Brazilian banking: Spoilt for choice

Brazilian bank are living a golden era. A consumer boom and high spreads on loans are lifting profits and rushing leaders up the ranks of the top global banks. A more thrusting, international corporate sector is luring Brazilian banks overseas to serve this blue chips client base. To fully capitalize on these opportunities, banks need to balance domestic and overseas opportunities carefully. They also have to keep a close watch on resurgent public banks and negotiate Brazil’s boisterous economy.

The rich pickings that Brazilian banks have been feeding off is reflected in global rankings. Itaú-Unibanco, the country’s largest private sector bank, has become number 10 in the world by market capitalization. It continues to have the most valuable brand in Brazil according to Interbrand, which today values it at R$20.7 billion, a figure that has doubled since 2008.

The financial sector is ring-fenced from much competition. It is dominated by local banks, which have been shrinking in number thanks to domestic M&A. Itaú’s merger with Unibanco and Santander’s purchase of ABN Amro’s Brazilian business are just two examples. The continental size of Brazil has effectively deterred new entrants from building organically while sky high share prices and a lack of sellers mean that there are unlikely to be large acquisitions from banks abroad, most of whom are still nursing wounds inflicted in the crisis.

Meanwhile, the Brazilian economy continues to be in rip-roaring mood and although there was a slowdown in the second quarter that is seen as natural after a spectacular first three months. Most economists are predicting a return to sustainable, if less spectacular, growth in the third quarter. Overall, this year growth is expected to be 7.5%, according to Itaú-Unibanco. Longer-term predictions see sustainable annual growth of around 5%.

The consensus view that Brazil is enjoying a Goldilocks recovery is not shared by all economists, however. More pessimistic economists believe that the warning light is already flashing yellow with industrial production figures at an unsustainable 15-20% in recent months and higher inflation than the Central Bank’s target. May’s inflation came in at 5.22% over a year earlier, the fifth consecutive month above the bank’s 4.5% target.

These economists also point to the interest rate tightening cycle which has seen the base Selic rate head back to 10.25% from 8.75% at the start of the year. They point out that although inflation is currently subdued, generous wage settlements and easier credit are pushing up consumption. Moreover, the trade balance is worsening as the high real encourages imports. If the government is unable to subdue the currency, Brazil could face a balance of payments crisis in a couple of years, they postulate.

Credit Markets
There are few signs of a slowdown yet and the domestic credit market continues to be the largest driver of profits for Brazilian banks.

Lending has been steadily increasing and outstanding credit reached R$1.53 trillion in June, up 2% in a month and 19.7% over a year, according to data from the Central Bank of Brazil.
In the cards market, revenue per card posted a significant increase of 5% in real terms in the second quarter, which, together with a 7.75% increase in the number of cards, accounts for a major increase in the revenue of this segment, according to Itaú’s second quarter report.

The credit market was dominated by private banks, but the crisis curbed their appetite and, spurred on by the government, public banks have grown portfolios hugely. Indeed, today state-owned banks are in top slots in both assets and lending.

Leading the pack by assets since the second quarter of last year has been Banco do Brasil, followed by Itaú, Bradesco and Santander. In the first quarter, the state-owned bank controlled 710 billion reais or 22% of the total assets, according to data from the central bank and M&A boutique Queluz Gestão de Ativos.

Banco do Brasil also leads in credit, according to Ivan Monteiro, CFO. The bank expects the total market for credit to hit R$2 trillion by year-end, an increase of 17.7% in one year. In the year to March, the bank’s credit portfolio grew 26% when contributions from the acquisition of Banco Votorantim which is now included in the bank’s figures, he notes.
Spreads continue to be extremely generous at 28.9% in July this year, according to Central Bank data, making Brazil a world leader in the amount it charges clients to take out loans. However, they have been consistently falling. Spreads were at 31.87% at the start of the year compared to 50% at the start of 2004, for example. That is slowly turning credit from a high margin to a high volume business.
Brazilian bankers like to point out that overall loan-to-GDP ratios in Brazil are conservative compared to other countries, particularly the developed world where households are deleveraging. At 45.3% of GDP in May, credit in Brazil lags behind other developing nations such as the UK that has seen rates top 100%. Even Chile has a credit-to-GDP ratio of over 60%, points out Monteiro.

The overall ratios may be low but the very high base interest rates and whopping margins in Brazil put a natural curb on credit: customers that have the financial means to do so prefer to pay in cash. There is increasing awareness among sophisticated consumers of the very high levels of interest they are incurring thanks to growing media attention.

That is accelerating a move by banks to hunt further down the social scale for consumer hungry individuals who have been starved of credit and are willing to pay up.
Celina Vansetti-Hutchins, analyst at Moody’s in New York, points out that as all banks have been chasing the safest markets, especially payroll deducted loans, the new leg of credit growth involves a poorer and less sophisticated layer of consumers, who are often accessing loans for the first time.

The ability of these customers to pay back remain untested, she notes. “We have not seen the seasoning of these credit portfolios. There may be a whole new trend of delinquencies in these lower classes,” she fears. As yet, there are few signs of deterioration at the Banco do Brasil with indicators of allowance for loan losses over 90 days decreasing, ending the first quarter at 6.7%, 20 basis point less than December last year.

Finally, banks continue to be constrained by high reserve requirements and taxes. Reserve requirements were eased during the crisis to stimulate lending but the Central Bank has been raising them again. In March, it increased compulsory deposits, for example.

Foreign Companies
The boom times in domestic markets are leading to substantial investments by banks to capture this market. At the same time, the internationalization of Brazilian companies is compelling them to look at how they can follow clients overseas.

The cream of Brazilian companies are now international and spanning an ever greater array of industries. These are not just the obvious candidates which are known outside of Brazil such as state oil company Petrobras and iron ore mining giant Vale together with the steel industry that grew up around cheap iron to take advantage of prices. Today, the Brazilian meatpacking industry boasts the largest companies in the world, including Marfrig and JBS Friboi. Soft commodities from the sugar/ethanol complex, to soy and coffee and orange juice also continue to grow fast. IT and technology companies, such as Totvs and TIVIT, are busy carving out niches overseas. They are increasingly demanding a global banking presence.

Itaú has been focused on integrating Unibanco but is putting together plans to expand abroad in areas such as capital markets banking (see below). The bank is focused on regional expansion and already has a presence in many of Brazil’s neighbours (see table). Still, the bank’s international operations account for just over 15% of total.

Bradesco has been more cautious still. Executives believe that Brazil offers richer pickings than are available abroad with faster corporate banking at home and opportunities arising in infrastructure, especially with the planned World Cup and Olympics events in Brazil.

That has allowed Banco do Brasil to take the lead. Monteiro explains that Banco do Brasil overseas aims to be a “niche bank that will provide solutions for Brazilians and for Brazilian companies”. The bank purchased a 51% stake in Banco de Patagonia in Argentina for $480 million earlier this year and is looking to pursue a policy of following Brazilian companies and communities abroad. Brazilian communities are concentrated in selected states of the northeast of the United States and Florida, as well as Japan and Portugal.

Many analysts question the bank’s strategy. They see little reason for a foray in Argentina thanks to erratic politics and the small size of the economy. “I can see no reason to be in Argentina except for political ones,” says Plinio Chapchap, partner at M&A boutique Queluz Gestão de Ativos and professor of finance at Profins Business School. Moreover, the middling size of Banco Patagonia as well as its commercial focus and limited geographic reach does not make it the best entry to the country, adds Vansetti-Hutchins. “It doesn’t make much sense for Banco do Brasil to expand aggressively outside Brazil with so many opportunities at home”.

Monteiro argues that Argentina is key for Brazil and many of the largest companies there are Brazilian, making the bank’s presence indispensable. Recent bond spreads suggest the economy is less risky than European countries such as Greece, he notes.

Capital Markets
The rapid growth of the domestic capital markets and Brazilian corporate appetite for foreign expansion is also forcing banks to balance growth at home and overseas in their brokerage and investment banking arms.
Itaú Securities, the most successful Brazilian bank capital markets franchises, has expanded in centres such as New York and Tokyo, but this appears mostly to be able to serve Brazilian companies rather than compete head-on with large global banks. It has grown in New York and is providing equities coverage in Latin American countries outside Brazil. The overall idea is to offer Brazilian multinationals more product and get into syndicates with US banks to distribute debt, equities and ADRs of Brazilian companies.
Santander is uniquely positioned as a large global retail bank with a significant presence in Brazil. The country is becoming a centre for financial transactions in Latin American business throughout the region, says João Teixeira, executive VP. The bank anticipates sustained economic growth and higher growth in capital markets as Brazilian companies still have a long way to go to access multiple sources of funding, he says.

The Brazilian economy is entering a new phase of large investments and, as the growth spurt in industry means that utilization is close to capacity, companies need to invest heavily just to keep expanding, he says. “Companies need to raise long-term capital, they can’t just depend on short-term instruments any more,” he believes. Furthermore, the infrastructure needs implied by the World Cup in 2014 and Olympics in 2016 require major public investments, too.

Much of the investment will come from foreign investors who dominate Brazil’s equity markets. That puts banks with a retail presence in Brazil and distribution overseas in a key position to exploit opportunities, thinks Teixeira.

Moreover, a growing number of multinationals are planning to list their Brazilian subsidiary on Bovespa as the multiples are higher than local markets to reflect relative economic growth, says Teixeira, who is in talks with a number of companies planning such a strategy. Santander itself carried out an IPO of its Brazilian business last year, raising $7 billion.

A drive to develop Brazilian Depository Receipts to attract more international companies will diversify Bovespa offerings further, says Teixeira. “There is a very significant movement to modernize the structure of capital markets,” he says.

That is adding to pressure on local banks to develop their investment banking capacity at home and overseas simultaneously. International investment banks have been ploughing funds into developing capital markets franchises with top salaries in São Paulo now substantially above those in New York, making the development of a full service investment bank an expensive proposition.

A final consideration is the evolving role of politics, a vital consideration in a country where a strong industrial policy is rapidly becoming a cornerstone belief.

State banks have long enjoyed privileges. They have cheaper access to funding than their private sector rivals because they have access to government business, such as judicial accounts, where interest payments are very low. That gives them a cheaper deposit base. Monteiro does not see the state banks losing this privilege and says that private banks will find it impossible to match the low loan rates that Banco do Brasil can offer customers.

State banks don’t have it all their own way, however, and often have to follow the fiat of government policies. Banco do Brasil’s old management knows this all too well: when they resisted government moves to step up lending in the crisis, many were fired or quit including president Antonio Francisco do Lima Neto. The question of political control and manipulation always hangs over the bank and explains why its shares trade at a discount, says Vansetti-Hutchins. “The question with Banco do Brasil is always: ‘Who’s really in control’?” she says.

October’s elections look likely to be a shoo-in for the current Workers’ Party under their new leader, Dilma Rousseff. She has said little about the role that state banks will play under her government. However, most analysts see more intervention and the promotion of selected Brazilian multinationals abroad. That suggests state banks may get more access to cheap funding but suffer from more intensive government intervention.

Brazilian banks need to weigh up myriad opportunities to position themselves for coming years; those that get it right will consolidate their leading positions. No wonder bankers display both optimism and anxiety about their future.

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