Brazil Banks: Worst Is Yet to Come?

As Brazil’s currency weakens and the iShares MSCI Brazil Capped ETF (EWZ) falls another 3% today, heed the observations of the RBS credit team who think the worst is yet to come for Brazil’s economy.


Analysts Alberto Gallo, head of macro credit research at RBS, along with Tao Pan, Mateja Popovic, Imogen Bachra and Ashleigh Gran write: “Brazil is dealing with the aftermath of past excesses: corruption scandals and political risk.

Risk premia have held on so far, but fundamentals continue to deteriorate. We think the worst is yet to come … Growth is likely to slow further, on lower public support. Private and public indebtedness rose as a result of stimulus programmes and easy credit.

While this fuelled consumption and asset price growth, Brazil must now deal with a combination of stagflation and cost reductions to achieve fiscal targets. Adding to this is rising political risk: consumer and business confidence have declined in line with President Dilma Rousseff’s approval rating (8% in July, the lowest on record since 1992).”

 But there is a way to play the situation, even though banks in Brazil have not fared well. RBS writes: “Brazilian banks have so far been resilient, but with a weaker economy, we expect asset quality to deteriorate.

Brazilian state banks are particularly vulnerable to a deteriorating economy, due to their exposure to SME [small and mid-sized enterprises] loans and high loan-to-value mortgages, and weaker capitalisation. New trade: Short dollar-subordinated Banco do Brazil 5.875% 2022 vs long dollar-subordinated Intesa 5.017% 2024.

Banco do Brazil (BDORY) is vulnerable to the domestic slowdown and political uncertainty, given its high loan exposure to SMEs and sectors linked to the Petrobras (PBR) scandal. Intesa Sanpaolo (ISP.Italy) is a Europe-focused bank, with 95.2% of its operating income generated in Europe (FY 2014).

In addition to being more isolated from emerging markets, Intesa is likely to benefit from on-going structural reforms in the Italian banking system and a domestic cyclical recovery, supported by continued European Central Bank easing … Brazil’s five largest banks control $R5.7 trillion in assets (103% of nominal 2014 GDP).

And total banking system loans are $R3.08 trillion (56% of GDP), with the top five banks accounting for 75% of these. Two of the banks are majority state-owned (Caixa and Banco do Brazil), two are private banks (Itau Unibanco Holding (ITUB) and Banco Bradesco (BBDO) ) and one is a government development bank (BNDES).

 Government subsidies led to an increase in credit between 2010 and 2014.” Itau shares are down 3.6% today, down nearly 7% in July and down more than 20% this year. Banco Bradesco shares are down more than 3% today, with a 5% decline this week and a nearly 24% tumble this year.

barrons.com