Downturn plays into regional hands

The economic downturn has temporarily alleviated the pressure on Brazil’s regional banks. They are using that breathing space to seek efficiencies, including cost cutting, improving customer service and seeking capital from new sources. They need to move fast: as national banks recover, acquisition of regional banks will once again become an attractive expansion strategy.

The economic crisis acted as a reprieve for many of Brazil’s regional banks. State-owned and regional development banks, which tend to have large deposit bases or state funding and do not depend on capital markets, have managed to increase market share at the expense of national private banks, which have been relegated to the sidelines.

Even so, the future looks uncertain. The story of regional banks in Brazil has been one of death by a thousand cuts. Today, the largest regional bank is ranked a relatively lowly 10th in Brazil by assets and 30 of the top 50 Brazilian banks are in São Paulo, according to data from the Banco do Brasil, the central bank.

Brazil has a history of universal banking, which makes it hard for regional banks to carve out interesting niches, according to Marcio Nakane, banking sector specialist at Tendências Consultoria in São Paulo. That history also makes regional banks direct competitors to national banks and the latter have picked off regional banks as they became successful, he says.

The most important category of regional banks are the remaining state-owned institutions. Even their ranks have been significantly thinned ever since PROER, a Federal rescue programme that started in 1995, forced states to privatise or shut these banks after many were found to be insolvent, says Plinio Chapchap, professor of finance at Profins Business School and partner at Queluz Asset Management in São Paulo.

State-owned banks

Today there are just five state-owned banks left in a country with 26 states and a Federal District. The largest is Banco do Estado do Rio Grande do Sul (Banrisul), located in Brazil’s southernmost state. The only other state banks in the country’s top 50 are those of the states of Espírito Santo, Sergipe and Pará.

Even these five are not safe. The process of consolidation and absorption has not weakened. In the past two years alone, the Federally owned Banco do Brasil (BB) has taken over the banks of the states of Santa Catarina and of Piauí and bought Nossa Caixa, a state bank in São Paulo. BB has been negotiating with the governments of Espírito Santo, the Federal District and Sergipe and has said it would like to buy Banrisul, too.

One reason that states may be susceptible to the right offer from the Federal bank is that a fundamental legal change will come into force in 2012, says Ricardo de Barros Vieira, president of the Banco de Brasilia (BRB), the state bank of the Federal District. At the moment, employers dictate where employees receive their salaries and usually pay salaries at the state bank. From 2012, employees will be able to choose where they receive their salary. This portability of accounts could see many individuals move accounts from state to private or other banks, he notes.

Given this time frame, it is not surprising that state-owned banks are working against the clock to improve their service and portfolio of products, says Mr de Barros Vieira. All regional banks are pushing ahead with cost-cutting, automating their systems and building risk management, while at the same time considering how to grow outside their home state and contemplating the role capital markets could play in funding.

Banrisul is seen as a bellwether as it is by far the largest state bank. It is also the number one bank in its state with a market share of 30%, says its CFO, Ricardo Hingel. The relationship between state and bank is paramount: Banrisul is responsible for the payroll processing of state employees under a five-year contract as well as those of many municipalities, and it has a large share of business from the companies that transact with the government, he says.

In line with other state banks, Banrisul is focused on funding for small and medium-sized business and agriculture. The bank had been moving into more attractive areas of the banking business, such as the payroll deducted credit market. It has substantial reserves and could lend a further 10bn reais ($5.88bn), increasing its outstanding portfolio of 12bn reais, says Mr Hingel.

The recession, however, saw the bank slam on the brakes. Recent signs of recuperation has management pondering how fast to push down on the accelerator: Mr Hingel says he is watching closely for signs of recovery. For now, management is taking a cautious approach. After all, Banrisul has seen non-payment of more than 60 days rise to 4.1% and allowance for loan losses are 9.5% of the consolidated credit portfolio, compared with 9.2% at the same time last year. He predicts the bank will experience 21% to 23% growth in credit this year and 25% for 2010, depending on the economy.

Mr Hingel is also looking closely at BB, which is pushing into the local credit market fast and has expressed an interest in buying Banrisul. He sees a sale as unlikely as it would require a plebiscite and constitutional change, and in recent polls 80% of the population have said they are against the idea.

To help it gain traction, Banrisul is eyeing expansion outside its home state from which it currently derives some 95% of its profits. The bank is opening 10 branches in the neighbouring state of Santa Catarina where many of its own citizens live, says Mr Hingel.

Banrisul has already opened up its capital structure and today is a mixture of public and private ownership. As it has significant reserves, it is not looking to capital markets as a significant source of funding in the near future. Still, the bank’s initial public offering (IPO) two years ago not only boosted capital by $875m but also drove the bank to be more transparent and disclose information systematically, according to Mr Hingel.

Smaller state banks

The bank of the state of Sergipe, the smallest state in Brazil, had a good recession: the contraction did not stop Banese posting strong first-half results, says its president, Saumíneo Nascimento. Profits in the first half increased 10.9% year on year, capital increased 19% and assets were up 9.5% to 2.3bn reais, he notes.

The real jewel in the crown for Banese, however, has been credit, which has grown by 30.6% year on year, says Mr Nascimento. The bank “exploited the window of opportunity to grow credit at a moment when national banks were more absent”, he says. The bank has key advantages in knowing its customer base well and has focused on growing lending to small and micro-enterprises, he says. Credit to consumers was up 20% but increased 67% for business clients, particularly in working capital, adds Mr Nascimento.

Banese has also been sharpening its use of automation and risk management to save money, says Mr Nascimento. By mid-October, the bank had spent 13m reais and intended to invest a further 5m reais by year-end, which will be spent on areas such as updating systems and installing new terminals, he adds. Banese has also implemented an intranet which connects different departments and has been working on beefing up its risk area, both to comply with national regulations and seek efficiencies.

Mr Nascimento recognises that Banese faces a tough challenge from rivals. There is going to be more competition, especially in the offering of lower interest rates in credit, and in winning the business of state and municipal business post 2012. “We need to be more agile, offer more alternatives in credit that are not commonly provided in the market, and broaden our range of products to ensure the loyalty of clients,” says Mr Nascimento.

As is the case with Banrisul, part of the solution lies in expansion. Banese already has correspondent banks in two neighbouring states and would like to expand its presence throughout the north-east, says Mr Nascimento.

Banese is also considering new forms of fund raising and recently sought ratings from Moody’s and Austin Ratings, says Mr Nascimento. Next year, the bank may offer shares through Bovespa. That would help diversify the ownership: the state has a strong participation, owning 90%, he adds.

Banese’s recent good results have allayed the immediate threat of a sale to BB. Marcelo Déda, the governor of the state of Sergipe, recently said that Banese has a significant role in developing the local economy and will not be sold. Still the possibility remains a nagging threat: “It has long been on our radar screen and has been widely discussed in the press,” says Mr Nascimento.

BRB’s story is similar to the other state banks. Recognising the rapid rise in the competitive threat, the bank started to cut costs some 18 months ago, principally through revision of contracts with suppliers and containing expenses, says Mr de Barros Vieira.

At the same time, the bank has been expanding its credit operations. The first half of this year was the best in the bank’s history in terms of profits and the second half looks more promising still.

In line with the other state banks, increases in lending by BRB as private banks retracted has been key to recent success. “As other banks were cutting back, we were automating lines of credit and increasing them,” says Mr de Barros Vieira. The bank focused particularly on the most conservative end of the spectrum, expanding payroll deducted credit in the public sector, where it remains the chosen provider for public sector employee salaries and benefits.

The bank also benefited from local circumstances: the economy of Brasilia, home to the majority of Federal government civil servants, was protected from the downturn as the government continued hiring, says Mr de Barros Vieira. The city is also Brazil’s richest, giving the bank a wealthy cross-section of clients, he adds, and the improved profitability has diminished the risk that the bank will be sold to BB.

In line with the other banks, BRB is planning expansion outside of its home market, planning openings in large cities in the centre-west of Brazil. Mr de Barros Vieira says that change and modernisation is essential as the bank fights off competitors. “BRB does not have the scale to compete with national banks. It has to build empathy and loyalty from customers, be efficient, well-liked and offer good products,” he says.

One problem for state banks is that their brand name is too associated with their home state, making successful expansion in new states difficult, according to Ceres Lisboa, analyst at Moody’s in São Paulo. Furthermore, if state banks start to lose market share, the state government gets uncomfortable and looks to sell them. Banrisul would be a particularly appetising addition not just for BB but also for Brazil’s largest private bank, Itaú-Unibanco. Moreover, Ms Lisboa says the national private banks are interested in entering as many new markets as possible, especially as interest rates and spreads are falling and all banks are seeking to compensate for the loss of profitability by building volume.

Brazil’s largest regional banks by total assets

Private banks

The history of acquisition by larger rivals is repeated on a smaller scale in the private sector, where local family-owned banks have been bought into larger banks or moved to São Paulo or both. Banco Real was created when Belo Horizonte-based Banco da Lavoura de Minas Gerais, catering mainly to coffee companies, moved to São Paulo. After a series of acquisitions, it is now part of Santander.

Private regional banks face a very different dynamic as the cost of funding is higher than national competitors and they are not used by the state for payments, limiting their deposit base. Of all the regional banks, they have been hit hardest by the financial crisis and have had to redefine their scope of action. They include banks such as BBM of Bahia and Banco Mercantil do Brasil (BMB) and Banco Rural, both of Minas Gerais.

Belo Horizonte-based Banco BMG, Brazil’s 23rd largest bank by assets, has experienced what many small and regional banks have been through. The bank recently instituted a ‘back-to-basics’ programme that has entailed severe cost-cutting and a focus on core products, says its CEO Ricardo Gelbaum.

That has seen administrative expenses tumble by 40%, with 32% savings in payroll, and the bank has shut down newer lines of business, including payroll deducted credit in the private sector, vehicle financing, and working capital, which accounted for more than 18% of the portfolio in June this year. The bank is now 100% focused on the ultra-safe area of government payroll credit, according to Mr Gelbaum.

With the cuts behind it, Mr Gelbaum is optimistic about the bank’s slimmed-down future. Many small and mid-sized banks exited the payroll deducted area in the crisis, whereas BMG increased its lending from 423m reais a month in 2007 through to monthly averages of more than 700m reais since April, says Mr Gelbaum. “If you strip out the first three months of the year, this is our best year in a decade.”

Difficulties for regional banks have centred on costs of funding. Mr Gelbaum says that BMG was able to get funding only at 110% of the benchmark CDI (money market interest) rate in September, compared to estimates of 104% to 105% for the large private banks and between 90% to 100% for Banco do Brasil. That has been coupled with a rise in BMG’s default rates from 1.4% in 2007 to 3.1% in the first half of the year.

The re-focus on the safest segment of the credit market is, not surprisingly, a tactic that almost all the large banks have been following, given the depths of uncertainty stemming from the recession. Nevertheless, BMG believes it has a unique model whereby it works through correspondents, typically shops, which use agents to actively target payroll workers and retirees by visiting schools, hospitals and places of work. “We have a proactive, agent-based model while the national banks have a reactive, branch based model,” says Mr Gelbaum.

As local financial markets recuperate, as witnessed by Santander’s Brazilian unit IPO, BMG is looking at all possibilities for fund raising from debentures to an IPO, says Mr Gelbaum. That will enable it to originate and keep portfolios - today, BMG mostly sells on portfolios to larger banks - and boost its reserves, which are currently 13.6%. It would also give the nimble bank the freedom to pursue interesting opportunities as the markets re-open.

Development banks

Brazil’s regional development banks have been more stable than their state and private counterparts. The national development bank, Banco Nacional de Desenvolvimento Economico e Social (BNDES), one of the largest of its kind in the world, has tended to overshadow its relatively smaller regional equivalents. Even so, these banks are surprisingly large. The biggest is Fortaleza-based Banco do Nordeste do Brasil (BNB), the largest in-country regional development bank in Latin America. Others include the Banco da Amazônia (BASA) based in the port city of Belém and smaller development banks in individual states such as Minas Gerais.

BNB covers nine whole north-eastern states and parts of two others, and has a particularly strong social role in this poor region. Reform and modernisation are less pressing thanks to the bank’s funding, which is in large part constitutionally guaranteed. Almost 40% comes from the Fundo Constitucional de Financiamento do Nordeste, which had assets of 24bn reais in June 2008, a fund that receives constitutionally mandated money. The BNDES and a workers’ fund supply another nearly 30% of the funding.

As part of the Federal government’s long-term policy of reducing inequalities, the bank is heavily shielded from market forces, says Mr Nakane. This liberty comes with strings: the fund has very specific application rules that limit the bank’s business to the north-east and to predefined segments, he adds.

Not surprisingly for a bank that is constrained in its actions, the BNDES’s record is mixed if generally improving, analysts say. BNB has a tradition of higher default rates, but has been working to get better at credit scoring and is actively monitoring the performance of projects to check the efficiency of spending, says Mr Nakane. BASA declined requests for an interview and BNB was not able to organise an interview with its president.

While the development banks are sitting pretty, the fate of other regional banks in Brazil hangs in the balance. State-owned banks will need to prove their mettle in the next two years, ahead of legal changes to government payments, if they are to avoid being sold and absorbed into bigger national institutions. Private institutions will need to be lean, mean and nimble to compete in a market where funding costs are key and national banks are ceaselessly penetrating new markets. Already, the national take-over of regional banks has become so common that regional banks are a shadow of their former selves.

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