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Brazil’s banks making hay in 2017 as rain forecast for 2018

Short-term factors driving strong improvements in earnings and ROE; revenues the issue next year as credit demand remains weak.


The Brazilian banks’ second quarter and first half 2017 reporting season is under way and the results suggest the banks will enjoy a strong year

However, despite the latest improvements in performance, some analysts are becoming more cautious about a deterioration in next year’s operating environment.

Brazilian banks are enjoying a confluence of positive short-term factors that are boosting results.

The cost of risk (a combination of the US 10-year Treasury rate, the 10-year Brazil CDS and the 10-year breakeven differential between Brazil and the US, which is calculated by Credit Suisse to be at 8.7% – much lower than the spike of 10.2% that followed May’s political shock) is a proxy for the cost of equity, which is helping to drive profitability.

Brazilian banks are also benefiting from improvements in asset quality, reflected in lower provisions and non-performing loans (NPLs), and the positive short-term benefit from lower interest rates, given that most banks don’t hedge the mismatch between loans and deposits.

Selic cutting cycles 



Fall (pts) 













* estimate



Source: Banco Central do Brasil

The early reporters – Bradesco and Santander Brasil – are good examples. Bradesco reported R$4.7 billion ($1.5 billion) in net income for 2Q17 – up 13% year-on-year and pushing return on equity to (ROE) 17.8% (up from 18.1% in 1Q17 and 17.5% in 2Q16).

Santander Brasil also continued its impressive momentum story with a 16.5% year-on-year increase in net interest income, to R$9.1 billion, and is on track to meet its ambitious target to improve its ROE to the level of the main private-banking peers in Brazil. ROE in the second quarter was 17.2%, up from 12.1% in 2Q16.

However, falling short-term interest rates will require an increase in volumes if banks are to maintain strong earnings, given the likely pressure this will have on credit spreads. The Selic – Brazil's key short-term interest rate – is predicted to end 2017 around 7.5% before bottoming out at 7.0% early next year.

There will also be limited potential for improvements in the cost of risk to drive further improvements in banks’ results in 2018, when banks will be looking for a growth in credit demand – which is linked to nominal GDP, and in turn to the political situation – to be the main driver.

Credit Suisse estimates that the system’s credit growth will fall by 1.3% this year and only grow by 1.7% next year due to credit amortizations outpacing originations. This projection, which would be equal to a real-term cumulative decline in system loans of 7% between 2016 and 2018, would take credit-to-GDP to below 45% for the first time since 2011.

Analysts at BTG Pactual agree. In a note on Thursday, analyst Eduardo Rosman prepared the ground for declining expectations for credit demand in 2018. The report bluntly states: “We believe most banks will have to lower their guidance for loan growth in 2017. We also expect the banks’ rhetoric for 2018 to be a bit more cautious than what they were indicating just a few months ago.”

The reason is yet another return of political risk in Brazil.

Brazil’s political milieu has soured dramatically since mid-May," writes Rosman. “Those who expected, back then, lending books to start growing will almost certainly be proved wrong.” 

He adds that his predictions of loan growth of around 5% and 8% in 2018 and 2019 respectively “are starting to look overly optimistic”.

Sluggish demand

Data from Brazil’s central bank show that the corporate segment is responsible for most of the sluggish demand for new credit. In 2016, loan originations ran 15% lower than amortization and this is to be around 11% lower this year, and Credit Suisse’s Marcelo Telles doesn’t expect originations to overtake amortizations until 2019.

According to Telles: “Even the expected pick-up in economic activity is not enough to make originations catch up with amortizations. Much higher levels of nominal GDP growth would be necessary for a faster catch-up, but [is] unlikely at this point.”

That uncertainty is caused by the direct correlation between credit origination and nominal GDP performance, with weak expectations this year and next given the political uncertainty and the presidential election next year.

Meanwhile, the boost to banks’ results this year from the falling Selic will turn into a challenge next year. The boost to earnings from the bank’s unhedged loans and deposits (only Itaú Unibanco is reported to hedge this risk) will fade and in its place will be a challenge for banks to manage the fall in net interest income brought about by a lower interest-rate environment.

In the longer term, banks will need to increase volumes – a difficult task given the weak economy.

Lower interest rates should be a positive for asset quality, although the weak transmission of Selic to spreads in the retail sector makes quantifying this impact challenging. Also, risk metrics have already been improving and, in the case of Bradesco at least, have been central to the improving performance.

Bradesco’s NPL ratio improved for the first time in nine quarters, down to 4.94% in 2Q17 from 5.63% in the first quarter of this year. Bradesco also revised its guidance for provisioning expenses related to bad loans in 2017 to R$18 billion to R$21 billion, from R$21 billion to R$24 billion.

However, Natalia Corfield, equity analyst at JPMorgan, points out that while asset quality at Bradesco was “somewhat better … further improvements might be limited by Brazil’s uncertain macro and political scenarios”. 

She also highlights the contraction of the bank’s corporate loan portfolio – down 1.8% when compared with the first quarter – as a potential trend that could put a brake on the bank’s positive earnings performance next year.

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