Distressed Funds Buy Brazil Real Estate Loans as Defaults Soar

(Bloomberg) -- Surging construction costs are sending delinquency rates skyrocketing among Brazilian developers, persuading a growing number of lenders to dump their loans and creating a feast for distressed-asset funds.

“I’m dealing with explosive demand from banks trying desperately to sell loans they made to construction firms,” said Eduardo Martins, a partner at MGC Holding, one of Latin America’s biggest distressed-asset managers. MGC, which oversees a face value of 23 billion reais ($4.21 billion) in consumer loans, has hired three executives since August to start a unit to analyze corporate real estate credit. 

The delinquency rate for builders reached as high as 20% in May for loans carrying market rates, meaning borrowers weren’t paying on time on 3.4 billion reais in loans, according to the central bank. The rate fell to 4%, or about 141 million reais in defaults in September, a reduction the central bank said could be explained by different forms of debt renegotiation.

That’s in a year with record real estate lending: New loans for builders and individuals reached an all-time high of 194.9 billion reais in the 12 months through August, more than doubling from the previous 12 months, according to Abecip, the association for real estate financing. 

A project from Manhattan Construtora, a midsize construction company in northeast Brazil, is a cautionary tale. The firm used financing to buy land and build 400 apartments in the state of Ceara, but faced a 35% increase in construction costs over the past two years. That made it difficult to finish the work, Martins said. Roughly a third of the customers who had made installment payments started asking for their money back, he said. They cited construction delays, prices hikes and rising interest rates in Brazil, which are starting to make mortgages more expensive. Some of them sued, according to Martins.

MGC stepped in and purchased the 130 million-real project loan for about 85 million reais, he said. The Sao Paulo-based company restructured the debt and issued bonds linked to real estate financing, so called CRIs. That injected new money into the project, and resolved the legal issues.  

MGC has purchased loans for two other projects and sold a total of 250 million reais in real estate credit-linked bonds this year, Martins said. It’s analyzing 17 others in Sao Paulo, Bahia, Ceara, Santa Catarina and Paraiba, according to Martins, who said he expects the number to double next year as interest rates keep rising and as sales start to slow.  

Brazil’s benchmark Selic rate stood at a record low 2% at the start of this year. It’s since climbed to 7.75%, and economists project it will continue to go as high as 11% by the end of 2022, according to a central bank survey.  

Diego Fonseca, a partner at Jive Investments, said his company is hearing from banks trying to sell loans for projects mostly from midsize, regional companies that cater to Brazil’s middle-class homebuyers. He is also receiving proposals to buy credit to hotels and shopping centers.

“Those firms bought a lot of land expecting interest rates would remain low for longer, and now they’re having a hard time finishing their projects,” Fonseca said. “The bigger builders can hold off on new launches to save cash to survive, but even some publicly traded ones are facing challenges.”

Jive’s own home sales sank 35% in September from a month earlier, he said, and the expectation for next year is to sell far fewer than the record 800 to be sold this year. Jive now holds a portfolio of 2,500 properties in 67 Brazilian cities that were seized as collateral in loans previously bought. It sells them through brokerage firms that are clients of the platform inGaia, in which Jive has a stake.  

Rising costs, fewer sales and increasing interest rates are compressing firms’ profit margins, and the real estate sector is the worst performer on Brazil’s stock exchange this year, with a negative return of 20%, according to data compiled by Bloomberg. 

Tecnisa SA’s 55% negative return is the worst in the bunch. But even bigger firms are suffering with lower returns and falling sales. EZ Tec Empreendimentos e Participacoes posted a 49% negative return so far this year and had 266 million reais in net sales in the third quarter, a decline of 20% from a year earlier and 7% lower than the second-quarter, according to its earnings statements.

Rossi Residencial SA is among firms with loans that have been up for sale in the secondary market, according to people familiar with the matter. Rossi didn’t reply to emails seeking comment.

Buying distressed debt and solving a project’s issues can be complicated, but returns can make it worthwhile, especially now that some market players learned during the 2015 crisis how to buy at better prices, said Rafael Fritsch, chief investment officer for distressed-asset funds at Canvas Capital.

Real estate credit-linked bonds structured by MGC return inflation plus 9% to 12% -- as high as 22% now -- with a maturity of 36 to 48 months. Jive’s investment in Viver Incorporadora e Construtora SA yielded 40% on average annually since it acquired in 2018 eight of the firm’s projects with about 2,000 legal claims against the builder, according to Guilherme Ferreira, a partner at Jive. 

Ferreira expects an increasing number of loans to be offered for sale in 2022, because “people and companies in Brazil have never been so leveraged.” Banks had a record 817 billion reais in real estate credit to individuals and firms in their books in September, the central bank said. 

“What is an opportunity for us is a potential risk for the nation’s economy and also for job creation,” Ferreira said.

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