Hedge funds target distressed Brazilian corporate debt

Hedge funds including value investor Seth Klarman and managers at Man Group have increased purchases of distressed Brazilian corporate debt after a bond-market sell-off pushed local borrowing costs to levels not seen in about 20 years. Funds are buying discounted bonds and providing financing to issuers undergoing liability-management talks or formal restructurings.

Rising interest rates in Brazil have increased refinancing costs for many companies. Firms with large short-term or foreign-currency obligations have faced higher interest burdens, leading to a rise in defaults, liability-management exercises and negotiated restructurings. Liability-management exercises involve offers to alter maturities or coupons to reduce the risk of formal default.

Credit-focused hedge funds are acquiring priced-down bonds and arranging rescue financing where issuers need cash. Financing can include debtor-in-possession style loans, debt-for-equity swaps and maturity extensions. Some funds are focusing on middle-market corporate debt that receives less attention from large institutional buyers and can trade at deeper discounts.

The current flow of distressed assets follows several years in which abundant liquidity and steady growth limited such opportunities in developed markets. The recent market dislocation has created a larger pool of stressed securities in Brazil’s corporate-credit market, attracting international funds seeking concentrated credit positions.

Bank lending conditions and the level of sovereign and policy rates affect how deeply stress spreads. Higher domestic policy rates raise companies’ interest costs and make external refinancing more expensive. Sectors with heavy leverage and narrow margins appear most exposed to the current pressure on balance sheets.

Trading volumes in stressed corporate bonds and the number of liability-management and restructuring deals have increased in recent months. How far the distress goes will depend on issuers’ ability to refinance at acceptable costs and the pace of any change in domestic interest rates.