Awards for Excellence 2016 Latin America: Brazil’s best are no longer the region’s best
The country’s biggest banks are only just starting to feel the pain, and there could be far more to come.
For the best part of a decade, the two largest private-sector banks in Brazil have been locked in a duel to be not just the best bank in the country but the region. A mixture of good management (driving internal consolidation) and luck – sitting pretty in a huge, growing economy with 200 million-plus consumers and with a legacy of high real interest rates – meant that Bradesco and Itaú Unibanco were, in switchable order, the best and second best banks in Latin America for years.
That has changed, even though a quick look at the banks’ headline figures would seem to show it’s almost business as usual, despite a deep two-year recession.
Closer scrutiny of some of the banks’ key metrics show a big decline versus the best banks elsewhere in the region. There are also severe concerns that these big players may be just months away from revealing the credit stress that has been steadily building beneath the reported delinquency numbers.
Instead, Credicorp’s Banco de Crédito del Peru has usurped them to become the best bank in the region, while many banks outside Brazil enjoy better dynamics.
Is that a bold claim?
Look first at return on equity. According to a UBS banking report, ROE at the end of this year should be 18.2% for Itaú and 17.4% for Bradesco. That’s a great return, albeit down on 2013, when Itaú reported ROE of 20.4% and Bradesco 17.3%. However, while the Brazilian pair have stood still or fallen back in the last three years, Credicorp has increased its ROE to 19.9%, from 15.7%.
But that’s not the whole story, for as the Peruvian bank’s ROE has increased, its cost of equity has also fallen. Meanwhile Brazil still has the highest cost of equity (15.8% for the system) in Latin America – and second highest in the big emerging markets after China. This dynamic between return and cost of equity is crucial.
UBS banking strategist Philip Finch has highlighted this trend. He found that Peru enjoys the strongest dynamic in the balance between increasing ROE and reducing COE. In the six months to April 2016, Peruvian banks had an annualized improvement in ROE of 1.7%, while COE fell by 2.8%. That, in part, helps to explain the strong performance of Banco de Crédito del Peru.
Another way to look at this is to consider book value. Banks with an implied ROE below their COE should trade below one times book value. Itaú has fallen, from 1.9x in 2013 to 1.6x at the end of 2016 and is forecast to fall to 1.0x in 2020. Bradesco’s book value ratio is falling too, from 1.8x (2013) to 1.4x (2016) and is predicted to drop to 0.9x (2020).
UBS also predicts Itaú’s loan portfolio will be steady this year (from 14.0% growth in 2013), while Bradesco’s should fall slightly, by 0.3% from 11.4% in 2013. Meanwhile, Credicorp’s loan portfolio is up by 15.3% (17.2% in 2013) and its net earnings grew 12.3% (compared with falling net earnings of -9% for Bradesco and -13.7% for Itaú).
Here is where the danger lies for Brazilian banks: reported NPLs are up – Itaú’s to 5% and Bradesco’s at 5.5%. But they are manageable, even at these elevated levels (Credicorp’s is 2.6%). But is there worse to come?
Brazilian telecom Oi’s spectacular bankruptcy protection filing (R$65.4 billion ($19.4 billion)) in mid-June was bad enough, especially for Itaú, which Credit Suisse estimates has an exposure to the company of up to R$5.7 billion, and could trigger higher provisions that wipe out the bank’s Q2 2016 earnings. But some fear Oi is just the tip of the iceberg.
Research by Bank of America Merrill Lynch shows how far Brazilian banks’ modest rise in NPLs is due to proactive credit. According to the central bank’s estimates, without loan negotiations, NPLs would have increased by another 70 basis points.
BAML research also points to the unsustainability of this dynamic, as the banks will have to move some of these loans into the impaired column. Contrast the relatively stable NPLs with data BAML collected on general indebtedness in the economy. Households are delaying payments and the number of indebted families has also increased, up 90bp in a year to 61.8% in March.
Households with overdue debt increased to 22.4% from 18.9% in March 2015.
The figure for households unable to pay overdue bills has hit 8.2%, up from 6.3% a year earlier. Corporate bankruptcy filings also increased, and were up 24.4% year-on-year in February. Not only will all this debt hit NPLs and provisions – with unemployment still rising, consumption will be hit harder still and demand for credit and investment will continue to fall.
In Peru, and elsewhere in the region, growth is picking up. Unemployment is low and demand for credit continues. It’s little wonder, then, that for the first time in a long time, Itaú and Bradesco aren’t getting envious looks from the best of the rest of Latin America’s banks.