It is hardly news that life has become more challenging for Brazil¹s big banks. With economic growth slowing and the Selic benchmark interest rate falling to earthly levels, lenders are waving goodbye to profitability rates above 20%.
Although consumer credit has not brought the bubble many feared, there is still the danger that lenders may have overextended, particularly if the economy which few can count on any more to grow at the 6% of years past turns for the worse.
On top of this, the government has been piling pressure on credit providers to lower the rates charged to consumers for loans, credit cards and other products. Private lenders are additionally challenged in that they have to compete with state-owned Banco do Brasil and Caixa Econômica Federal, which enjoy lower-cost federal funding.
Brazil¹s larger banks are best equipped to withstand lower profits and an increase in impairments, as well as the new lower interest rate environment.
The key will be keeping credit costs low.
³The Selic is in an adjustment phase and is moving towards a normal rate that is compatible with the solid fundamentals the Brazilian economy now has,² Bradesco CEO Luiz Trabuco Cappi tells LatinFinance. ³The quality of our economy means there is no longer any reason for double-digit interest rates. Bradesco¹s working scenario is one in which Brazil has changed for the better and this change is permanent.²
For the second year in a row, Bradesco¹s diversification and retail focus leave it in a strong position to confront these challenges. Focused on organic retail growth and buoyed by an insurance business responsible for 30% of its profits, the well-capitalized bank has nearly caught up with Itaú Brazil¹s biggest bank since its merger with Unibanco in 2008 in terms of total assets.
As of June 30, Itaú was Brazil¹s largest bank by assets with $888 billion reais ($437 billion), with Bradesco at $831 billion reais. In 2008, the gap was much larger, with Itaú leading by $632 billion reais to $454 billion reais. The growth has been entirely organic. Since the Itaú-Unibanco merger, organic expansion has been the key for all the players, with no remaining large banks left to buy.
While other banks have made small acquisitions abroad, Bradesco still sees plenty of room to grow in Brazil. The bank has been aggressively expanding its retail operations this year, redirecting resources after losing out on the postal bank contract to Banco do Brasil.
³The price in the auction was too high,² says Luiz Angelotti, the bank¹s executive managing director, explaining why Bradesco did not continue with the contract. ³We had an alternative plan which we decided was better. We made the correct decision. This adds more value for the company.²
The bank opened 1,000 new branches in the second half of 2011. Bradesco reckons it can retain the postal clients who will be reluctant to shift their accounts.
³We don¹t expect to invest in retail abroad,² Angelotti. ³Our main strategy is to invest in the Brazilian retail business. There is plenty of opportunity for growth in Brazil.²
The bank sees its limited presence abroad solely as a means of supporting Brazilian companies overseas.
³We have a better return here in Brazil and we know the market very well,² says Angelotti. He highlights upward trends in social mobility over the last eight years and points out that 40 million Brazilians have yet to tap banking services.
Its extended presence across the country, its broad range of clients and its insurance business, leaves Bradesco better placed to compete with the other large domestic banks.
Its insurance business also offers plenty of room to expand. Brazil has exceptionally low insurance premiums for such a large country. This stands at about 3.2% of GDP, and compares with 8% in the US and 11% in Japan.
Bradesco also believes there are opportunities to be found in the consolidation of the Brazilian insurance market where there are still many small companies.
Trouble from Brasilia
As the country¹s benchmark rate plummets, the government is pressing lenders to charge customers fees closer to international norms. In September, Bradesco lowered its interest rates on credit card products, along with other banks.
Improving efficiency is the key to operating in this new environment. In this regard, Trabucco Cappi says the bank¹s prospects are ³good.² The main challenge for Bradesco is how to do this while also expanding the scale of its activity, Trabuco Cappi says. As part of this the bank also wants to enlarge the relationships it has with existing clients who are demanding new products and services.
The bank sees ROE in the long term to be in the region of 18%-20%, compared to 20% this year. The spread adjustments should continue in the future, says Angelotti, and there are some factors are not under Bradesco¹s control, such as the delinquency ratio, taxation and administrative costs. Angelotti expects delinquencies to reduce in the future, but says the government needs to do its share to reduce taxes and administrative costs.
³We are taking measures to reduce the cost of our credit and credit card operations,² Trabuco Cappi says. ³The reduction in interest rates will improve default ratios and expand the loan portfolio. These effects are positive for banking.²
So far, the impact of these reductions in spreads has been mostly marginal even for state banks, according to Fitch. This is mostly due to asset growth remaining strong and to reductions in deposit rates. The ratings agency expects that the effect on overall margins will become more important over time, as they will more clearly highlight operational inefficiencies.
Lower spreads, increased competition, the outlook for slower GDP growth, and greater capital requirements will limit Bradesco¹s future profitability ratios, Fitch says, but they will be at good levels and better than the peer average.
Coping with a new reality
Non-performing loans have been an increasing problem for Brazil¹s banks.
Bradesco¹s delinquency ratios have nudged up this year, though not as much as other banks. Small and medium-sized business lending was affected in 2011, and this year vehicle loans have caused concern, affecting the delinquency ratios for banks including Itaú and Banco do Brasil.
The sector¹s NPL rate has reached 6% this year, according to Fitch, compared to 2% in some Latin American countries, and a 4% emerging markets average.
Angelotti expects Bradesco¹s delinquency ratio to reduce in the second half to around 4% (where it was at the beginning of the year).
³The decrease should continue in 2013,² Angelotti says. ³In this area, structurally lower Selic rates are a good thing, as businesses and individuals will find it easier to make payments.²
Solid employment figures will have a positive effect on individuals¹ ability to make payments. The bank expects the unemployment rate to improve from an already low 5.6%. Fitch says the bank¹s credit quality is in line with its peer average and its loan loss coverage among the highest in the sector.
Bradesco¹s large competitors have started to venture into the payroll lending segment, once the focus of the sector¹s mid-size banks. Normally, experimentation starts with smaller players and trickles up to the likes of Bradesco and Itaú. This year Itaú formed a $1 billion reais joint venture with mid-sized lender Banco BMG for payroll lending. The deal allows Itaú access to the fast-growing payroll lending segment while keeping the risks at arm¹s length. If it goes well the joint venture could be a model for other large players to follow.
Itaú has also moved this year to bring credit card processing in-house, spending more than $5 billion to buy up all of the shares in Redecard.
Though seen as an expensive acquisition, the synergies created are expected to be positive for the bank.
With inflation threatening to rise in 2013 possibly forcing the central bank to lift rates next year‹ this may not yet be the time to experiment.
Still the steady expansion seen for Brazil¹s economy ahead should provide ample room for Brazil¹s large banks to keep growing.
Bradesco plans to continue to expand organically to keep pace with its large public and private competition. At the same time lower funding costs and continued government pressure to lend more to stimulate the economy should help Banco do Brasil and Caixa continue to grow stronger.
³The greater participation by the federal banks on the market is positive and creates a challenging situation,² Trabuco Cappi says. ³However, challenges have always been part of banking activity in Brazil. The current situation is motivating us to redouble our efforts and overcome these challenges once again.² LF