Brazil’s retail banking market could be about to consolidate into the hands of local players, as international participants struggle with poor economic performance and growing regulatory demands. A report by Fitch Ratings in February showed that foreign-owned banks’ participation is on a declining trend: from 20.9% of total assets in December 2008 to 14.7% in September 2014. And now HSBC is considering selling its Brazilian operation and rumours of Santander selling its Brazilian bank persist.
The poor results from the subsidiaries of HSBC (and to a lesser extent Santander) in Brazil have increased doubts about the viability of the business. HSBC’s retail operations have failed to gain scale, representing just 2.7% of the financial system’s assets and, as management has discovered, it is hard to be profitable as a niche retail player in Brazil.
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“HSBC has been excluded from the ATM system in Brazil – if you are a customer you can’t use the ATMs of other banks and, whether or not that has been deliberate on the part of the other banks, it has restricted the appeal of the bank,” says a London-based equities analyst who declined to be named commenting specifically on HSBC. “The management has lost its direction and focus: there has been no attempt to try to restore lost market share.”
The analyst adds there have been credit risk process missteps that, while not unique to HSBC, have frustrated the management team’s ability to improve results. HSBC’s Brazilian bank reported a -5% ROE while the top four listed banks make between 18% and 20%. “Clearly they are underperforming. You have to question why returns are so low at a time when others are seeing a restoration in their profitability – just what is going on with provisioning and asset quality issues?”
The analyst also points to the bank’s cost/income ratio, which is at 66% compared with the market’s average of between 40% and 45%.
“If you are managing a business properly you have to address these issues – there just seems to be a lack of direction at the local level,” he says.
HSBC’s CEO Stuart Gulliver is considering selling the Brazil business, which currently accounts for 7.4% of global revenues and 58% for Latin America. Its small market position makes it increasingly untenable. Having less than 3% of the market makes profitability hard and is also attracting new capital requirements for banks that, like HSBC, are considered global systemically important banks (G-Sibs).
“The global bank of the future won’t be able to be present everywhere,” says an analyst. “Regulation is forcing G-Sibs to make some difficult choices; if you are a big global bank like HSBC and you have a 3% market share in Brazil – which makes the bank almost irrelevant – what is the point in having these operations?”
Despite its small local presence there is consensus that a local buyer would be interested, with Bradesco believed to be in pole position. A banker in São Paulo suggests that it is “Bradesco’s turn” after Itaú’s merger with Unibanco, adding that incorporating HSBC within Bradesco would lead to a combined entity of roughly the same size as Itaú Unibanco, and would therefore be easier from a regulatory point of view. But why would either be willing to pay for something that would not significantly add to their market position or competitive advantage?
“It would be a defensive move. I am often asked who a foreign bank could buy to enter Brazil and if HSBC were bought by a local, that closes the door for ever on foreign competition,” says a São Paulo-based financial equity analyst for one of the leading US investment banks.
Fitch’s February report highlighted that Chinese and Middle Eastern banks have expressed an interest in Brazil, and stated: “Brazil’s Central Bank has been slow to issue new licences and give preference to new bank entrants that can assist challenged local banks – either foreign owned or locally domiciled.”
According to the analyst, the acquisition of HSBC by a local player would leave very few opportunities for foreign entrants. “The only other bank I could think of is Banco Safra but the owner [Joseph Safra] has zero interest in selling,” he says.
Transformative
The other possibility is Santander, which is a less clear-cut case. Its ROE is 9%, compared to around 20% for the private banks, and analysts say it is over-capitalized and lacks scale. It is often used by Brazilians as their second bank, but, at 8% of the market in terms of assets, it is still an important player.
“That would be a very interesting transaction, and I think you would see both Itaú and Bradesco go after that because, with a general market share of about 10%, adding Santander to either bank would be transformative,” says a local banker, who declined to be named.
Meanwhile, as the domestic market potentially consolidates into the hands of the local players there are other rumours linking Itaú to a bid for Banamex in Mexico. The Brazilian bank has a stated ambition of becoming more of a regional player and with Citi potentially considering offers there is an obvious attraction, but the timing might be bad for the Brazilian.
“Banamex is currently valued at about half the market cap of Itaú. It is not an easy transaction to digest,” says one financial institutions analyst. “And with Itaú trading at 1.5 times book value, and the Mexican banks trading at between 2 times and 2.3 times book, it could be very dilutive to do this deal right now.”
