The latest concerns are a pay strike from branch employees, seeking a 16% pay rise and a guaranteed bonus equal to one month’s salary (and other benefits), as well as the possible reintroduction of the CPMF financial transaction tax and an increase in social contribution levies, which will hit post-tax profitability.
|The improvement in NIM could be faster and higher than the 15bp level|
Meanwhile, the deteriorating economy is also starting to bite and analysts think investors are over-emphasizing the coming increase in net interest margins (NIM) and underestimating the increasing cost of risk.
Credit Suisse set out a pessimistic view of some of Brazil’s banks in its October report. Despite recent poor share price performance, the Swiss investment bank cut all large banks to underperform, from neutral, as it lowered its growth estimates for the Brazilian economy into line with the consensus (-3% in 2015 and -1.5% in 2016).
Unemployment is predicted to rise to 11.5% and contagion from the corruption enquiry’s impact on construction companies and the scaling back of Petrobras’ investment plan will hit both those industries’ supply chains.
Although NPLs remain low by international standards, both individual and corporate delinquencies are rising. Data from Serasa Experian show that requests for court-supervised reorganizations have spiked in the second half of this year and the figure is now 2.4 times the historical average. Such a large spike in solvency challenges for large corporates is likely to have a knock-on effect on the SME sector through the supply chain.
Credit Suisse also believes individuals’ income-to-debt servicing will deteriorate until 2017, putting pressure on NPLs and demand for new credit. The bank expects demand for credit to be around 3% at best. In cutting its rating on all Brazilian banks it argues: “Private-sector banks are still trading at a 30% to 60% premium to book value, when ROEs are expected not to exceed their cost of capital over the next two years… it becomes difficult to justify such a premium at least in the short term.”
Currently, Itaú has a return on equity of 24%, which exceeds the 18.3% cost of equity, while Bradesco has a ROE of 21% against a cost of 21%. However, Credit Suisse projects that both will register a ROE below the cost of equity for the next three years. Meanwhile, Santander and Banco do Brasil already report ROEs below the cost of equity.
Analysts point to Brazilian banks’ low earnings (P/E) multiples as an entry point but Credit Suisse also discounts this. Its report, whose lead author is Marcello Telles, argues that consensus expectations are optimistic given the banking industry’s headwinds and says that earnings growth will be lower for cyclical and structural reasons.
“The cyclical component is derived from the asset quality deterioration cycle whereas the structural component comes from the fact that loan growth will be structurally lower for the next five years on the back of a more penetrated credit market, structurally lower GDP expectations and deleveraging as a medium term trend,” he says.
However, UBS’s Brazilian banks strategist Philip Finch is more optimistic and stresses higher system-wide NIM as a source of strength. He believes that increased loan repricing could push up the sector’s NIM by another 45bp (it is currently 7.2%) for 2016 – which would offset rising provisions. Finch has a buy rating for the two main private banks, Itaú, and Bradesco, and he thinks the system’s high coverage ratio (190%) would enable NPLs to rise by 44bp without the need for additional provisioning.
|Brazil: special focus|
Therefore, for Finch, the improvement in private banks’ pricing power, due to the increased Selic rate and lower competition from the public banks as they face fiscal constraints, will drive strong earnings performance.
He says that a historical analysis of the performance of spreads in past cycles suggests the private banks are set to benefit. “Based on past cycles analysis spreads could go up to 33.5%, 290bps higher than in June 2015 (30.6%). From June 2014 to June 2015 spreads went up by 490bp while NIM increased by 25bp. This suggests that another 290bps increase in spreads should improve NIM by another 15bp.”
However, Finch adds: “As banks are now repricing loans not only for funding costs that have gone up over the past year or more, but also for higher credit risk and taxes, and given the absence of ongoing upward pressure on funding costs – as the Selic is forecast to have now peaked – the improvement in NIM could be faster and higher than the 15bp level.”
Credit Suisse sees strong net interest income expansion in 2015 but thinks projections for 2016 are too optimistic. “Lack of volume growth reduce the impact of repricing and is a drag to NII [net interest income] and an expected additional increase in rates next year may do more harm than good as liabilities reprice faster than assets,” it says.