In the midst of Brazil’s political turmoil and recession, the banking sector has shown resilience, but at what cost? Melodie Michel reports.
In early February 2017, Brazil’s largest private bank, Itaú, posted Q4 2016 earnings of R$5.8bn (US$1.86bn), and returns on investment (ROE) of 20.7%. The results, although down compared to R$5.7bn in net income in Q4 2015, beat analyst forecasts and also saw CEO Roberto Setubal announce a new payout policy of distributing 35 to 45% of annual proﬁt to shareholders, as opposed the average payout of 31% since 2008. Setubal expects to maintain this policy “for a few years”, he said, signalling a positive forecast for the bank.
Other private banks have also fared well. Banco Safra, which is solely owned by billionaire Joseph Safra, posted a 2.7% increase in net income between 2015 and 2016, to R$1.7bn (US$425mn). And Santander Brasil, the largest foreign bank in Brazil by assets, also exceeded expectations in 2016 on the back of an increase in fee income and declining loan-loss provisions.
These results stand out considering the Brazilian economy contracted by 3.9% in 2015 and 3.4% in 2016, unemployment stood at 11.8% in November 2016 and bankruptcy ﬁlings trebled in the past two years. The relative positivity may be down to the fact that the banking sector has seen much worse.
A 2007 research paper by the Central Bank of Brazil points out that between July 1994 and December 1998, 83 banks suffered some kind of intervention from the government, and no fewer than 59 collapsed (22% of the overall number at the time). “This is exactly what happened in the global economy in 2008: Brazil had already gone through that in the late 1990s. As a result, the central bank created stricter supervision on banks. Now the international capital requirements have increased a lot, but Brazil had already imposed capital ratios that were much stricter than the US or other international players before 2008,” explains PwC partner and ﬁnancial services leader Alvaro Taiar.
The banking crisis of the late 1990s had another constructive outcome in the creation of the credit guarantee fund (FGC), which is made of mandatory contributions from all banks, calculated as a percentage of deposits, and used as emergency liquidity during crises – mostly to save midsized banks. This means that larger banks tend to contribute more than smaller ones, for a fund that does not beneﬁt them, but as Taiar explains, solidarity in avoiding crises is never a bad thing.
“It’s important for the big banks that there are no failures even in the midsized banks because that could create some stress in the market, which could be
a problem for them,” he tells GTR.
Changes of strategy
But these regulatory conditions were not the only thing shielding banks during the current recession. Taiar points out that banks counted on their multi-product offering and gradually increased revenue from service fees on bank accounts, credit cards and even lending. This provided them with a level of security should interest revenue drop. As an example, Bradesco, another major Brazilian bank, saw its service fee revenue grow by R$3.2bn (US$1bn), or 12.8%, in 2016.
There was also a notable shift in the way banks allocated loans in the past year. Bradesco again showed a 7.1% reduction in SME lending between 2015 and 2016, despite overall corporate loans growing by 5.1% in the same period.
Other banks followed this trend, which they say was particularly motivated by the ratio of non-performing loans (NPLs): in December 2016 these stood at 1.3% for Itaú’s large corporate portfolio, compared to 5.8% for SMEs.
“The bank had to reduce its participation with SMEs and midcaps due to a rise in non-performing loans, and we focused instead on large corporates. Of course, other banks did the same, so there was increased competition as we all fought for the same names. Meanwhile, midcaps are probably having to pay more or provide more collateral for their ﬁnancing,” says one Brazilian banker, who spoke to GTR on condition of anonymity.
Some of the bankers interviewed for this feature meekly mention pressure on prices as a result of the sector’s concentration on the most creditworthy companies. And although the number of requests for new corporate loans decreased consistently throughout 2016, the banks’ new strategy is no doubt partly responsible for the country’s credit crisis, which saw 5,500 companies go bust in 2015.
For some bankers, competition has grown weaker, as the crisis has forced public banks to give up their aggressive bidding strategy.
“When the crisis started about two years ago, private banks were already conservative in lending. They reduced it a lot in advance of the crisis. The same is not true of government-owned banks, because the government at that time used banks to keep the economy going for another year or so, competing to give loans and increasing their portfolio a lot faster than private banks,” explains Taiar at PwC.
“But after a while, they realised the crisis was very strong so even they stopped to lend to riskier corporates. They are now having some problems because of these loans, but still, they are proﬁtable.”
Proﬁtable or not, the two state-owned banks have announced a series of measures since they realised just how bad the economy has become: Caixa plans to cut staff by one-third (10,000 jobs), aiming to save R$1.8bn (US$580mn) by 2018, while Banco do Brasil intends to close 402 branches and slash at least 9,000 jobs to save up to US$900mn.
Restructuring efforts have become the focus of these banks, while loan portfolio expansion has been put on the backburner, giving more space for private banks to increase market share.
Alternative revenue sources
Brazil’s trade ﬂows reduced dramatically during the current crisis. Exports dropped by 15% and imports by 25% in 2015, according to World Trade Organisation (WTO) data. This reduction was reﬂected in banks’ trade ﬁnance portfolio, with one banker placing the drop at around 10% since the crisis began.
And with Brazil being stripped of its investment grade status by all major ratings companies between September 2015 and early 2016, banks also suffered downgrades. This affected correspondent banking relations. “The most signiﬁcant impact we felt from the crisis was a reduction in our correspondent banking network as a result of Brazil’s downgrades,” says GTR’s source, adding that conversations to resume these lines are ongoing now that the recession is ending.
But there has been one silver lining: the gap between local (Brazilian real) and international (US dollar) interest rates. In 2015, US dollar Libor rate stood at an average of 0.79%, while the Brazilian rate (commonly known as Selic) remained at over 14% until October 2016.
One banker goes as far as saying that this spread between funding and lending costs caused “record revenues” in the local banking market. “While trade ﬁnance volumes decreased, the treasury side did very well, with strong demand for working capital ﬁnance,” they tell GTR.
For Taiar, the revenue gained this way provided an important lifeline to the sector. “It doesn’t mean huge proﬁts for the bank: part of this is used to cover NPL losses and taxes. We are now reading that the government is trying to push to reduce the spread, however, the spread itself is what saved the market,” he says.
Sitting at 13% at the time of writing, the Selic rate is expected to reach 10% by 2020, and then drop to single-digit levels – something Brazil hasn’t seen since 2013. Meanwhile, the US Fed has started its raised monetary policy, with interest rates expected to hit 2.25% in 2020.
While this normalisation will drastically reduce an important source of revenue for Brazilian banks, there is hope that the redressing of the economy (with GDP expected to grow again from 2018) and the adjustments made by banks to deal with the crisis (including record levels of investments in technology) will make up for any losses and, hopefully, allow banks to return to a normal risk appetite for companies of all sizes.
Competition and consolidation
The Brazilian banking market has seen a high level of consolidation, with the largest ﬁve or six banks controlling about 80% of overall assets. According to Taiar, this started with the 1990s ﬁnancial crisis and continued over the past two decades, with each large bank acquiring “about 40 banks; two or three per year”.
Recent examples have shown that starting business in Brazil as an international bank is not easy: HSBC, Citi and Société Générale all exited or scaled back their Brazilian activities between 2014 and 2015, and in the past 20 years, the list of foreign banks trying and failing to penetrate the market includes Bank of America, BBVA, Intesa Sanpaolo and Crédit Lyonnais.
Challenging the monopoly of the big four (Banco do Brasil, Itaú, Caixa and Bradesco) is a risky bet, particularly on the retail front. “The reason is simply leverage,” says Taiar. “It’s very difﬁcult to do retail without a big client portfolio because all the investment in technology, marketing and branches doesn’t pay off if you only have a midsized bank. Now there are discussions about digital banking, and at least one of them is making a lot of noise [the online-only Banco Original]. That could bring new players to the market, but at the same time the big banks are also investing in their digital platforms to compete against these new players.”
On the corporate banking front, competition authorities are becoming stricter when approving domestic acquisitions for fear of creating too-big-to-fail banks. In the past few years, Canada’s Scotiabank acquired what used to be Commerzbank’s Brazilian subsidiary, China’s Bank of Communications bought 80% of Banco BBM, and China Construction Bank purchased a 72% stake of Banco Industrial e Comercial (BicBanco). All three are looking at using their new acquisitions for corporate and investment banking, and the anticipated recovery gives them hope of success.
But judging by the following comment by GTR’s local banking source, Brazilian banks will not give up market share without putting up a ﬁght: “The Brazilian market is very competitive, and difﬁcult to navigate for foreign banks. Many foreign banks have exited, and the Chinese banks that entered since then will face the same difﬁculties. This is because local banks have a strong track record, but more importantly a strong understanding of Brazil’s complex culture and regulations.”