Latin America: Banco do Brasil begins to convince

Banco do Brasil’s CEO Paulo Rogerio Caffarelli has expressed confidence that the bank will see a significant recovery in profitability and other financial metrics during the rest of this year, due to a combination of a return to growth for the Brazilian economy and the fruition of his strategic recovery plan.

Caffarelli, who became CEO in May, spoke to banking analysts in São Paulo in early March and outlined his plan to prioritize a return to a level of profitability seen in the private sector.

This seemingly innocuous goal is significant for the bank that is majority state-owned and that has, in the past, sacrificed profitability to act as a counter-cyclical tool of the government’s macroeconomic policy by extending consumer credit to bolster consumption.

Speaking just days ahead of the release of Brazil’s Q4 GDP figures that showed a 3.6% decline in the economy in 2016 – following a 3.8% fall in 2015 – Caffarelli forecast that the fiscal adjustment being undertaken by president Michel Temer will lead to GDP growth of 2.3% next year, inflation of 4.5% and interest rates of 9%.

The bank’s spokesman, Omar Barreto Lopes, didn’t return Euromoney’s emails or calls, but analysts who attended the sell-side event said the bank’s strategic plan continues to impress. 

Caffarelli’s first step to shoring up support for the stock from equity analysts was to provide a roadmap to improving capitalization without the need to issue new equity.

The bank has been shedding non-core assets and has signalled it will sell its 59% in Argentina’s Banco Patagonia rather than dilute existing shareholders, which took some of the overhanging pressure off the stock.

According to Tito Labarta, banking analyst for Deutsche Bank – who attended the event – management said it can reach a CET1 ratio of at least 9.5% by 2019 through these asset sales, but has ring-fenced core businesses – such as credit cards – and will not IPO these businesses to protect profitability.

Marcelo Telles, banking analyst for Credit Suisse, says that CET1 was also boosted in the first nine months of 2016 by a reduction of R$118 billion of risk-weighted assets – or a fall of 14% to R$722 billion.

In a client note dated January 25, Telles estimated that, on a fully loaded basis, CET1 was 7.5% and he thought the bank’s target to build up capital to exceed its 9.5% target by 2019 without issuing equity was now achievable.

He wrote: “We are thus removing our previous R$7.5 billion capital need estimate from our models and estimate Banco do Brasil can organically reach CET1 of 12.5% by 2019.”

The bank has also been focusing on a cost-cutting exercise and in November announced it will close 7.4% of its branches and reduce other costs to save R$750 million annually. It also announced an aggressive voluntary dismissal programme that could potentially incorporate 18,000 workers, or 16.5% of the workforce.

Credit Suisse estimates these initiatives will drive core opex 2.0% lower this year when compared with last year, driven by a 2.5% reduction in personnel expenses and a 1.2% reduction in administrative expenses.

Caffarelli also outlined other policies to boost profitability, such as a new compensation structure for the management team to achieve a level of profitability that is comparable to its private-sector peers.

Technology will be crucial for achieving this and progress is being made: 43% of individual accounts are now opened through mobile platforms.

The falling base rate in Brazil will also have some positive impact on the bank’s net interest margin – at least in the short term.

While a lower Selic will improve funding costs, the private-sector banks should be slow to lower spreads and 58% of the bank’s loan portfolio was contracted before 2015 and can still be repriced higher – with the bank saying it is very active at rolling over loans at a higher interest margin.

Also, while higher-than-expected provisions hit the bank’s Q4 results, this was due to the adoption of a new internal rating system rather than a deterioration in the quality of its loan book.

In fact, non-performing loans (NPLs) have performed well in recent quarters. In Q4 16, NPL 90 days were down 46 basis points quarter on quarter, or 3.3%; although this was flattered by a R$3 billion write-off of a single case – without this write-off the NPL would have nudged up 23bp.

According to Deutsche’s Labarta: “Management expects provisions to maintain relatively stable in 2017 after adjusting for non-recurring provisions in 2016. The bulk of the improvements should occur in the corporate portfolio as the economy improves.”

While there is consensus among those quoted banking analysts about the positive operational momentum being created at Banco do Brasil, that doesn’t translate into a uniform view about the bank’s valuation.

Deutsche Bank has a target price of R$39.00 and Credit Suisse increased its to R$36.00 from R$27.00 to reflect the positive outlook for the bank with buy and outperform recommendations respectively.

Credit Suisse’s Telles, writing when the stock was at R$30, called the valuation “compelling” as it was trading at 0.9-times 2017E P/B and 7.5-times 2017 P/E “which we find attractive in light of its sustainable ROE of 16.5% and 2016-2019E CAGR of 31.9% and in the absence of the need to raise equity.”

However, UBS has maintained its scepticism and its sell recommendation, with a 12-month target price of R$23.00.