Poland picks a popular private path
Investec’s 60-fold leap in value
When South American inflation was raging the best bank was the one that pulled in the most deposits and invested them in high-yielding government paper. Efficient processing was the key to getting the money working quickly and to boosting float revenues. In Brazil, the private-sector bank that did this most effectively was Banco Bradesco. With 2,543 branches compared with Itau’s 1,873 and Unibanco’s 1,195 (the second and third largest players), Bradesco would still be well placed if inflation returned.
But times change and when the Real Plan was introduced in 1994, bringing inflation down to moderate levels, different skills were needed. The bank that most effectively seized the new opportunities was Banco Itau. It was among the first Brazilian banks to introduce service charges to compensate for the loss of float revenue a highly controversial move at the time. Itau has also proved the best at realizing the potential for growth by acquisition; it has been the most astute in growing its lending book; and it is Brazil’s second largest private-sector fund-management operation, another useful source of fee income.
On top of this, analysts compliment Itau on its hard-nosed internal culture in which senior executives, many of them trained engineers, have the tightest grip imaginable on the running of the bank. In all productivity and efficiency ratios, Itau’s performance is impressive and it does the best job among its peers of delivering returns for shareholders, taking account of the high capital ratios and low gearing of the balance sheet that Brazilian banks regard as prudent in view of their country’s history of economic turmoil.
Itau also stands up well in regional comparisons (with Argentine and Mexican banks) of core earnings, equity/loan ratios, coverage of bad loans and share price. And with its push into the Argentine retail sector, its investment-banking joint venture with Bankers Trust, and its overseas operations in the Cayman Islands and Luxembourg, Itau has taken the first tentative steps to becoming both international and universal.
“Itau is more efficient than the other two banks [Unibanco and Bradesco] and has been the most agile at replacing float revenue with fee revenue,” says Celso Boin, banking analyst with Deutsche Morgan Grenfell in Sao Paulo. Itau’s fee revenue as a percentage of total revenue is 27.4% compared with 17.8% for Unibanco and 17.0% for Bradesco. Its cost/income ratio is 72.8% compared with Bradesco’s 79.9% and Unibanco’s 82.2%.
“Our vision is to be the leader in performance,” says Itau president Roberto Setubal. “We don’t want to be the biggest but the best.” Of the bank’s fascination with quantitative analysis, he says: “We love it and we know how to use it. We have a profit measure for each client, for every person who has an account. Even if a client made a withdrawal from an ATM machine 300km away, we can identify that cost. It’s very useful for pricing products correctly.”
Yet despite Setubal’s claim that Itau does not want to be Brazil’s biggest bank, it has the opportunity to be just that. Sao Paulo state bank Banespa is due to be privatized in the next six months and Itau is likely to be among the bidders following on from its acquisition of Rio de Janeiro state bank Banerj last July. By all measures Banespa is a very large undertaking. It has R$13 billion ($12 billion) in deposits, slightly more than Itau and only R$5.5 billion less than Bradesco. Banespa has 1,441 branches and R$71 billion in assets although 46% of its private-sector credits are non-performing. Any smaller bank that captures Banespa will immediately be catapulted into the big league of Brazilian banking. If it goes to Itau, Bradesco or Unibanco, the acquisition would put that bank firmly in first place.
“Banespa is the decisive factor in Brazilian banking,” says Roberto Attuch, banking analyst with Banco de Investimentos Garantia. “Its sale will change the face of the industry. Itau’s experience with Banerj is a good learning curve for them in pursuing Banespa. It will allow them to price Banespa correctly before putting in a bid.”
In the acquisition of Banerj Brazil’s first bank privatization Itau assigned a team of 40 to carry out the due diligence. Insiders claim that by the time they had finished, Itau executives knew the bank better than Rio state personnel. Along the way Itau identified $3 billion in pension and other liabilities which it persuaded the central government to guarantee with federal bonds and it obtained central-bank guarantees against claims on the bank by contractors. Banerj added $3.1 billion of assets to Itau and increased deposits by $2.4 billion.
When Itau executives finally got the keys to Banerj and moved in, they were positively surprised by what they discovered. “We found a lot of the staff had a good [educational and professional] background and they wanted to work in a different kind of bank,” says the new executive director of Banco Banerj, Ronald Anton de Jongh, but adds that many tellers were being paid double private-sector rates.
“The people were good but the systems were poor,” he says. “The technology was almost zero. Rio de Janeiro state didn’t invest anything in that bank for 20 years.”
Apart from investing in new systems, Itau also has to decide whether to keep the Banerj name. “Our market research shows that cariocas [inhabitants of Rio de Janeiro] like the name because of its tradition as the state bank. Cariocas are more patriotic about their state than other Brazilians and the name is important to them. We are not sure whether we will keep it in the long term,” says Anton de Jongh. Returns at Banerj are already outpacing most analysts’ expectations.
But Banespa is altogether a tougher proposition. Competition to buy the bank will be greater, especially now that Itau has shown what can be made of a state bank, and this will push the price up. Banespa’s larger scale will make a turnround more difficult. Also, with the central bank intervening in late 1994 because Banespa had liquidity problems, its financial track record is hardly inspiring. Financial statements were only recently released after a long gap because the bank’s previous administrators, fearing criminal charges for taking the bank into negative worth, obtained a court order blocking their publication.
“The figures just came out recently and they are very strange,” says Tomas Zinner, president of Unibanco, which is also interested in Banespa. “We have to adjust them. The structure of the sale will also be important to evaluate how much we could pay for it. Probably they will be selling control 51% of common shares.
“If we are successful in the public bidding then there are several decisions to be made: do we run it as a separate name? Do we integrate it? Whatever. It’s very premature. Whoever buys Banespa, there will be no loans, or only a small amount of loans and a lot of liquidity. Liquidity we have a lot of ourselves so it’s a question of how you manage this liquidity. It would be a question of buying a franchise.”
Says Itau’s Setubal: “We would like to buy Banespa as long as we can buy it with the right conditions for our shareholders. We would not buy it just to be number one. For some bankers Banespa is the last opportunity to be in the first tier. We are already in the first tier.”
Unlike Unibanco which even after its acquisition of Banco Nacional in 1996 concentrates on the middle- and higher-middle-income groups in Brazil, Itau and Bradesco are mass-market banks. Itau’s acquisition of Banco Frances e Brasileiro strengthened its position in the corporate segment and among high-net-worth individuals but has not substantially changed its profile in the market.
The management styles of Brazil’s three big private-sector banks reflect their different market segments. Bradesco’s approach is populist and paternalistic with only long-serving employees gaining access to the top. The Bradesco culture is extremely strong and has been compared to that of a religious group’s. Like a German bank, Bradesco holds stakes in many industrial companies but analysts are sceptical of the bank’s investment abilities.
At the other end of the scale is Unibanco, which has the most decentralized management of the three. Management at both Unibanco and Itau are regarded as highly professional but there is greater involvement of the shareholding families at Itau. Roberto Setubal, the president, is the son of Olavo Setubal, chairman of the board of directors and the man credited with originally taking the bank to its first-tier position. In addition, the elder Setubal was once mayor of Sao Paulo and a political figure of national importance. He was definitely a hard act to follow.
Making the burden easier was the presence of two non-family presidents at the bank between Olavo and the arrival of Roberto in the hot seat in April 1994. Observers of the bank say that Roberto Setubal has proved himself a worthy president especially following the Banerj acquisition, a move Olavo was known to have reservations about.
“Olavo is involved in the big decisions like whether we are going into Argentina or whether we are going to buy a bank,” says Alfredo Setubal, who heads capital markets and is the only other of the seven Setubal siblings to work in the bank (though another works for the group insurance company which has been sold by the Itausa holding company to the bank). Alfredo, an art lover, is one of the few non-engineers among the senior executives.
Would Alfredo, who at 39 is four years younger than Roberto, like to be president? “No, never,” he retorts. “Besides, the president would need a commercial-banking background not an investment-banking one like I have.” Alfredo dismisses as idle gossip market talk of conflict between the Setubals and the other shareholding family, the Villelas. The rumour is that the Villelas, who hold a larger proportion of the shares than the Setubals, are unhappy about their lack of executive involvement.
Both Roberto and Alfredo Setubal point out that the Villela family member who, in generational terms, could have played a leading role in the bank, Alfredo, was killed in an air crash in the early 1980s and that his children have not yet made up their minds about whether to be involved in the bank.
While some analysts think further expansion could dilute family holdings, others disagree, pointing to the bank’s inner reserves. Garantia’s Attuch puts hidden reserves at $720 million, $500 million of which is the excess provisions over non-performing loans. Definitely Itau could buy a controlling stake in Banespa out of its own resources and even without using its hidden reserves, says Attuch, though this would depress its capital ratio.
The impressive capital strength of Brazilian banks is the starting point for a debate about which one is the best performer. All three banks have hidden profits by excessive provisioning and their BIS capital ratios are high by international standards Bradesco’s is 25%, Itau’s is 18% and Unibanco’s is 12%. Low leverage of the balance sheet (Brazilian credit is 30% of GDP and Itau’s lending is 35% of total assets) and extremely conservative provisioning (Itau posts as a loss any credit that is 60 days overdue) mean that the top Brazilian banks can easily withstand the current economic crisis. (Speculative attacks against the real have prompted the government to tighten fiscal and monetary policy, sending interest rates soaring and leading to predictions of low or even negative growth this year.)
But are the banks using capital efficiently and giving shareholders a fair return for the level of risk? With such a high capital ratio, Deutsche Morgan Grenfell’s Boin declares of Bradesco: “It’s not a bank, because they don’t want to take risks in the market. It’s more of a holding company.”
Boin has put together figures showing adjusted levels of equity and profits if excessive provisions and the differences between book and market value of securities held are factored in (see table). This shows that Itau gives the best adjusted return on average equity of the three 19.8% compared with Bradesco’s 14.9% and Unibanco’s 17.7%.
“Bradesco is using hidden reserves to boost earnings whereas Unibanco ought to provide a higher return on equity because its leverage is higher. Unibanco doesn’t seem to have cut costs following the Nacional acquisition,” says Boin. “Itau provides the best risk/return ratio among the three.”
One reason Itau is the analysts’ favourite in Brazil is the astuteness and transparency of its reporting. This is down to executives such as director Silvio de Carvalho and senior vice-president Henri Penchas.
“De Carvalho has helped make things very transparent to the market,” says an analyst. “Whenever I complain about something, the next quarter there is an explanation dealing with it.” For example, Itau now gives a breakdown of dollar assets and liabilities, something which, as shown by the Asia crisis, can be critical to a bank’s performance.
Of Penchas, one analyst says: “He is outspoken and frank. Meetings with him are very productive. If he can’t discuss something he will say so. He won’t give you bullshit.”
An illustration of Itau’s finesse with the balance sheet is its treatment of housing loans. Under Brazilian rules, banks are required to make housing loans at fixed returns equivalent to 70% of savings deposits. This is unattractive business, especially as, until recently, recovery was difficult because the property could not be used as effective collateral. What Itau does is to keep non-performing loans on its books because writing them off would mean taking on new loans to fulfil the quota.
Says Penchas: “We have high profits, high reserves, high expenses, high return on equity. This is the situation south of the Equator.” But Penchas acknowledges that this could alter. “In the future if spreads go down it will be impossible to have such good returns with such enormous cash holdings.”
Itau has a reputation for being alert to changes and it was the first major Brazilian bank to introduce customer charges. During the inflationary period the costs of servicing customers were absorbed into the high profits. But when monetary conditions became more stable, Itau realized the necessity of weaning its customers off their habit of writing cheques to delay payments. Some clients wrote thousands of cheques a month for amounts as little as one or two dollars. Petrol stations allowed customers to forward-date cheques by as much as 30 days. Unsurprisingly Itau’s actions prompted a consumer backlash.
“It was a nightmare,” recalls Itau vice-president Milton Luis Ubach Monteiro who oversaw the project. “The media came down on us but we were determined to see it through.”
Patient managers explained to customers that the bank was only trying to cut losses on their accounts and not trying to profit from them. Eventually the concept was accepted and other banks followed suit.
But Itau’s strategy can be as much defensive as offensive. After the 1982 debt crisis it set up a bank in the Cayman Islands with no exposure to Brazil. While no-one at the bank would say so on the record, a 10.2% stake was taken in Banco Portugues de Investimento, a bank with retail and investment activities in Portugal, with one eye on the bank nationalization talk of some politicians in Brazil.
Itau is noted for its caution. After the current market turmoil, plans to double the capital of its joint venture with Bankers Trust, Itau Bankers TrustBanco de Investimento, were postponed. When the Real Plan opened up new areas of lending many banks were unprepared and suffered considerable losses during economic downturns. “Itau concentrated on [lending to] the industrial sector rather than the consumer sector. They didn’t go into housing or agricultural credits [in a big way],” says Deutsche Morgan Grenfell’s Boin. It’s one of many Itau policies that its shareholders can be thankful for. Brian Caplen
