Banco do Brasil rattles cosy credit markets

On August 13, state-owned Banco do Brasil made an announcement that shook the Brazilian banking industry. The bank was once again the country’s largest in assets and lending, dethroning newly merged Itaú-Unibanco. The gloves are off in the fight for market share in Brazil’s profitable, fast-growing credit markets.

The announcement of Banco do Brasil’s asset gathering and credit performance came as a surprise to investors. In a recession, deposit-taking and lending were up hugely, and far ahead of competitors.

The state-owned bank announced total assets reached a whisker under 600bn reais ($331bn) at the end of the second quarter, up nearly 44% from a year earlier. The credit picture was similar, with a total of 252bn reais, up just under one-third from the second quarter of 2008.

Itaú-Unibanco’s growth numbers looked wan in comparison. Its assets were worth just over 596bn reais, up 15% year on year, and its credit portfolio were at 266bn reais, also a relatively cautious-sounding 15% up from the second quarter of 2008.

The switch in leadership positions and the perception that the public bank was lowballing sparked a nasty and rare political spat. The normally sanguine Roberto Setúbal, CEO of Itaú-Unibanco, acknowledged rates charged by public banks had been falling faster than at private firms, but he insisted that the reduction in spreads at public banks was not sustainable. “It is not possible to maintain the growth in [credit] portfolios in a sustainable way,” he said.

That led to a furious rebuff from finance minister Guido Mantega. “It is good that [private banks] wake up or they will lose more market share,” he said, before directly attacking Mr Setúbal. “The president of Itaú got it wrong. He was not expecting the results at Banco do Brasil, he spoke out and made a mistake, a serious error,” he said concluding that: “If [private banks] don’t follow Banco do Brasil’s example, they will eat the dust of public banks.”

New-look Banco do Brasil

The growth spurt at Banco do Brasil comes on the back of big changes. The bank always had the scale and national presence to compete, with more branches than any other, but was seen as bureaucratic and uninterested in competing on price in credit. Two substantial changes have transformed the bank’s attitude.

The first is secular and long under way. The bank has pushed increases in efficiency and automation. “We have processes that are much more vigorous than our competition,” says president Aldemir Bendine. “Our performance in losses and recuperation is stronger than competitors. We have automated much of the process of granting credit. We are the leader not only thanks to our presence but because we are much more agile,” he adds.

The second shift has been management changes that align the bank tightly to the government’s pro-credit policies. In April, after sustained government criticism of the bank’s excessively cautious record on lending during the downturn, previous bank president Antonio Francisco de Lima Neto announced he was quitting. Mr Bendine, a career banker and former vice-president for new retail business, was the anointed successor. The latter quickly set about increasing credit in the teeth of the recession.

Banco do Brasil was able to extend credit as it benefited in the crisis as a safe haven for depositors, providing it with cheaper costs of funding. “Our deposit raising grew in the most difficult moment of the crisis, showing the strength of confidence in the bank,” says Mr Bendine. “In times of crisis, we find that Banco do Brasil is perceived as attractive,” he notes.

The state-owned bank was a large beneficiary of deposits in reais and even saw dollar inflows, reflecting the depth of mistrust of some foreign banks, adds Celina Vansetti-Hutchins, senior analyst at Moody’s. The Brazilian bank also continues to benefit from state-mandated accounts such as escrow judicial accounts, which account for some 25% of deposits.

That all adds up to substantial differences: in 2008, the cost of funding for the Banco do Brasil was some 90% of the inter-bank lending rate (CDI) whereas Itaú-Unibanco and Bradesco was some 104% to 105% of the same rate, estimates Ms Vansetti-Hutchins.

Banco do Brasil used its firepower to extend credit and push down spreads, despite economic uncertainties. The bank’s lending rose 69% to 68.5bn reais in the second quarter year on year. Not only that, but average spreads fell from 7.1% to 6.9% between the first half of 2008 and 2009, according to the bank’s numbers. Indeed, the average annual interest rate Brazilian banks charged in August was the lowest since December 2007. That is partly a reflection of lower benchmark rates, which have fallen from 13.75% at the start of the year to 8.75% today.

Battle lines are drawn

The big question mark now lies on how private-sector banks can compete. That will depend on their ability to raise funds in capital markets and whether a normalisation of the economy will see a reversal in the trend to move deposits to the safety of a public bank.

Capital markets are already thawing fast, with the Bovespa index up more than 50% from its low point. Santander’s Brazilian operation is already preparing an initial public offering (IPO) that could be worth some $5.6bn to expand in Brazil, which it sees as one of the most attractive in the world. The corporate bond market is reopening for larger names, with steelmaker CSN reported to be planning a $750m issue in early September.

If the cost of funding gap between public and private banks narrows, there will be yet more pressure on spreads as the emphasis turns to market share. Mr Bendine recognises that competition will be tougher in the next 12 months, but sees Banco do Brasil staying on top. “Not only will we maintain our leadership in credit, we will increase it. As the competition starts to raise funds in international capital markets, this will also be part of our programme,” he says.

The aim is to increase the free float of the bank to 25% on the Bovespa market by June 2011 as well as issue American depositary receipts, for which there is not yet a date as it needs approval from the board of directors, says chief financial officer Ivan Monteiro.

Moreover, Banco do Brasil will be able to put further water between itself and the competition thanks to two key acquisitions, says Mr Bendine. First, the bank is taking a 49.9% management share in Banco Votorantim. That was not incorporated in second-quarter numbers since the deal is awaiting approval from the central bank, expected imminently. Second, the bank has acquired Nossa Caixa, a state bank of São Paulo, which has 17bn reais in assets, he notes.

Mr Monteiro does not think that the breakneck expansion in credit as well as the absorption of two banks at the same time will put strains on the new management. “We have always worked well with absorbing banks, such as the Banco do Estado de Santa Catarina,” he notes. The state bank of the southern state was acquired in September 2008.

The Votorantim acquisition will bring further strength in auto loans, already an area of fierce competition. The Nossa Caixa acquisition will extend the bank’s presence broadly in the key state of São Paulo and allow it to expand in deposits, assets and other services, says Mr Monteiro.

The Nossa Caixa purchase puts particular pressure on Santander’s Brazilian presence thanks to geographical overlap, says Ms Vansetti-Hutchins. The Spanish bank has a strong focus on São Paulo state because of its acquisition in 2000 of another São Paulo state bank, Banespa, she notes. Still, the Spanish bank has announced plans to open 600 branches in Brazil by 2013, expanding its network by almost one-third.

Credit types

In today’s parsimonious market, the credit battle is focused on the most conservative areas. Banco do Brasil has been targeting auto loans and payroll-deducted credit, says Mr Bendine. The strategy is to concentrate on those areas that have the lowest rates of default, adds Mr Monteiro.

The Banco do Brasil increased its vehicles portfolio from 4.7bn reais last June to 8.2bn reais in June this year and its payroll deducted credit from 14bn reais to 29.5bn reais over the same period. With unsecured credit an unattractive proposition in a recession, private banks have also focused on these two areas.

The effects can be seen on prices for consumers. At the height of the crisis in November last year, vehicle financing cost an average of 37.7%, compared with 26.9% in July this year, according to figures from the central bank. The public bank is a long way ahead of its large rivals as a price setter. In fixed-rate lending, Banco do Brasil was 13th in vehicle financing, offering an average monthly rate of 1.53% in late August. Bradesco and Itaú ranked 30th and 31st, respectively, both with monthly rates of 1.88%.

Dealing with defaults

The focus by Brazilian banks on lending on secured assets is not surprising. Defaults have been increasing in key areas of the credit markets and banks have had to increase provisioning. In July, the central bank reported that the average default rate had grown to 5.9% from 5.7% in the previous month, representing the eighth consecutive month of increase and the highest level since 2000. Bankruptcies are lower at Banco do Brasil than at private banks, according to Mr Monteiro. The bank has 3.3% of its portfolio outstanding for more than 90 days, he says.

Defaults should not get much worse as the economy is improving and the next 12 months promise to be rosy for public and private banks alike. A central bank survey of economists at the end of August points to growth of 4% next year, reflecting growing optimism about the speed of the recovery. Unemployment numbers - a key factor for credit - keep surprising on the upside. Next year, the credit market should be big enough to accommodate growth for all banks.

The danger is that in the not too distant future, the Brazilian banking system will repeat the excesses of banks in the developed world while the government’s intervention may prove less benign, especially in the run-up to next October’s election.

Brazilian politicians have long taken a keen interest in credit spreads, recognising the link between extending credit and winning votes. The new, more amenable management at Banco do Brasil has been keen to oblige the government, so far with great success.

Next year, president Luiz Inácio Lula da Silva is seeking to transfer his mantle to the relatively little-known Dilma Rousseff, who has been lagging in polls, and there is likely to be continued pressure on the state bank to keep up its lending bonanza. Ms Vansetti-Hutchins adds that while the Banco do Brasil has improved its risk management, in this field Itaú-Unibanco remains the leader.

More broadly, political suasion may also have an impact on the revocation of what were supposed to be temporary measures to boost credit in the downturn, such as a reduction in the level of reserve requirements last year. The central bank said in September that it is not ready to re-impose such requirements.

That poses the question of just how much credit is sustainable. Credit as a percentage of the country’s gross domestic product (GDP) is moderate by international standards, at 45% in August. That is partly because of the traditionally high interest rates. Moreover, the speed of pre-crisis credit growth was an astronomical 30% a year and even this year credit from large banks could grow as much as 25%. Lastly, the short history of credit in Brazil makes it difficult to predict patterns.

Mr Bendine does not worry about the long-term sustainable growth in Brazil’s credit markets. He says: “We have the capacity to perhaps double the credit-to-GDP ratio here in Brazil from today’s levels. I believe that credit at 80% of GDP is reasonable. Our financial system is more conservative and more solid and banks have not been pushing the boundaries. Yes, there has been a big movement in credit, but salaries are growing in a sustainable way. The country will continue to attract substantial investment.”

Others are more worried. Ms Vansetti-Hutchins recognises the strides made by the Banco do Brasil in improving risk management and transparent credit approval, but says it still lags behind Itaú-Unibanco. Not only that but Banco do Brasil is both more answerable to the government, and increases in credit at a yearly clip of 30% to 50% are unsustainable in the longer term, she says.

Moreover, although the public bank’s aggressive stance in the recession looks set to pay off thanks to a recuperation of the Brazilian economy, the country is not out of the woods yet and signs of fragility in the recovery could yet hurt the bank’s credit portfolio.

Future prospects

Whatever the outcome, Banco do Brasil’s more active role is having a profound impact on the business model for credit in Brazil. It has long been a rather gentlemanly game of high margins and low volume. Much more active participation from public banks is turning the industry on its head with banks fighting for market share by pushing down spreads. “It’s going to be a very tough fight from now on,” says Ms Vansetti-Hutchins.

For the next couple of years, an ever-broader cross-section of Brazilian consumers should enjoy access to cheaper credit in a broader range of products from banks. There comes the risk, however, that as profits drop in secure areas, banks will move deeper into unsecured areas.

If the short term looks rosy, the long-term future for Brazil’s credit markets is about fast change and a price setter that is closely linked to government.

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