New data out of Brazil shows that the credit crisis has arrived in force, particularly hurting smaller banks. The governments reaction has been broad-based as it seeks to prevent a rapid economic slump and includes pressure on private sector banks to help unfreeze credit. Consolidation in the banking sector may make things worse.
Recent data coming from the consumer sector and banks in Brazil are ugly. Sales of cars fell 11% in October compared to the previous month, after years of double digit growth. Small and medium-sized banks have reported fast deterioration with much-admired Daycoval, for example, reporting a drop of 18.4% in net profit in the third quarter to 47.1 million reais and a decline of 10.8% in deposits between the second and third quarter to 2.0 billion reais.
Total volume of all credit outstanding in the consumer and corporate sectors in the Brazilian economy in September, including government directed loans, was the highest ever. That number could end up being the high water mark. In that month, credit reached 1.15 trillion reais, an increase of 34% year-over-year and representing 39.1% of GDP, according to banking association Febraban. That compares to levels of just under 30% as recently as last September but is still lower than many other Latin countries. Chile has total credit to GDP levels of more than 60%, for example.
The days of 30%-40% per year credit expansion are over, reckons Plinio Chapchap, professor of finance at Profins Business School and partner at Queluz Gestão de Ativos, a boutique asset manager and corporate advisor. He believes that credit will not grow at all next year.
One key sector may even retreat: Brazil produced three million cars last year of which 70% were financed, adds Chapchap. Already, car manufacturers are reducing output and if Brazil manages to match these figures next year, it will be an impressive achievement, he believes.
Banks will only able to increase profits by charging more, says Chapchap. Indeed, spreads have risen across the board. Average spreads across all consumer lending were up by 3.6% year-over-year, with banks charging interest of 53.1% per annum, following to some extent the difficulties they face in raising new funds. For corporate the average spread is up 2.1% in 12 months with banks charging on average 28.3%.
But not even these fatter spreads can help small and mid-sized banks that raised funds through IPOs, debt markets and increasingly through securitization in the boom times, but now find themselves shut out. They will simply enter a state of suspended animation offering no new loans, Chapchap believes. If a shark doesnt swim, it dies, he says.
When will smaller banks be able to be able to raise funds? asks Norberto Barbedo, vice president in the corporate area of Banco Bradesco. Not in 2009. This will only happen in 2010. The banks will need to rely on Banco do Brasil and others to buy both shares and credit portfolios. Barbedo estimates that small- and mid-sized banks represent a significant 20% of total credit portfolios.
It is unclear if smaller banks have a viable business model in current market conditions, says Celina Vansetti-Hutchins, senior analyst at Moodys in New York. Executives at small banks Daycoval, Banco PanAmericano and Banco BMG all declined to be interviewed.
Forcing a Breach
At the start of the crisis, the Brazilian government appeared complacent. Not any more. A series of measures have been speeded through to stabilize the real, which lost close to 50% against the US dollar from its peak at 1.56 (August 4) to its trough 2.37 (October 9), and was still some 35% down from that peak by November 7. Currency stability is vital because banks have relied on dollar fund raising. The government has also sought to encourage banks to lend. Measures include rapid reductions in reserve requirements, which have long been exceptionally high, at close to 50%, compared to 10%-15% in developed markets.
More controversially, the government is pushing through congress a proposal, MP 433, that would allow public sector banks Banco do Brasil and Caixa Econômica Federal to buy other financial institutions. It also pressures large banks to buy credit portfolios from smaller banks as a pay-back for reserve-easing measures.
Not surprisingly, that is hitting stiff opposition. Bradesco has maintained all lines of credit operating normally, says Barbedo. He notes that the bank has already bought some three billion reais in portfolios of smaller banks, but says it faces constraints from doing more thanks to the relatively poor quality of portfolios of these banks and their incompatibility with Bradesco lending policies.
We have analyzed portfolios that include financing for 15 year-old cars and six-year old motorbikes, says Barbedo. Bradesco has policies that require loans for motorbikes to be made only for new models and with a down payment, he points out. The government is effectively asking Bradesco to contravene its own lending policies, Barbedo points out. Furthermore, loans were made cheaply at 3.5% over CDI, he complains.
If anything, the proposed merger between the number two private bank Banco Itaú and the third bank Unibanco may exacerbate the credit problem, reckons Barbedo. Clients that use both banks will find that their lines of credit have been concentrated and will be reduced, seeking them to diversify through other financial institutions.
The merger may also trigger further consolidation, repeating the problem. Banco do Brasil was negotiating a deal to buy lending bank Nossa Caixa with 51.4 billion reais in assets and was rumored to be talking to Banco Votorantim in early November. The latter has denied it is for sale. Bradesco, which has been back-footed by the merger, is likely to want to acquire to keep pace.
The problem is that with the credit freeze and drop in profits of small banks, they are no longer attractive. These small banks are not acquisition targets. They dont add value for large banks, says Chapchap.
Large banks that have the ability to buy would demand a low price and cultural differences make sealing a deal difficult. Large banks dont want to do charity and want to keep using funds in the best way possible, agrees Vansetti-Hutchins. The analyst says she has spoken to senior executives of the large banks on the issue.