Why won’t Petrobras be able to renegotiate its colossal debt?

Bruno Meyerhof Salama

Professor, FGV Direito SP

Petrobras most likely won’t be able renegotiate its massive debt with banks. And much of the problem can be attributed to a fact that tends to go unnoticed: in Brazil there is no bankruptcy regime applicable to state-owned companies.

Petrobras’ US $127.5 billion debt as of September 2015 is virtually unpayable. It is one of the largest corporate debts anywhere in the world. Banks hold approximately half of it and the other half is with bondholders. Considering the cash that Petrobras had on hand at that time, and its EBITDA (a proxy for a company’s operating profitability in the previous 12 months), the company would need about four years to pay off its debt if it were able to direct all its cash into creditor’s pockets.

This may not seem like a complete disaster. But this EBITDA is being partly generated by subsidies from the Brazilian taxpayer (gas is currently overpriced in Brazil so as to boost Petrobras profitability). Moreover, Petrobras still has huge commitments to its pre-salt endeavor, as the investment bill is still US $20 billion in 2016 alone, even after several cuts. Furthermore, the official figures do not take into consideration Petrobras’ operational leases that could practically double the size of the debt – a fact that currently everyone prefers to ignore, including rating agencies. Unsurprisingly, Petrobras is now trying to sell everything it possibly can.

So, what is a bank to do when faced with a large borrower in this situation? Let’s forget for a moment that we are dealing with Petrobras and consider a more general case. If a debtor is experiencing such difficulty, there are basically three options for the creditor bank. The first option is to initiate collection proceedings. Here, the practical outcome is to force the debtor into bankruptcy. Financing contracts of large companies often contain cross-default clauses. Late payment of one contract leads to accelerated maturity of the others. The bank thus collects debts through bankruptcy and is paid in part. The balance has to be written off.

Writeoffs reduce profitability and signal weakness, and both are dangerous in times of economic downturns. Therefore, instead of collecting the debt, the second option is to roll it over, that is, to exchange the old for fresh debt. Rolling over gives time for the borrower to get its financial house in order (by reducing current expenditures, selling assets, renegotiating with customers and waiting for resumption of market prices). And rolling over debt can also be good for the creditor bank, which maintains a chance of fully recovering its credit.

A third option is to renegotiate the debt by reducing principal, interest, or lengthening the lending periods. For the lender, this strategy makes sense when the expected value of the renegotiated amount is greater than the expected value of credits in the course of bankruptcy proceedings.

So then: will Petrobras be able to rollover or renegotiate its massive debt with its current creditors? Most likely the answer is no. Normally creditors fear pushing debtors into insolvency, for fear of incurring losses in the course of bankruptcy. Not with Petrobras. Here’s why.

Under Brazilian Bankruptcy Law, a state-owned company (such as Petrobras) cannot file for bankruptcy. True, there are some subtleties at play here. Under article 173 of the Brazilian Constitution, state-owned companies are said to be subject to the same legal framework as private companies with respect to civil, commercial, labor and tax rights and obligations. In light of that, some argue, the Bankruptcy Law should also apply to state-owned companies, even if the law itself expressly says otherwise. But since this argument has never been tested in court, counting on it is a plunge into an uncertainty even deeper than the pre-salt itself…

Recently, Petrobras was saved by the bell – or, rather, by the support from the China Development Bank, which loaned US $10 billion as part of a deal that secured future supplies. It helped Petrobras’ buy time, but more money from China will be necessary if oil prices fail to recover quickly.

And what if Chinese money doesn’t arrive? In that case, when the creditor banks come to beat down Petrobras’ door, there won’t be much of an alternative for the Brazilian Treasury government, other than capitalizing and rescuing the company. Defaulting would generate a sequence of dangerous effects; and privatization remains anathema to the federal government. Knowing this, there is no reason for creditors to rollover or to renegotiate anything yet. If Brazil had adequate legislation, perhaps the result would be different.