Brazil: BMG’s short-sighted asset sale to Itaú
Sale of JV stake will boost capital ratios but adds strategic uncertainty, while the acquisition further strengthens Brazil’s largest private bank.
BMG’s sale of its 40% stake in a payroll loans joint venture to its partner Itaú has been welcomed by a credit rating agency as it bolsters the mid-tier bank’s immediate financial stability. However, others question the strategy and impact to the bank’s future profitability and viability.
For Itaú, it is another important counter-cyclical acquisition of a Brazilian asset, after it bought part of BTG Pactual’s Recovery business and its about-to-be-announced purchase of Citi’s Brazilian bank.
Robert Stoll, director at Fitch Ratings in New York, described BMG’s decision to sell its 40% stake in BMG Consignado for R$1.28 billion ($397 million) as “credit positive”, as it is “expected to strengthen BMG’s credit metrics, mainly the capitalization ratios, while it continues to grow its core business of credit-card lending backed by payroll deduction”.
This short-term evaluation is correct: analysis of its balance sheet shows that the bank’s capital ratios have been steadily declining. BMG’s tier-1 capital ratio was at 6.7% in June, compared with 15.7% in December 2014. Given that the bank’s profitability is low – net income in the first half of 2016 was just R$33 million – capital replenishment capacity is limited. On top of that, Basel III rules will negatively impact on its subordinated debt that is currently used as tier-2 capital.
However, one fixed income analyst says that the deal highlights BMG’s longer-term strategic challenge.
“The bank’s future becomes somewhat uncertain following the sale of the JV,” he says. “The bank’s partnership with Itaú to form the JV led to the transfer of BMG’s payroll operations to the new company, which made BMG a significantly smaller bank in terms of asset size and with a weaker competitive position. BMG has lost a good asset with a strong partner that provided the bank with a solid dividends stream.”
Since the joint venture with Itaú was established in 2012, BMG’s retained payroll loan portfolio – a previous strength for the bank – shrank from R$10.4 billion in 2014 to a residual portfolio of R1 billion by June 2016. The bank’s effort to expand into other segments such as the corporate payroll credit card businesses have not been enough to offset the loss.
Meanwhile, SME business loans fell from R$2.7 billion in mid 2015 to R$2 billion in the first quarter of 2016 and remained flat in the second. This reflects weak demand for credit in Brazil as well as a conservative risk policy by the bank’s management. It is still unclear if new businesses – such as the launch of BMG Seguros in the insurance sector – will provide large enough additional revenues.
Analysis of the remaining credit portfolio shows the bank’s strategic aims: the volume has remained level at R$8 billion but the composition has changed. The payroll credit card loans segment has increased from R$1.7 billion to R$4.4 billion, while vehicle financing and non credit-card payroll businesses have been discontinued.
“This failure to grow the entire credit portfolio suggests it will continue to struggle to add the scale it needs to dilute fixed costs and expenses, in which case profitability will remain low,” says the fixed income analyst.
He also pointed to the volatile yields on the bank’s outstanding bonds – the BMG 19s peaked at 16% in February (as rumours circulated in Brazil about a possible acquisition of Banco Pan by BMG) before falling, recently trading between 7.8% and 9.7% – as a potential source of a liability management exercise if the bank is able to secure better priced debt due to its improved capital ratios.
Meanwhile, Itaú has taken 100% ownership of a performing asset and has concluded a 10-year exclusive agreement with BMG to use the smaller bank’s distribution channels. Neither bank provided details about the financial incentives for this marketing agreement.
BMG deal follows other opportunities taken by Itaú as smaller banks suffer: at the end of last year Itaú bought 82% of Recovery do Brasil Consultoria, a credit recovery company, from BTG Pactual as the latter dealt with the liquidity crisis caused by the arrest of the bank’s then-CEO Andre Esteves. Itaú paid R$640 million for Recovery and bought some of BTG's credit portfolio.
Itaú’s share price reflects this momentum: in early October its market cap was $85 billion – making the Brazilian bank the largest emerging market bank outside China. It fell as low as $42 billion in early February this year.
Itaú’s acquisition of Citi Brazil is expected to be agreed by October 10 in another example of the continued consolidation of the private Brazilian bank sector into the hands of Itaú and Bradesco. Citi entered into exclusive talks with Itaú at the end of September after Santander Brazil failed to match the larger bank’s valuation for the unit that has a retail credit portfolio worth an estimated R$8 billion.
Itaú’s acquisition of Citi Brazil comes as Bradesco announced that its purchase of HSBC’s Brazilian banking businesses was finalised at the beginning of October.