(Bloomberg) -- Two of Brazil’s largest money managers fueled the rebound in bonds of Banco do Estado do Rio Grande do Sul SA in the past month, confident it would withstand the impact of historic floods in the south of the country. They won’t know the accuracy of that bet for months though.

JGP Asset Management and Ibiuna Investimentos snapped up the bonds in the state bank, known as Banrisul, after they tumbled in the aftermath of floods that devastated the Rio Grande do Sul state. The market, they said, had overreacted to the natural disaster.

It’s a risky bet. Torrential rains submerged about four-fifths of the state, which is home to 11 million people and accounts for around 53% of Banrisul’s risk exposure. The flooding damaged roads, infrastructure, energy distribution and logistics, according to Fitch Ratings, which placed Banrisul on negative watch. But JGP and Ibiuna remain confident in its financial stability. 

“Banrisul is one of the few Latin American credits that offer good risk-adjusted returns,” Eduardo Alhadeff, managing partner at Ibiuna, said in an interview. The lender has a “robust” balance sheet that should be able to absorb the expected increase in bad loans, he said. 

The bond prices have largely recovered from the collapse that followed the floods. Dollar notes due in 2031 last changed hands at 94 cents on the dollar, near pre-catastrophe levels.

A spokesman for the bank declined to comment for this story.

Buying Back

Prior to the catastrophe, Ibiuna held Banrisul’s local tier 2 subordinated financial notes, according to Alhadeff. The firm then sold that debt after the floods, before building a new position in the company’s dollar bonds. 

JGP also had a “small exposure” to Banrisul’s financial notes prior to the events. It held those bonds and went on to buy dollar notes when prices dropped, according to Alexandre Muller, a credit portfolio manager at JGP. 

“It’s been hard to find pockets of value” in Latin America, said Muller, adding that he only built new positions in Banrisul and Peruvian zinc miner Volcan in offshore bonds this year. “It’s these kinds of dislocations that we try to arbitrage.”

The floods in Rio Grande do Sul — one of Brazil’s richest states — caused massive disruption to industries from banking to auto manufacturing, insurance and the powerhouse agricultural sector. 

Banrisul’s vulnerability in the region outweighs any other lender, with its risk exposure of about 53% compared with 12% and 7.2% for its peers Banco do Brasil SA and Itau Unibanco Holding SA, respectively, according to Banco Bradesco BBI SA. 

Helping Hand

Banrisul’s loan portfolio totaled 53.9 billion reais as of March, according to company filings.

The bank in May announced a series of relief measures to help companies and individuals hit by the flooding. That included a credit line of 7 billion reais ($1.3 billion) to help companies with their working capital needs. For individual banking clients in certain municipalities, the bank is offering to renegotiate debt obligations, as well as a three-month grace period, according to a press release.

The federal government has also provided a 15 billion reais emergency credit line through the national development bank BNDES to aid businesses in the state.

Jean Lopes, an analyst at Fitch Ratings, said that Fitch had placed the credit’s outlook on negative watch because there is limited visibility on the longer-term impact of the catastrophe. 

“Waivers and emergency credit lines for business owners are important, but with the waivers that the banks are giving, we will only be able to see the full impact in three or four months,” he said.

In that vein, Alhadeff said that Ibiuna conducted several stress tests on Banrisul prior to buying the bonds. The firm subjected the bank to a hypothetical shock that was three-times as large as the hit during the Covid-19 pandemic. Even in that scenario, the bank’s balance sheet was able to provision for defaults, he said.

“We can’t exactly predict how much default there will be, but there is a very remote chance that it will be greater than what we calculated in our worst-case scenario,” Alhadeff said. “Yes, defaults should increase, but there is room to absorb that.”

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