Brazilian banks could be entering a new credit cycle


Rob Dwyer
Published on:

Macro-economic recovery and falling Selic paint positive outlook; credit growth frustrating the rosy outlook.

There are signs the banks are moving into a new and positive credit cycle as Brazil approaches the end of its monetary-easing cycle and expectations for the country’s GDP growth in 2018 improve.


Philip Finch, UBS

“After four years of downturn, Brazilian banks are approaching a new lending cycle,” says Philip Finch, financial analyst at UBS.

The Selic interest rate is expected to fall to between 6.5% and 7.0% in early 2017 and, crucially, is expected to remain around that level for at least a year.

The reduction of the country’s base interest rate by more than half in the past couple of years should add to the trend to improving asset quality and lower provisions.

Meanwhile, GDP growth is forecast to hit around 3% next years – sparking expectations of renewed credit growth and banks’ re-risking lending portfolios.

Finch recently visited Brazil and has subsequently upgraded the country’s banks to overweight as a result of those meetings.

“With GDP growth expectations rising, we believe the banking sector is about to move into a new lending cycle with a re-risking of loan book expected to help offset NIM pressure,” he says.

Risks remain

However, as yet there is no sign of a recovery in credit demand, with highly leveraged companies and consumers, and still-high unemployment at 12.6%.

GDP growth is also still modest, albeit positive, and risks remain. Itaú Unibanco says it expects Brazil’s third-quarter GDP growth to just edge up 0.1% quarter on quarter and predicts annual growth this year of just 0.8%.

Itaú also says the risks to its 2018 GDP forecast (3%) are to the downside, with likely lower agricultural growth after a bumper harvest in 2017. Drought conditions are expected, meaning higher use of expensive thermal power plants – and industry cutting production to avoid higher costs or to profit by selling power contracts back to the grid.

Also, political uncertainty in a presidential election year and uncertainty regarding fiscal reforms could lead to a deterioration in investor confidence in Brazil – damaging financial conditions.

Such underwhelming growth seen so far has yet to feed into renewed credit demand. In September, data from the central bank showed that total bank lending contracted by 2.0% year on year and fell by 2.1% when compared with the previous month.

Credit Suisse states in a client note that, as a result, bank lending as a percentage of GDP remains on a downward path – to 47.0% in September from 47.1% in August.

Cutting back

Meanwhile, lending by BNDES fell by 11.3% (year on year) in September as the state development bank continues to cut back its dominant role in credit in Brazil – a large part of this dynamic. Earmarked loans continued to contract, with year-on-year growth in this segment declining from -2.8% in August to -2.9% in September.

According to Credit Suisse: “While non-earmarked loans have rebounded in recent months as a result of easing monetary and financial conditions, earmarked loans continued to contract, a movement driven mainly by the stricter lending conditions imposed by public-sector banks.

“We think this process will remain in place in the short term, preventing a sharp acceleration in total bank lending in the coming quarters.”

Tito Labarta-160x186
Tito Labarta,
Deutsche Bank

Deutsche Bank’s Tito Labarta agrees, saying: “Loan growth remains weak and NIMs face pressure from lower interest rates.” 

However, Labarta does point out that banks’ results will be supported by the continued improvement in asset quality, which is leading to lower provisions.

This dynamic was seen in the recent Q3 results: Bradesco and Itaú both beat the markets’ expectations due to lower operating expenses and lower provisions. Meanwhile, Banco do Brasil continues to impress by delivering on its cost-cutting programme that is designed to boost the bank’s return on equity.

To be fair, the upgrade by Finch at UBS noted a potential improvement in lending growth and banks’ “re-risking” of their portfolios – particularly to SME and consumer segments – but wasn’t predicated on this dynamic.

Indeed, he didn’t change his forecasts for lending growth – 5.2% in 2018 and 8.3% in 2019 – although he does stress that in his October meetings with senior managers of Brazilian banks they “indicated that loan origination, notably among the consumer book, has started to pick up”.

Rather, UBS’s view comes from the technical improvements from the lower Selic rate that will drive a positive earnings cycle, with the cost of risk falling and having an impact on banks’ cost of equity (CoE).

According to Finch: “There is a high correlation between the Selic rate and the Brazilian banks’ implied CoE. The falling Selic suggests CoE could come down further, with potential upside for bank valuations.

“Our model indicates that Brazilian banks’ implied CoE is at 13.8%, but could fall to 13.5% should the Selic fall to 7.0%.”

Also, better cost control and falling inflation will reduce cost growth – coupled with better asset quality and therefore lower provisions – and combine to improve earnings and return on equity.

The move to rationalize branch networks and the focus on the improvement that digitization can bring to operational leverage should continue to bring efficiencies to the large Brazilian banks.