Downgrade of Brazil Oil Giant Stirs Wider Concern
Moody’s move to lower Petrobras’s debt to junk status sparks worries for broader economy
WALL STREET JOURNAL
WILL CONNORS and
Updated Feb. 25, 2015 9:35 p.m. ET
SÃO PAULO—A decision by a major credit-rating firm to downgrade to junk status the debt of Petróleo Brasileiro SA is stoking fears that Brazil’s sovereign rating could be next.
Moody’s Investors Service late Tuesday slashed the debt of the company, known as Petrobras, two notches to Ba2, two steps below investment grade, on continued concern about the fallout from a corruption scandal and the state-run oil giant’s ability to pay down about $135 billion in debt.
The downgrade was the third by Moody’s since October. Still, the size and timing of Tuesday’s cut surprised some analysts and sent the country’s leaders into a defensive crouch. Brazil’s largest company, Petrobras plays an outsize role in the nation’s economy, which is flirting with recession.
Petrobras’s newfound junk status is “an unequivocal blow” to the administration of President Dilma Rousseff , Eurasia Group analysts wrote in a note on Wednesday, and “there is growing concern over a negative spillover effect in macroeconomic management and potentially in Brazil’s sovereign rating.”
Ms. Rousseff said administration officials had failed to persuade Moody’s not to downgrade the debt of Petrobras, which is under investigation for an alleged bribery and money-laundering scheme. “The government will always try to avoid a downgrade, it is absolutely natural,” Ms. Rousseff said. She said Moody’s action reflects “a lack of correct knowledge of what is going on at Petrobras.”
The rating cut is the latest reversal for Petrobras, whose stock and traded debt were already in a free fall. The company’s shares, which tumbled 5.5% on Wednesday, have shed more than 64% of their value since September.
The company is a major economic engine in Brazil: It is responsible for more than 10% of the country’s investments. The company’s 2013 revenue was 304.89 billion reais, roughly $106.3 billion. It directly employs more than 86,000 people, and indirectly thousands more. The company’s woes have created paralysis in the construction sector, which depends upon it heavily.
Moody’s action could trigger similar downgrades by other rating firms. It is certain to raise borrowing costs for Petrobras because many large fund managers are permitted to put clients’ money only into investment-grade securities.
The cost to buy insurance against a Petrobras default has more than doubled since September, to around six percentage points from 2½, said Pablo Spyer, an analyst at São Paulo-based Mirae Asset Securities. He added that the costs of credit-default swaps are also rising for Brazil’s sovereign debt and other Brazilian corporations because of Petrobras.
Petrobras said Wednesday it doesn’t have any legal obligation to its debtors following a rating downgrade or to losing its investment-grade status. The company, which hasn’t yet released its audited third-quarter earnings, said, however, that it is “working to guarantee the transparent and accurate disclosure of its 2014 financial results as soon as possible,” and that it is “implementing a series of measures aimed at preserving its cash position and reducing its leverage.”
The junk rating is also a setback for Ms. Rousseff, whose economic team has been trying to convince investors that fresh management recently installed at Petrobras can right the ship, and that her government’s new austerity measures can revive Brazil’s sinking fortunes.
Some economists have assumed that the government would guarantee Petrobras debt or otherwise bail out the company if needed. A minister close to Ms. Rousseff denied on Wednesday that there is any plan to do so at this point.
Still, the deepening woes at Petrobras have investors on edge about the state of Brazil’s economy, which some analysts predict may contract both in 2014 and 2015, in what would be the first back-to-back decline in gross domestic product since the Great Depression.
“In a context where the economy isn’t doing well” and the government is trying to spend less, the downgrade “is unfortunate,” said Benito Berber, the senior Latin America strategist at Nomura Securities in New York. “If the government decides to lend a hand, it would be a clear linkage to the sovereign risk.”
Petrobras is reeling from a vast corruption investigation, known as Operation Car Wash. Federal prosecutors allege that executives from Petrobras and some of the nation’s largest construction firms conspired to inflate the price of Petrobras contracts, kicking back a portion of the ill-gotten gains to politicians.
Two Petrobras executives are among nearly 40 people charged with crimes including money laundering and fraud. In the coming days, charges are expected to be filed against Brazilian politicians that allegedly took bribes.
Petrobras has said it was a victim of the scheme, recently set up an internal compliance division to prevent future wrongdoing, and said it is cooperating with investigators. This month, the company replaced most of its executive suite. The company’s new chief executive, Aldemir Bendine, is the former head of Banco do Brasil, the country’s biggest lender.
Petrobras hasn’t released audited third quarter earnings that were originally due in November. The company’s auditor refused to sign off on those earnings until Petrobras determines the value of the inflated contracts tied to the corruption probe and writes off those bad contracts.
Petrobras says it will report the audited earnings by the end of May, a month after an April 30 deadline. If it misses that deadline, the company could be responsible for paying around $70 billion to debtholders, said Bruno Rovai, an economist at Barclay’s.
As the problems pile up for Petrobras, they also add to the trouble for Brazil’s economy.
The Brazilian treasury may have to come up with the money to help Petrobras pay its debts, Mr. Rovai said, in which case Brazil’s gross debt as a percentage of GDP, today at an already-high 63.4%, would grow by five percentage points, likely triggering a sovereign-debt downgrade.
Higher borrowing costs for the company are also likely to impair Petrobras’s investment plans, further weakening the economy. Petrobras has said it would cut its $220 billion investment plan by $16 billion. Several international drilling companies have recently said Petrobras may end their drilling contracts in Brazil.
In Brasília on Wednesday, several members of Ms. Rousseff’s Workers’ Party sought to defend Petrobras and play down the Moody’s decision.
Sen. Edison Lobão, the former minister of mines and energy, said Moody’s downgrade was inaccurate. “I think Petrobras has not hit rock bottom and will not,” Mr. Lobão said. “[The company] has all the conditions to recover quickly. This decision was hasty.”