Brazil’s banks see multiple drivers for 2018 growth

COPYING AND DISTRIBUTING ARE PROHIBITED WITHOUT PERMISSION OF THE PUBLISHER: CHUNT@EUROMONEY.COM

By:
Rob Dwyer
Published on:

GDP and credit growth should offset lower NII; greater efficiencies also sought to preserve strong results.

As the Brazilian central bank nears the end of its cutting cycle – with the Selic (the Brazilian central bank’s overnight rate) predicted to be at or near 7% in the first quarter of 2018 – the focus for the improvement in the results of the country’s banks is set to switch to credit growth.

Brazil’s banks have been profiting from an improvement in the cost of the country’s risk, better economic prospects and reduced political noise.

Most have also been benefiting from the falling Selic as they run unhedged mismatches between loans and deposits, which have been boosting earnings in the short term. However, to continue improving earnings next year, the banks will have to compensate for lower net interest income with renewed growth in the loan portfolio, as well as deeper cost cutting.

“The timing and the magnitude of the credit recovery in Brazil is the main theme these days”
Marcelo Telles, Credit Suisse

“The timing and the magnitude of the credit recovery in Brazil is the main theme these days,” says Marcelo Telles, Credit Suisse’s equity analyst for Brazilian banks, who in October increased his forecasts for credit growth in the system to -1.1% in 2017, 3.1% in 2018 and 6.5% in 2019 (from -1.3%, 1.7% and 5.6% respectively).

brazil-loan-growth-300x431
He says that he expects loans to individuals and small and medium-sized enterprises to lead the way, but the corporate segment will be a drag (-6.8% for the year until August).

“The better but still relatively modest growth in the short term is explained by the carry-over of weak credit originations in the past two years compared to amortizations,” notes Telles.

Following an 8.7% decrease in originations in 2016, Credit Suisse anticipates a 1.5% decrease in 2017, a 6.7% increase in 2018 and a 9.8% improvement in 2019.

“The issue affecting the system’s ability to grow the loan portfolio balance is the fact that originations are now running substantially lower than amortizations,” argues Telles. “Even the expected pick-up in economic activity is not enough to make originations catch up with amortizations.”

Modest driver

If these forecasts are broadly accurate, credit growth will be a modest driver of banks’ results – especially when combined with lower net interest margins (even adjusting for expectations that private-sector banks will see higher rates of growth at the beginning of this cycle than public banks).

Therefore, Brazil’s banks, particularly the publicly held institutions, will need to push further with their plans for better efficiency if they are to maintain recent momentum.

Banco do Brasil’s management appears to grasp this.

The bank has announced a plan to cut 7.4% of its branch network and convert a further 7% to points of service, meaning an approximate 9,400 reduction in the bank’s headcount.

The annual savings announced by the chief executive could generate around $3 billion – around 9% of total operational expenditure in 2016.

The bank also reduced its dividend pay-out ratio to 25% from 40% in 2016 and used retained earnings to meet Basle III capital requirements without raising new capital, which, coupled with the plan to sell its Argentine subsidiary Banco Patagonia, has been supporting the bank’s share price.

Philip-Finch_160x186
Philip Finch, UBS
UBS, for example, has responded by upgrading Banco do Brasil’s equity. In October, it moved the bank to neutral from sell. Lead financial institutions analyst Philip Finch says proprietary research suggests Brasil’s management could increase savings through even deeper cuts to its network: a further 10.7% of branches (beyond those already announced) would lead to another 20 basis point uplift in return on equity (ROE).

Banco do Brasil’s chief executive, Paulo Rogerio Caffarelli, who assumed control in May 2016, aims to get the bank’s ROE up to levels comparable with his private-sector peers. He has already had some success: from 8.8% reported in 2016 to 13% forecast this year by UBS, and 14% expected next year.

Credit Suisse’s Telles has Banco do Brasil at outperform – driven by this improvement in ROE, which he believes will hit 17% in the coming years. Also, from a credit growth perspective, Telles points out that Banco do Brasil’s efficiency-drive needs to get ahead of its exposure to falling credit participation from state-bank BNDES.

Big impact

The reduction in BNDES’ portfolio is impacting the pass-through disbursements of all financial institutions in the system. The end of the crowding-out by the state development bank (with greater competition from the debt markets, for example) will lower the participation of large corporates’ debt on the banks’ balance sheets – with Banco do Brasil having a 27% share of this top-tier corporate sector.

The private banks are also targeting the public banks’ domination of the rural and real estate sectors, as the decline in the Selic rate increases the competitiveness of non-earmarked lending. Banco Santander has been particularly active in targeting rural credit growth and has hired a team of 100 agro-engineers to boost its agricultural lending department.

However, in the short term, the banks should be driven by the retail sector, says Telles.

“The portfolio of loans to individuals should resume more quickly,” he says. “Originations in the retail sector are up 7.5% in 2017, driven by payroll and auto loans.”