Corporate Bond Downgrades Could Pressure Brazil

August 14th at 8:30am by Tom Lydon

One day does not make a trend, but Tuesday’s price action in BRIC ETFs may prove to be a bad sign for Brazil bulls. On a day when U.S. stocks closed modestly higher, the iShares MSCI Brazil Capped ETF (NYSEArca: EWZ) lost 0.63%. Of the other three major single-country BRIC ETFs, the WisdomTree India Earnings ETF (NYSEArca: EPI) was the worst performer with a gain of almost 0.8%.

EWZ’s Tuesday’s disappointed comes a day after the largest Brazil ETF flirted with $46 only to see a sharp intraday reversal that sapped the fund’s Monday upside, leaving the ETF with a modest gain. Two days of disappointment from EWZ come just as signs of hope were emerging from various BRIC ETFs, prompting some investors to think funds tracking Latin America’s largest economy were finally poised to turn a positive corner. [BRIC ETF on the Cusp of Breaking Out]

Over-leveraged corporate balance sheets are seen as a problem for some Brazilian companies, including some EWZ holdings, and that problem could be exacerbated if ratings agencies downgrade Brazilian corporates. That would lead to increased borrowing costs, punishing borrowers that issue corporate bonds in U.S. dollars at time of substantial weakness for the Brazilian real. [BRIC, Emerging Markets ETFs Need Brazil Back in the Game]

Moody’s Investors Service, Standard & Poor’s or Fitch Ratings have negative outlooks on 26 Brazilian corporate borrowers with about $104 billion in dollar-denominated debt, report Boris Korby and Julia Leite for Bloomberg. That is triple the amount of negative outlooks on Mexican corporate bonds, according to Bloomberg.

Brazil’s corporate leveraged reached its highest level in five years last year. Petrobras (NYSE: PBR), Brazil’s state-controlled oil giant, and airline Gol Linhas were mentioned in the Bloomberg piece. Two Petrobras securities combine for over 11% of EWZ’s weight, but Gol is not found in the ETF.

EWZ is not the only ETF that would be vulnerable to downgrades of Brazilian corporate bonds. The WisdomTree Emerging Markets Corporate Bond Fund (NasdaqGS: EMCB) allocates nearly a quarter of its weight to Brazilian bonds. While 62% of EMCB’s issues are rated BBB or higher, the remainder are rated BB or lower. Four Brazilian issues, including bonds from Petrobras and Vale (NSYE: VALE), are found among EMCB’s top-10 holdings.

EMCB has a 30-day SEC yield of 4.9%, 145 basis points higher than what is found on the iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEArca: LQD).

WisdomTree Emerging Markets Corporate Bond Fund

ETF Trends editorial team contributed to this post. Tom Lydon’s clients own shares of LQD.

 

 

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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