanket tariff increase proposed by Mr. Trump could affect Brazil through currency devaluation. “This type of competitive tariff policy could lead to currency depreciations worldwide.”

Mr. Vale observes that this is already happening to some extent. “The recent depreciation in currencies reflects concerns over a potential Trump administration, as markets weigh the risk factors such a government could pose for U.S. fiscal and economic policy.” Mr. Trump’s victory, he adds, could keep these concerns around exchange rates alive, “given his signaling of economically challenging policies.”

Mr. Vale expects no direct measures against Brazil under a Republican administration, “despite the political disagreements likely to arise with the Lula administration.” However, the U.S.-China rivalry is unlikely to change regardless of the election outcome, as Livio Ribeiro, partner at BRCG and researcher at the Fundação Getulio Vargas’s Brazilian Institute of Economics (Ibre-FGV), explains: “This is a state-to-state confrontation, not merely a clash between administrations.”

“Trump brings more noise,” Mr. Ribeiro said. “He’ll likely push policies perceived as aggressive from the start, like general tariffs and specific taxes targeting China. But in the end, it’s mostly noise rather than substantial change in frequency.”

On Mr. Trump’s proposed general tariff, Mr. Ribeiro explains that if the measure is uniformly applied, it would raise the cost of U.S. imports globally. “The real risk here is getting caught in a cycle of tariffs and retaliations—a non-trivial concern. But we need to separate Trump’s noise from what his administration will actually implement,” Mr. Ribeiro pointed out.

Welber Barral, a partner at BMJ and a former foreign trade secretary, notes that certain Brazilian industries are still affected by Mr. Trump’s policies from his first term, including steel, aluminum, and copper. According to Mr. Barral, a general tariff hike could also impact Brazilian exports of manufactured goods.

Another factor, according to Mr. Barral, is that Brazil competes with the U.S. in exporting agricultural goods to China. He points out that during Mr. Trump’s previous term, tensions with China led to increased Chinese purchases of Brazilian agricultural products, such as soybeans.

“Protectionism isn’t good for anyone. In the end, everyone loses, though effects vary across supply chains. Trump’s main challenge is his unpredictability.”

Political scientist Hussein Kalout suggests that Mr. Trump’s victory would likely strain Brazil’s current administration. The Republican agenda contrasts sharply with President Lula’s priorities, and Mr. Trump’s return could end today’s aligned perspectives between the Brazilian government and the U.S., according to Mr. Kalout, former secretary of strategic affairs under the Temer administration, a researcher at Harvard, and adviser to the Brazilian Center for International Relations (CEBRI).

“Trump has shown a preference for an international policy agenda that conflicts with Brazil’s current stance. His is a climate-skeptic, anti-multilateralist agenda that opposes reforms in international organizations, particularly the WTO [World Trade Organization],” Mr. Kalout points out.

Mr. Trump’s presidency could accelerate inflation and halt the recent trend of falling U.S. interest rates, impacting foreign capital flows to emerging markets like Brazil. Former Brazilian ambassador to China and CEBRI adviser Marcos Caramuru suggests that if Mr. Trump enacts the import tariffs he’s proposing, it “would disrupt the global economy, potentially driving export companies to invest in the U.S. The impact of his policies could be more significant than Biden’s.”

Mr. Caramuru adds that Mr. Trump’s proposed high tariffs, combined with limited foreign labor availability, would drive up U.S. inflation. “As a result, interest rates may stop falling, and more capital could shift to the U.S., affecting emerging markets like Brazil.”

*By Marta Watanabe, Camila Zarur, Paula Martini — São Paulo and Rio de Janeiro

Source: Valor International

https://valorinternational.globo.com/
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Pará launches anti-deforestation development plan

Key goal is carbon neutrality in land and forest use by 2030

11/05/2024

Governor Helder Barbalho of Pará signed into law the “Amazon Now State Plan” on Monday, aimed at curbing deforestation and promoting sustainable development across the state. A primary goal is to achieve carbon neutrality in land and forest use by 2030. The plan also outlines directives for land regularization, strengthening environmental monitoring, and fostering a low-carbon economy.

Key measures in the new law include establishing the State Anti-Deforestation Force, a unit dedicated to monitoring forest areas in Pará, and the creation of the Eastern Amazon Fund, a financial mechanism designed to attract and allocate resources for environmental conservation, ecosystem restoration, and sustainable development projects.

The law also provides incentives for rural producers to adopt low-carbon practices and encourages active participation from local communities, including Indigenous and quilombola groups, in conservation and restoration efforts.

Gabriela Savian, deputy director of public policy at the Amazon Environmental Research Institute (IPAM), believes that formalizing the plan—originally introduced in 2019—is crucial for providing predictability and legal certainty for sustainable investments. “It’s essential that subnational states have long-term, low-emission economic development plans, with a well-defined strategic direction,” she said, noting that over 80% of Pará’s emissions stem from deforestation and forest degradation.

The plan uses an average of greenhouse gas emissions between 2018 and 2022, based on data from Brazil’s National Institute for Space Research (INPE). The aim is for Pará to reach near-zero emissions by 2030, which will require not only controlling deforestation but also expanding secondary vegetation areas to compensate for lost forest cover.

To monitor compliance, the government has created a Permanent Monitoring Center responsible for tracking actions and publishing periodic progress reports. Another body, the Climate Science Panel, made up of research institutions, will contribute technical recommendations and strategies for the plan.

The proposal also includes the establishment of the Pará Forum for Climate Change and Adaptation, a platform that will allow local communities and social organizations to participate in policy discussions and action oversight. These groups will be involved in forest conservation and promoting sustainable practices.

The law aligns the state with Brazil’s national commitments, such as the Nationally Determined Contributions (NDCs) under the Paris Agreement and the United Nations’ Sustainable Development Goals (SDGs). The plan also emphasizes adopting the REDD+ mechanism, an international system incentivizing forest conservation, which would reward Pará for reducing emissions from deforestation.

*By Murillo Camarotto, Fabio Murakawa — Brasília

Source: Valor International

https://valorinternational.globo.com/
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U.S. elections pose potential strain on Brazil relations

Analysts highlight tensions in climate, human rights, and geopolitics, but more aligned if Kamala Harris wins

11/05/2024

The outcome of Tuesday’s U.S. elections could pressure the convergence of the U.S.-Brazil agenda and the stability of bilateral relations. Experts consulted by Valor suggest that much of the economic ties’ robustness is likely to remain, regardless of the winner. Still, risks of discord in areas like climate, human rights, and geopolitics may increase.

The U.S. is the top investor in Brazil. Commercial engagement is also growing, with Brazilian exports to the U.S. hitting a record this year, helping reduce Brazil’s trade deficit with the U.S.

Beyond the economic sphere, relations between the countries, currently led by presidents Biden and Lula, converge on cross-cutting issues like climate but are not free of disagreements.

“Bilateral relations have reached a stage of maturity under the Biden-Lula agenda, converging on topics like the environment and human rights, particularly concerning decent work, with initiatives from the United Nations and the International Labor Organization (ILO) to regulate app-based activities,” said Cristina Pecequilo, an international relations professor at the Federal University of São Paulo.

“The larger issue remains in the geopolitical arena. As Brazil returns to a more neutral, independent foreign policy, reviving classic international agenda principles, not just in bilateral relations, a series of discrepancies arise from the fact that the U.S. would rather see Brazil supporting its policies more directly and not diverge, for instance, on conflicts between Russia and Ukraine and Israel and Palestine.”

Besides that, she added, is the weight of the growing Brazil-China relationship within BRICS, the very Brazil-U.S. relationship, and the upholding of reforms in the international order, which conflict with U.S. interests.

If Ms. Harris wins, she noted, continuity in proximity on cross-cutting issues is expected until the end of President Lula’s term, with divergence on some geopolitical matters.

Under a Trump administration, there could be greater economic protectionism and increased pressure for Brazil not to deepen ties with China amid the China-U.S. tensions.

“A Trump victory might also embolden far-right forces to feel more represented in exerting pressure. Thus, a Trump administration would certainly make it harder for Brazil to navigate these cross-cutting agendas.”

Bruna Santos, head of the Brazil Institute at the Wilson Center in Washington, said there is an overlap of agendas and quite similar views for the first time in U.S.-Brazil relations.

“Both current presidents are over 70 and became presidents after well-established political careers, confronting right-wing leaders with similar characteristics, such as [Jair] Bolsonaro and [Donald] Trump, and both had election results challenged by public demonstrations on January 8 [2023] and January 6 [2021],” she said.

“Moreover, there is a shared labor agenda involving unions, a central point of their meeting in February 2023, with both looking at energy transition as a path for economic development. This is unique.”

Ms. Santos noted that Brazil and Latin America as a whole aren’t a priority for any White House candidates, but the Brazil-U.S. relationship today is solid. “They are good friends, good companions, good partners. They aren’t allies in foreign policy, but they have a very consolidated relationship,” she said.

“The fact that Brazil considers the U.S. its second-largest trade partner [after China] is highly significant, as is the level of American direct investment in the country. It’s a bilateral relationship based on high-value-added products, which is also very important for Brazil.”

The U.S. remains the largest investor in Brazil. American foreign direct investment (FDI) stock rose from $123.9 billion in 2020 to $190.8 billion in 2021 and $228.8 billion in 2023, the highest level since at least 2010, according to the Central Bank’s official records. This is over four times the direct investment stock from Spain, the second-ranking country.

Data from the American Chamber of Commerce for Brazil (AmCham Brazil) show that the U.S. share in Brazil’s FDI increased from 11.8% in 2015 to 21% in 2019 and 25.8% in 2023.

In recent years, trade in goods and services between the two countries has grown, with intensified investment flows, especially in sectors like technology and the green economy, said Abrão Neto, CEO of AmCham.

“We expect the positive trajectory in trade and bilateral investments will continue. The U.S. is the main destination for Brazilian exports of industrial goods and high-tech products like aircraft, machinery, and equipment,” he said.

“Additionally, we’re watching a new cycle of American investments in Brazil in sectors like technology, data centers, and renewable energy. In 2023, U.S. companies announced 126 greenfield projects, the highest volume in a decade. Conditions are favorable for these results to intensify.”

From January to September this year, Brazilian exports to the U.S. grew 10.3% compared to the same period in 2023, reaching a record $29.4 billion, according to the Brazil-U.S. Trade Monitor by AmCham Brazil.

In recent years, increased shipments to the U.S. have significantly reduced Brazil’s trade deficit with the U.S., which fell to $1 billion in 2022 from $13.9 billion in 2021.

He noted that there are presidential elections in Brazil or the U.S. every two years, a cycle of political changes that is anticipated.

“In general, governments and businesses in both countries handle these transitions well. Behind political cycles, there are consolidated, long-term economic interests,” he said. “Moreover, Brazil and the U.S. have institutional maturity and strong incentives to maintain this cooperation.”

He added that the current Democratic government’s emphasis on sustainability and climate would undergo significant change under a potential Republican administration, but recently adopted policies like the Inflation Reduction Act and the Chips Act have bipartisan support, indicating continuity regardless of this Tuesday’s election outcome.

The same applies to the importance placed on the U.S. geopolitical rivalry with China and supply chain resilience, topics that are likely to remain priorities on the American political agenda.

“For Brazil, the ideal is to seek balance, defending its interests and maintaining partnerships with both countries. But [this] will increasingly be like walking a tightrope,” added Abrão Neto.

*By Marsílea Gombata — São Paulo

Source: Valor International

https://valorinternational.globo.com/
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Congress gains greater weight in city budgets

Study reveals legislative power over city budgets and federal influence loss over mayors

11/04/2024

In the past four years, parliamentary budget allocations to municipalities have nearly doubled the amount voluntarily transferred by the federal government to local administrations, according to an exclusive study by the technical advisory team of Congressman Pedro Paulo obtained by Valor.

These sums are already significant relative to what smaller municipalities receive annually from the Unified Health System (SUS), the Fund for Maintenance and Development of Elementary Education (FUNDEB), and the Municipal Participation Fund (FPM).

The report highlights the growing influence of the Legislative branch over city budgets, particularly in smaller municipalities, and the declining federal government influence over mayors. From 2016 to 2020, the federal government allocated R$66.4 billion to municipalities through voluntary transfers, while parliamentary allocations totaled R$43.6 billion. Between 2021 and 2024, this trend reversed: mayors received R$96.5 billion endorsed by lawmakers, compared to R$49.9 billion in discretionary federal funds.

This figure masks that in 2023, half of the R$21.3 billion in discretionary spending by the Lula administration in municipalities was directed by congressional indications. This resulted from a deal to pass the so-called Transition Constitutional Amendment Proposal (PEC). In exchange for releasing R$170 billion for the Executive, Congress maintained control over “secret budget” funds, which the Supreme Court had abolished the previous year.

According to the study, the federal government’s voluntary transfers to municipalities were mainly through discretionary ministry funds and the former Growth Acceleration Program (PAC). These Executive resources reached R$27 billion in 2020, during the pandemic. Since then, Congress has assumed control over these funds by creating the so-called rapporteur allocations (popularly known as the “secret budget”), expansion of other transfers, and the end of PAC. Municipal allocation funds increased to R$28.8 billion in 2024 from R$7.8 billion in 2019, a 269.2% growth.

Parliamentary preference is for transfers to municipalities. Last year, the amount reached R$23.1 billion, equivalent to 15.2% of what they received from the Municipalities Participation Fund (FPM)—distributed based on population size and local income, historically the primary revenue source for small cities. For state governors, lawmakers and senators’ allocations totaled R$4.5 billion in 2023, just 3.5% of the R$129.3 billion received via the State Participation Fund (FPE).

Regarding health and education funds, the smaller the city, the more significant the impact of parliamentary transfers. In municipalities with fewer than 5,000 inhabitants, the average per capita budget allocation was R$355.80, equivalent to 71% of what they received from SUS and 36.5% of FUNDEB (although not all municipalities in this category received all three transfers). In contrast, those with over 50,000 inhabitants received R$105.2 per capita—24% of the funds from SUS and 12% from Fundeb.

The data also show that the lower the Human Development Index (HDI), the higher the value allocated by parliamentarians. Municipalities with an HDI below 0.600 received R$263 per capita. Those with an HDI between 0.600 and 0.750 received R$143 per inhabitant, while those with an HDI above this range received R$47 per resident.

On the other hand, the study also points out significant discrepancies among municipalities. “There is a notable concentration of entities receiving amounts below R$200 per inhabitant [in 2024],” it said. The average value was R$236.30 per resident, but 89 locations exceeded this by almost four times, reaching over R$919.

“The ten municipalities receiving the least per capita allocations [in 2024] had a total of R$6.7 million for a population of 3 million, averaging R$2.20 per inhabitant,” the report noted. Leading this list is Itaí (São Paulo), with R$21,500 in parliamentary transfers for its 25,900 residents, equivalent to R$0.80 per capita. The list also includes the capital, Belém, with R$3.7 million in allocations for a population of 1.4 million.

“Conversely, the ten municipalities with the highest per capita transfers totaled R$76 million for a population of just 33,000, with an average transfer of R$2,300,” the study said. Davinópolis (Goiás), with 1,900 residents, tops the list with R$2,745.40 per capita.

Twenty-six cities received more from direct transfers to states and municipalities without the need for agreements than from the FPM. Of Roraima’s 15 towns, 12 are in this situation. This method is favored by mayors and congress members because it allows funds to arrive more quickly, as it doesn’t require a project submission or federal government evaluation. However, it faces criticism for its lack of transparency.

Lawmaker Pedro Paulo, who commissioned the study, believes the data show that although parliamentary allocations require improvement, they have effectively delivered federal resources to where people live. “What I’m highlighting is that transparency needs significant improvement. However, parliamentary transfers are a channel for more Brazil and less Brasília,” he said.

The lawmaker argues that municipalities face public pressure for actions that fall under state and federal government responsibilities and parliamentary allocations are a way to empower them after years of revenue concentration in the federal government. “In the Rio de Janeiro election, the primary topic was public security, which is a state responsibility,” he said.

He suggested, as part of the study, reserving 3% of parliamentary allocations for municipalities with up to 10,000 inhabitants and an HDI below the national average, creating a “national portfolio of local investment projects,” and allocating funds to cities that improve their fiscal and public policy indicators, along with implementing more transparency, traceability, and growth control rules.

“There’s no doubt that we have a Frankenstein compared to other countries, but wait. Just like FUNDEB, SUS, FPM, and FPE, it’s a resource that somewhat reduces the federal authoritarianism of the government. Even if unintentionally, in a haphazard way, it is taking on a redistributive and progressive character,” he said.

*By Raphael Di Cunto, Marcelo Ribeiro — Brasília

Souarce: Valor Inernational

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Brazil set to speed up interest rate hikes

Market anticipates policy rate to hit 12.5% per year by mid-2025; some forecasts suggest a return to 13%

11/04/2024

Amid a deteriorating economic outlook and tighter financial conditions since September, the Central Bank’s Monetary Policy Committee (COPOM) is expected to take a more aggressive stance in its current tightening cycle. An acceleration of the Selic policy rate hike to 50 basis points is widely anticipated by the financial market, which has revised its expectations for the base interest rate upward. However, even with this adjustment, inflation is projected to drift further from the 3% target within the relevant horizon.

Of the 125 financial institutions surveyed by Valor, only three expect a smaller hike of 25 basis points. The rest anticipate that the COPOM will act decisively, raising the Selic rate by 50 basis points to 11.25% per year in response to the significant deterioration in economic conditions. Contributing factors include the Brazilian real’s depreciation to R$5.90 per dollar, worsening inflation data, a persistently heated labor market, and increasingly pessimistic inflation expectations as reported in the Focus Bulletin and the breakeven inflation rate market.

The market sentiment is reflected in asset prices. On the yield curve, the probability of a 50-basis-point hike stands at 74% versus a 26% likelihood of a 75-basis-point hike. In the digital options market, the chances of a 50-basis-point increase were at 86% by Friday’s close, while the probability of a 75-basis-point increase stood at 10%.

Itaú Unibanco’s superintendent of economic research, Fernando Gonçalves, cites notable shifts since September as justification for a quicker pace of tightening, especially the currency devaluation. At its last meeting, the Central Bank modeled scenarios with the FX rate at R$5.60 per dollar, but the updated FX rate for this meeting is closer to R$5.75.

“This brings an important inflationary push. We’re also observing a tightening labor market, inflation expectations above the target, and lingering uncertainty about the U.S. election outcome, which could impact U.S. interest rates. All of this signals a need for higher rates in Brazil,” Mr. Gonçalves explained.

The market’s upward revision of Selic rate expectations began following the release of the COPOM’s third-quarter Inflation Report, which projected inflation above target through 2026 and into early 2027. Many in the market interpreted this as an indication that interest rates must rise even further to achieve the 3% target.

According to XP Asset Management’s chief economist Fernando Genta, to bring inflation back to 3% within the relevant timeframe, the COPOM would likely need to raise the Selic rate to around 15% in the current tightening cycle. Although Mr. Genta’s official projection is for a lower base rate of about 13% by mid-next year, he believes any effective tightening must counter not only the effects of expansionary fiscal policy but also the impact of the recent rate-cutting cycle, which took the Selic from a peak of 13.75% to 10.5% between August 2023 and May this year. “I don’t think 15% is excessive. The challenge is how much disinflation we need to implement in an economy that’s growing beyond its potential,” Mr. Genta, a former assistant secretary in the Economy Ministry, remarked.

Mr. Genta anticipates that the Central Bank will likely pursue a more gradual path toward reaching the inflation target, favoring a moderated tightening cycle that brings the Selic to 13%, with a series of 50-basis-point hikes, beginning with this week’s meeting. “Given the data, I believe the Central Bank could move even faster, but signals from its directors suggest otherwise,” he notes.

Central Bank officials recently attended meetings in Washington during the International Monetary Fund (IMF) and World Bank annual gatherings, where market participants gauged that the threshold for a sharper 75-basis-point hike remains high. This perception has reinforced expectations of a 50-basis-point hike cycle.

Despite these expectations, the yield curve is pricing in an extended tightening cycle. As of Friday, the market projected the Selic rate would reach between 13.75% and 14% in 2025, essentially returning it to levels seen until 2023, when the Central Bank initiated the easing cycle.

Considering current inflation trends and recent currency pressures, Barclays’s chief economist for Brazil, Roberto Secemski, sees “a clear upside risk” to his projected 12% peak for the Selic rate by the cycle’s end.

However, a slight reduction in fiscal stimulus, emerging signs of potential economic slowing, and easing wage pressure from recent employment data have led Barclays to maintain its current outlook of two more 50-basis-point hikes followed by a final 25-basis-point hike in January.

Mr. Secemski is watching closely for the communication strategy the COPOM will use this week, particularly in a climate of heightened volatility from domestic fiscal risks and the upcoming U.S. election. “The COPOM will have to decide whether to leave its guidance open, as it did in September, to preserve credibility or indicate an intention to continue the current pace for the next decision,” he explains.

Mr. Secemski notes that these options carry trade-offs. If the COPOM avoids guidance on its next steps, the yield curve could respond by pricing in a possible acceleration in December. Conversely, if the committee signals a commitment to 50-basis-point hikes in December, this may cap the market’s expectations, which could be seen as restrictive and counterproductive as the Central Bank seeks to bolster credibility.

Mr. Secemski’s baseline scenario is that the COPOM will likely opt for open-ended guidance, “especially given domestic fiscal uncertainty and the approaching U.S. elections.” The Barclays economist believes the Central Bank will likely prioritize flexible communication rather than locking itself into a specific future course.

Luiz Felipe Maciel, chief economist for Brazil at Bahia Asset Management, expects the tone of the Central Bank’s communication to remain “tough.” He anticipates that the COPOM’s inflation projections will indicate further deterioration, even with the elevated interest rates factored into the Focus Bulletin.

Mr. Maciel does not foresee a meaningful reduction in fiscal stimulus in 2025, which he believes will keep the economy heated and inflation under pressure. “Some fiscal stimuli directly benefit those more likely to spend. There’s fiscal injection happening, and states and municipalities are also increasing their expenditures,” he says. He notes that if the government implements significant fiscal adjustments, it could alleviate pressure on the Central Bank, marking “the first concrete signal since the administration began that spending could indeed decrease.”

Given the current economic environment, Mr. Maciel sees the risk tilted toward even higher interest rates than Bahia Asset’s 13% projection. “With unemployment heading toward 6%, everyone will need to revise their inflation forecasts,” he adds.

While he initially disagreed with the Central Bank’s decision to resume tightening in September, André Leite, chief investment officer at TAG Investimentos, now projects that the Selic rate will reach 12.5% by the end of the cycle. According to the Central Bank’s model, this level should bring inflation down to 3.15%, provided rates remain high for an extended period. However, Mr. Leite expects political pressure on the Central Bank to intensify by the second half of next year, with interest rate cuts beginning in September and bringing the Selic to 10% by 2026.

“This 13.5% priced in by the market would likely bring inflation closer to 2% rather than 3% over the relevant horizon. Even with our projection of 12.5%, maintaining that rate for 18 months seems unsustainable given the level of pressure to reduce rates,” says Mr. Leite. “We expect the Central Bank to begin rate cuts by September 2025, continuing down to 10% by 2026. We believe the decision to start cutting will be driven more by political than technical considerations.”

From a communication perspective, Mr. Leite suggests that “the ball is in the fiscal court.” He describes the upcoming meeting as “more about buying time than making a significant shift in monetary policy.”

*By Gabriel Caldeira, Gabriel Roca, Victor Rezende — São Paulo

Source: Valor International

https://valorinternational.globo.com/
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Lower House rejects wealth tax, advances tax reform regulation

Proposal was introduced by the Socialism and Freedom Party (PSOL) in bill establishing Goods and Services Tax committee

10/31/2024

Brazil’s Lower House rejected the creation of a Wealth Tax (IGF) and, with this decision, completed the second phase of tax reform regulation on Wednesday (30). The proposed tax was introduced by the Socialism and Freedom Party (PSOL) within the bill to create the administrative committee for the upcoming Goods and Services Tax (IBS). The text now moves to the Senate.

The committee will be comprised of state and municipal representatives to manage administrative operations, oversight, and the allocation of the IBS, which will replace the Tax on the Circulation of Goods and Services (ICMS) and the Service Tax (ISS) under the new tax system. The bill sets operational guidelines for the committee and outlines the transition to the new framework, including fund distribution among states and municipalities.

The primary debate in the Lower House focused on PSOL’s amendment to create the Wealth Tax, which was rejected by a vote of 262 to 136. The proposal called for a 0.5% annual tax on wealth between R$10 million and R$40 million, 1% on assets between R$40 million and R$80 million, and 1.5% on wealth exceeding R$80 million.

Congressman Ivan Valente (PSOL, São Paulo) argued that the payment would be a “pittance” for multimillionaires and would still include deductions. He noted that the tax is already provided for in the Constitution but has never been regulated.

On the other hand, Congressman Gilson Marques (New Party, Santa Catarina) criticized the tax proposal, arguing that the wealthy would move their money out of Brazil. “Multimillionaires invest in cities, create jobs, and support the economy,” he said.

The initiative only gained support from left-leaning parties: PSOL, Brazilian Socialist Party (PSB), Workers’ Party (PT), Communist Party of Brazil (PCdoB), and Green Party (PV). Meanwhile, the Social Democratic Party (PSD), Brazilian Democratic Movement (MDB), Republicans, and Podemos, from the governing coalition, along with opposition parties Liberal Party (PL) and New Party, voted against taxing millionaires and billionaires. The coalition of the Brazil Union Party, Progressive Party (PP), Brazilian Social Democracy Party (PSDB), Citizenship Party, Democratic Labor Party (PDT), Democratic Republican Party (PRD), and Solidarity allowed members to vote freely due to internal differences.

Despite advocating for taxing the wealthy, the Lula administration remained neutral due to disagreements among coalition parties in Congress. “The government understands that the world is debating this and that it will be a central issue at the G20 discussions next week,” said Congressman Reginaldo Lopes (PT, Minas Gerais), who is also the deputy government leader.

On the other hand, lawmakers upheld a provision for a five-year review of products and services with reduced tax rates to assess the effectiveness of these tax expenditures. The PL had called for the removal of this requirement, but the proposal was rejected by a 292-106 vote.

Other adjustments made on Wednesday were the result of agreements between parties and the bill’s rapporteur, Congressman Mauro Benevides Filho (PDT, Ceará). He introduced four changes to the base text approved by the Lower House in August.

The Lower House rejected a proposal to apply the Inheritance and Gift Tax (ITCMD) to VGBL (Free Benefit Generator Life) pension plans left as an inheritance. This tax was requested by governors, who claim that these instruments are used to bypass inheritance taxes, but it faced resistance from plan operators.

The rapporteur also accepted that companies contracting self-employed business owners for services will not be held liable for unpaid taxes. “If an Uber driver doesn’t pay tax, the platform should pay. But now, no one will be responsible,” Mr. Benevides criticized. However, he included this amendment as part of the agreement to pass the bill.

Additionally, the bill removed the provision to apply the ITCMD tax to the disproportionate distribution of profits among business partners and the ban on companies within the same economic group from transferring the ICMS or future IBS credits to one another.

*By Raphael Di Cunto, Marcelo Ribeiro, Valor — Brasília

Source: Valor International

https://valorinternational.globo.com/
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Banks become shareholders in restructured companies

Strategy is being used in bankruptcy processes involving multiple creditors

10/31/2024

The conversion of debt into equity during company restructurings has firmly established itself as a debt reduction and deleveraging strategy in the Brazilian market. This mechanism has been increasingly employed in major bankruptcy processes, with more creditors, including financial institutions, more comfortable with the idea of becoming shareholders in restructured companies. This approach also enhances the recovery potential of loans previously considered irrecoverable, thereby avoiding more drastic write-offs.

In the case of retailer Americanas, banks became shareholders as part of a debt conversion, a necessary step in efforts to rescue the company, which was embroiled in a fraud scandal. Another example is the logistics company Sequoia. For Brazilian airline Azul, debt conversion is also on the table as a solution to its crisis. This practice is included in Light’s restructuring plan. It is similarly part of the out-of-court recovery plan for 2W.

In Brazil, significant cases of debt conversion first emerged between 2015 and 2016, such as construction firm OAS, in the wake of the anticorruption task force Car Wash. Companies owned by former billionaire Eike Batista also ended up in creditors’ hands, like MPX, now known as Eneva. According to experts, in many instances, conversion was the only viable alternative. In Eneva’s case, the energy sector company managed to recover.

Giuliano Colombo, a restructuring partner at law firm Pinheiro Neto, explains that the trend of converting debt into equity in restructuring processes is on the rise, a shift noticeable after the 2020 amendment to the Bankruptcy Act, which reduced the risks associated with creditors becoming shareholders. “A better legal framework was established, and now the perception is that it’s possible to manage the risk,” he states.

According to Mr. Colombo, before this legislative change, banks historically failed to capture potential operational improvements in companies to which they were creditors. Today, financial institutions feel more at ease participating in conversions, especially in processes involving publicly traded companies, since monetizing shares is easier when they can be sold in the secondary market.

In some negotiations involving conversion, a lock-up period—market jargon for a temporary restriction on selling shares—may be established, although this is not a standard practice.

“Some creditors have the flexibility to receive shares through other vehicles [within the financial institution], such as FIPs [private-equity investment funds],” Mr. Colombo notes. “This perspective shift is here to stay,” he adds.

Mr. Colombo highlights that the effect of conversion is immediate in calculating a company’s value, as debt can be quickly reduced, which also reflects in the value of shares traded on the stock market, since the cost of debt servicing, which was consuming cash flow, is reduced.

The Pinheiro Neto partner also explains that conversion is often a component in restructuring strategies and creditor negotiations, alongside other options like receiving discounted payments or issuing new debt with a longer maturity, allowing creditors to be paid later but without a discount.

Thomas Felsberg, one of Brazil’s leading bankruptcy experts, says that debt conversion is “extremely useful” for adjusting the capital structure of insolvent companies. “Reducing debt can make a company viable. Often, this may even result in a change of control.” Mr. Felsberg notes that conversion is often partial and involves debt considered “unpayable.”

Mr. Felsberg points out that this instrument is quite common in the United States, where notable restructuring successes have involved debt conversion into equity. A well-known example is General Motors, where creditors who converted debt into shares recovered more than those who received cash.

Daniel Lombardi, a partner at G5 Partners, notes that debt-to-equity conversion is not new but is increasingly used in crafting debt solutions for companies undergoing restructuring. He emphasizes that such conversions are complex, especially for commercial banks. Public banks, he reminds, face restrictions on this type of operation.

The G5 executive mentions that there are now funds specializing in special situations, or “special sits,” that lend to companies with mechanisms for equity participation in problem cases and are prepared to take over management—unlike banks. “Commercial banks have less incentive for this solution.”

Mr. Lombardi explains that, within the framework designed to cater to various creditor profiles, debt conversion is one of several options. Other components of a solution can include debt extension and asset sales. These alternatives are pursued when others do not adequately address maturities. “It’s a mosaic of solutions, and debt conversion is one more option,” he says.

Fabiana Balducci, a partner at BR Partners in the restructuring area, notes that a complication in debt-to-equity conversion arises because many fixed-income funds have statutory restrictions against holding shares. Today, she says, many managers are seeking more flexibility to avoid significant write-downs on receivables.

Azul, Light, Sequoia, Americanas, and 2W declined to comment.

*By Fernanda Guimarães — São Paulo

Source: Valor International

https://valorinternational.globo.com/
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