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Small caps face their worst debt repayment capacity in five years

Writer's picture: Seneca Evercore | NotíciasSeneca Evercore | Notícias

(Neofeed) A study by Seneca Evercore reveals that the interest coverage ratio of small caps listed on the stock exchange is at its lowest level since 2019. With expectations of higher interest rates, companies will need to seek solutions.

Patricia Valle

When the basic interest rate dropped to 2% during the Covid-19 pandemic, many companies saw a great opportunity to take out cheaper loans to accelerate growth. However, this situation quickly changed as interest rates returned to double digits, making debt more expensive.


For companies that haven’t recovered their revenue generation, the result is that now, in 2024, these loans are becoming a heavy burden, tightening the financial rope around their necks.


It’s no exaggeration to say that some are close to default. According to a study by the financial advisory boutique Seneca Evercore, shared with NeoFeed, small caps on the Brazilian stock exchange are nearing a point where they cannot generate enough cash to pay off their debts.


To arrive at this conclusion, Seneca Evercore calculated the interest coverage ratio (cash generation capacity, or EBIT, divided by debt interest costs) for companies in the small caps index (SMALL11), which includes companies such as Arezzo, Allos, Usiminas, Fleury, Casas Bahia, and others. The index revealed a score of 1.3. Back in early 2019, this score was 2.7. The closer the score is to 1, the greater the risk of default.


According to Daniel Wainstein, managing partner at Seneca Evercore, this scenario requires companies to pursue more robust financial planning, whether through debt restructuring with rollover issuances or mergers and acquisitions (a trend that’s heating up the market in the coming months).


“This is the time for companies to seek out the capital markets to extend their debt maturities. There’s room for this, given the high demand for private credit and structured products,” says Wainstein.


He adds, “It’s also a good time to consolidate markets. Private equity funds are seeing a great opportunity to enter, while companies with better-managed debt are viewing this as a chance to grow through acquisitions. We’re already seeing strong demand on both fronts.”

The new expectation of higher interest rates for a longer period—driven by inflationary pressures in the United States, delaying interest rate cuts there—makes it even more difficult for these companies to pay off their debts in the coming months.

This situation stems from an overly optimistic mindset among business leaders during the low-interest period, who took out loans assuming rates wouldn’t rise much or that productivity would quickly improve. Neither scenario came to pass.


Small and medium-sized businesses face an even more delicate situation than large corporations because they have less access to the capital markets. They rely more heavily on bank financing, which remained expensive even when the Selic rate was in single digits.

According to research by the financial advisory firm, the average long-term working capital interest rates for legal entities offered by the four largest lending banks in Brazil is 24.85% per year—a credit spread of 12.73%, the highest since June 2022, when it stood at 14.05%. When the Selic rate was at 2%, this average was 17.68%.


The high levels of credit spreads practiced in Brazil show that banks have become accustomed to this level of profitability and struggle to be more competitive.

“The Selic rate may go up or down, but banks charge roughly the same spreads. They can’t operate profitably with spreads below 11% to 13% due to the robust structures they’ve grown used to,” says Wainstein.


Until recently, this wasn’t an issue because there was little competition in the market. Now, the reality is different. According to Seneca Evercore’s analysis of Central Bank data, while bank financing accounted for 70.6% of corporate credit in December 2018, it dropped to 54.2% in February 2024. Meanwhile, the capital markets, through debt issuance and securitization instruments, captured 45.8% of the corporate credit market.


“The capital markets have changed significantly in recent years, with tax-exempt securities, the growth of credit funds, and wealth management. Companies are realizing that it’s better to have a diversified funding base than to depend on three banks. This has made the market more competitive, but it’s still primarily large companies that have better access to this funding,” concludes Wainstein.


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