Probability of default falls to pre-pandemic levels in Brazil and Mexico

Despite the second wave of COVID-19 in Latin America's two largest economies, probabilities of default for Brazilian and Mexican firms have dropped to pre-pandemic levels, a sign that the arrival of vaccines and better preparedness have alleviated bankruptcy fears across sectors in the two countries.

Brazil and Mexico have dealt very differently with the pandemic. While the government led by President Jair Bolsonaro provided a more robust stimulus response, Mexico was less willing to further deteriorate its fiscal accounts to aid businesses and individuals. Both countries refrained from implementing strict lockdowns when compared to regional peers.

According to S&P Global Market Intelligence's median one-year market signal, the probability of default, or PD, for Brazilian companies in the consumer discretionary sector stands at 3.97%. All other surveyed sectors show probabilities of less than 2%, with financial companies clocking in at 0.9%. The scores represent the odds that a company will default on its debt within the next year based on fluctuations in the company's share price and other country- and industry-related risks.

Although Mexico's PD levels across sectors remain higher by comparison, those have also dropped to levels seen before March 2020.

With both countries averaging more than 1,000 coronavirus-related deaths per day, however, the risk of seeing new spikes in PDs across worst-hit sectors has certainly not passed, analysts say.

Economic growth prospects remain tenuous, especially for Mexico where GDP contracted by 8.5% in 2020, according to official figures. That fall was considerably steeper than the 4.7% drop expected for Brazil, according to a recent S&P Global Ratings report. For 2021, Brazil's economy is expected to grow 3.2%, recovering a higher proportion of lost ground compared to Mexico, whose rebound has been projected by S&P Global Ratings at 3.9%.

At the expense of a soaring fiscal deficit, Brazil was able to prop up output by spending close to 10% of GDP on stimulus packages and aid. Mexican authorities, meanwhile, proved much more austere, spending only 1.1% of GDP.

But despite their respective macroeconomic downturns, these have not translated into widespread bankruptcies or defaults for publicly traded companies in either country. Only four defaults were reported by S&P Global Ratings in Mexico during 2020, and just three in Brazil, as companies faced little or no difficulty in renegotiating bank loans or restructuring debt.

"The economic decline in 2020 was brutal, but there were [government] support measures and refinancing was abundant, which allowed the default rate to remain much lower than we expected," Diego Ocampo, Senior Director & Sector Lead for Latin America at S&P Global Ratings, said, adding that "several sectors even reduced their debt levels."

"Banco Central do Brasil and the federal government implemented financing mechanisms to grant loans to companies at very attractive and subsidized rates, which allowed for credit to expand substantially, and non-performing loan rates remained at historically low levels," said Carlos Macedo, an analyst at Ohmresearch, an investment research firm.

These measures allowed the outstanding balance of credit in Brazil to expand by 15.5% in 2020.

And, for Ocampo, neither country's default rate should pick up significantly this year, as companies are expected to start seeing the benefits of vaccine distribution. It is also unlikely that local and federal governments will enforce severe lockdowns that might cripple economic recovery, implying that revenue streams will face fewer obstacles, he added.

While Brazil's national government has been slower than others in the region to implement vaccination campaigns, the rollout of vaccines offers "some light at the end of the tunnel for hard-hit companies," said Nikhil Sanghani, Latin America economist at Capital Economics.

As containment measures are eased, both economies will pick up over the second half of the year, Sanghani said, also noting that vaccine distribution and the relaxation of restrictions may come even quicker in Mexico, as the country is aiming to reach all priority workers and those over the age of 40 by the end of the second quarter.

Most vulnerable sectors still face risks

While PDs have subsided in line with expectations of improved operating conditions, the sectors of the Brazilian and Mexican economies that fared worst during last year's economic outage still face major risks.

"If there are more and very pronounced waves, vaccination does not go according to plan and recovery is milder, sectors that are coming from a year without cash generation, value destruction and restructurings could see a spike in defaults," Ratings' Ocampo said, pointing specifically to airlines, transportation infrastructure, gaming and entertainment, hotels, retail restaurants, oil & gas, and commercial and office real estate.

If harsher lockdowns were to be required, Brazil has effectively exhausted its fiscal capacity to provide stimulus to such companies, while the Mexican government would likely uphold its austerity, Capital Economics' Sanghani said.

"As a result, a wave of corporate default is still possible over the coming months," he concluded.