Fitch Ratings-Sao Paulo-09 January 2015: More Brazilian construction companies are expected to default in the coming months and numerous downgrades will likely occur, according to Fitch Ratings. Accessing credit lines, receiving payments for completed projects and recognizing claims related to contract amendments has become increasingly more difficult. The decision by OAS S.A. to default on two separate debt obligations during the past week despite having an estimated BRL1 billion of cash on hand has set a bad precedent for Brazilian engineering and construction corporates (E&C) that will heighten contagion risk.
All Brazilian constructions companies were placed on Rating Watch Negative during November 2014.
Key areas of concern listed in that rating action, along with the status of those items, are listed below.
--The financial impact upon the companies of a more challenging operating environment due to the high concentration of the backlog of several companies with the government:
Risk is high that several corporates will default in an effort to preserve liquidity during this period of high uncertainty about the future prospects of the sector. Accessing financing has proven extremely difficult and receiving payments from Petrobras and other clients is challenging. With several key managers and executives incarcerated, getting financing will be difficult for many companies.
--The inability of certain companies in the sector to participate in future projects with government entities:
Petrobras has temporarily banned 23 business groups involved in the Lava-Jato investigation from taking part in bids with it, or being contracted by it. Out of this list, Fitch rates the construction units of the following groups: Andrade Gutierrez; Camargo Correa; Galvao Engenharia; Mendes Junior; OAS; Odebrecht, and Queiroz Galvao. The other companies included on the list were: Alusa; Carioca Engenharia; Construcap; Egesa; Engevix; Fidens; GDK; IESA; Jaragua Equipamentos; MPE; Promon; Setal; Skanska; TECHINT; Tome Engenharia; and UTC.
--Potential suspensions, delays, or partial writedowns of existing receivables and claims with Petrobras:
Petrobras has suspended the payment of multiple claims with several corporates, which has squeezed their working capita positions. These claims relate to payments for contract amendments. Fitch believes the environment to pay claims will continue to be bad for several months, as employees will remain reticent to sign contract amendments, or payment upon work completed through amendments, as they do not want to become embroiled in the scandal. Seeking recourse through arbitrage channels is time consuming.
--Potential restructuring, suspension, or delays under existing contracts between Petrobras and certain corporates in the sectors:
Petrobras has cancelled the UFN III fertilizer plant project. The consortium for this project was composed of Galvao Engenharia and Sinopec. Although this project has no direct link to the Lava-Jato investigation, the decision to cancel this project indicates the degree to which the relationship between Petrobras and its contractors has deteriorated.
--Increased scrutiny of any existing or future contracts with Petrobras or any other government entity:
Construction companies are reporting difficulty receiving payment from other public entities or institutions, as well as private companies. The motivations vary. Employees in public entities or agencies may have a fear of being contaminated with the scandal. Others may be using the cover of the scandal to delay or avoid payments with construction companies, in an effort to strengthen the financial profile of the public entity or institution.
--A reduction in access to funding from private banks, capital markets, and government related entities such as BNDES:
Capital market access has ground to a halt for Brazilian construction companies and Petrobras. The degree of corruption related to these companies has also heightened concern about market access for other Brazilian companies, particularly family owned corporates rated in the 'B' category. In talks with banks and corporates, Fitch has identified a more restricted stance toward lending to contractors. Some committed lines have been withdrawn.
--A slowdown in the pace of private concession agreements, since corporates in this sector often act as investors, operators and/or contractors:
No private concession agreements have been completed since the end of November.
--Probable financial penalties:
Fines and penalties have yet to be determined but are highly likely and are predicted to be sizeable.