After two years of the worst recession experienced in decades, and unprecedented corruption scandals that tainted political and business elites, Brazil’s largest banks now look in good shape. Itaú Unibanco, Bradesco and Santander – the largest privately owned groups in the country – closed 2016 with pre-tax profits significantly higher than a year earlier: 150% and almost 300% growth for Itaú and Bradesco, respectively. There was an even more significant improvement for Santander, which turned the business profitable again after the previous year’s loss.
Things were similarly good for the largest 20 lenders operating in the country. With improving macroeconomic data and a number of policy changes set to benefit lenders, the future looks brighter still.
“Some of the positive factors that we’ve celebrated in 2016 and 2017 are the results of macroeconomic policy: declining inflation and interest rates,” says Luiz Carlos Trabuco, CEO of Bradesco. “There’s a decoupling of the financial sector and of the political situation. Here we are today, looking at a new scenario, where we’re seeing stronger rule of law and economic principles. The worst is behind us.”
Retaining confidence
Brazilian banks’ careful risk management, which helped deliver 2016’s results, will now be supported by the early signs of economic recovery. Markets still have confidence in the country, despite the violent political turbulence brought on by the corruption investigation dubbed 'Operação Lava Jato', which translates as 'Operation Car Wash'. And after diving since mid-2014, the Brazilian real gradually started to gain ground against the dollar last year.
Furthermore, a new policy at BNDES, Brazil’s development bank, aims to reduce the distortion brought by its subsidised long-term rate to the loans market. The TJLP, as the rate is called, will be replaced in 2018 and a new rate will gradually be reduced and brought in line with the government’s five-year bonds’ rate by 2023. The TJLP was nearly half the central bank’s benchmark rate, the Selic, for the past two years, and ranged between 5.5% and 7.5% against a Selic that moved from 12.25% and 14.25% in 2015 and 2016. A reduction of the Selic to the current 9.25% is already helping reduce distortion, and some expect it to drop to 8% by the end of 2017.
The BNDES’s subsidised rate will also favour projects that show social and environmental impact, allowing private sector banks to become more appealing alternatives for any other type of borrower. Although there are doubts over the pace at which a heavyweight such as BNDES can change direction, its newly stated policy inspires hope.
Over the past decade, the development bank and the two major public sector lenders, Banco do Brasil and Caixa Econômica Federal, have gained prominence as the government sought to enact its policy on the growth of national corporate giants as well as social policy through them, often crowding out private sector banks from specific markets.
“Banco do Brasil, Caixa Econômica and BNDES have more than 50% of banking assets. If you go back 10 years, this was probably about 30%,” says Citi Brazil’s CEO, Helio Magalhaes. “The government at the time used the public sector banks to finance business more than it should have.”
Santander Brasil’s CEO, Sergio Rial, adds: “We have a saying, ‘the state has arrived in Brazil before the market’. [But] there’s plenty of room for us to change over time. Brazil responds incredibly well to [a protracted] low-interest-rate environment from an economic point of view. We may be surprised by how the economy picks up beyond 2018. I feel very comfortable that this will trigger new investment and that banks, both private and public, will take a much more market-driven pricing strategies approach than we’ve seen in the past.”
Issuer optimism
As the Selic stabilises around a smaller figure and the Brazilian economy improves, Mr Magalhaes is optimistic that there will be more activity from issuers that have been postponing expansion and financing plans in the hope of more favourable conditions. “The change from public to private [sector bank financing] will take some time, until we see the economy on a more sustainable growth path and companies deciding to finance projects,” he says. But he is confident that the change will come.
Lower interest rates would also reinvigorate the local capital markets by making corporate issuance more appealing to investors typically drawn to the well-paying, low-risk sovereign bonds, says Candido Bracher, CEO of Itaú Unibanco. “[It] will pressure Brazilian investors, such as pension funds, which usually have aggressive inflation and actuarial targets, to diversify their allocations away from government bonds into corporate credit and, in a second stage, once the economy starts to recover in a sustained way, into equities,” he adds.
A further boost will be provided by the government’s new impetus on infrastructure. The government’s current portfolio is equal to 85bn reais ($25bn) of planned works, ranging from airports to highways, from hydroelectric power to oil and gas projects. BNDES’s minor interest in such deals will help attract private sector financing (the bank could provide subsidised loans on a transport project of up to a maximum of 50% of total).
“I think that once the political crisis is over and demand for infrastructure financing increases, there will be a financing gap due to the BNDES's more defensive posture,” says Mr Bracher. “Brazilian banks will be well positioned to bridge the gap.” He mentions lending, financial advisory as well as the structuring of products to raise financing from export credit agencies, multilateral agencies and the debt capital markets.
New deal structures are also set to push up the frequently underwhelming internal rate of return on infrastructure projects, which has often deterred international investors. The rate would go from about 8% to 13%. While other measures have been designed to attract foreign companies to Brazil’s infrastructure, international investors have proved good sources of business for Brazilian banks even during the crisis.
Foreign buyers
While the recession and political turmoil stifled local activity, international investors stayed active in Brazil as the crisis forced a number of disposals. For example, as a corruption scandal hit state-owned oil giant Petrobras (which, at the same time, found itself dealing with unsustainable levels of debt), the company sold valuable assets, which were snapped up by international competitors and investment funds.
With a total of $75.8bn, foreign takeovers of Brazilian targets were almost twice the value of local mergers and acquisitions (M&A) between the beginning of 2015 and early August 2017, according to data provider Dealogic. Brazilian banks’ M&A advisory business benefited from the international buying spree, which in 2016 resulted in a ratio of foreign to local buyers of four to one.
“Something very important to highlight is foreign investment, which remained high and helped compensate for the lack of local investment,” says Mr Trabuco. “Brazilian banks are particularly active in supporting foreign investors and foreign acquisitions in Brazil.”
This trend is set to continue, says Santander’s Mr Rial. One set of buyers in particular will provide many growth opportunities to Brazilian banks ready to provide financial advice: Chinese companies. China has been particularly active in the energy sector, with State Grid of China carrying out 2016’s largest takeover in Brazil, the $8.61bn acquisition of CPFL Energia. Bradesco, Itaú and Santander all worked on the deal, alongside UBS and Bank of America Merrill Lynch. Another Chinese company, China Three Gorges, the world’s largest hydroelectric power group, secured the largest Brazilian deal of 2015, the $3.7bn acquisition of the Jupia and Ilha Solteria hydroelectric plants. Chinese buyers pepper the list of the largest international takeovers of Brazilian companies over the past two years.
“What makes Brazil particularly interesting for [China] is the size of deals,” says Mr Rial. “If you think about [electricity] distribution lines, there aren’t many other countries in the world where you could have a 4000-kilometre distribution line, [which runs] from the Amazon to São Paulo.”
Smoother operations
Progress with ambitious reforms aimed at modernising labour, tax and pension rules is also encouraging, particularly as this work continues amid the ongoing corruption investigation. A better business environment will help attract more foreign players, as well as boost local activity – and therefore financing needs, in terms of both loans and in corporate bonds and equity issuances – despite political risk. While adding to this risk in the short term, the judicial work to uncover corporate and political wrongdoings will also hopefully lay the foundations for stronger institutions and rule of law, improving Brazil’s business environment and, ultimately, boosting banks’ prospects.
“The coming years should see brisk activity in both debt and equity capital markets; the risk to this scenario is of course political uncertainty,” says Mr Bracher. But Mr Rial adds: “Politics is not influencing what needs to be done: thinking about reforms in the midst of so much pull and push right now is remarkable. We’ll get to 2018 in much better shape than [we would have done without the Lava Jato].”
As Brazil seems to be taking a path to sustainable growth, expectations are high for its banking sector.
