Plunging Brazilian Interest Rates and Your Portfolio
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The top three Brazilian banks – Banco Santander Brasil (NYSE: BSBR), Banco Itau Unibanco (NYSE: ITUB) and Banco Bradesco (NYSE: BBD) have fallen between 20% and 30% since March. Of course, everyone is skittish about foreign banks and slowing global growth right now. However, the Brazilian banks’ fall comes after a much more concrete threat to profits: a slashed benchmark rate.
Brazilian banks have reaped huge profits over the last decade because Brazil features some of the highest interest rates in the world. In April, the average commercial interest rate was 35%, down from 37% in March, and credit card rates remain above 150% APR. The high interest rates are a holdover from the turbulent and inflation-plagued 1980s, when extreme uncertainty justified high risk premiums. But in the booming economy of the last decade, banks have reaped most of that interest, often on short-term loans, in profits. While high rates made sense in the past, they smack of rent-seeking in 2012.
Brazilian President Dilma Rouseff has aggressively cut Brazil’s benchmark interest rate, SELIC, from 12.5 in October to 9 in April, the biggest cut to any country's benchmark in that period. Finance Minister Guido Mantega has repeatedly gone on record to say that the rate is not up for debate and could be cut further this year. The reasons behind cutting the SELIC make both macroeconomic and political sense. First, Brazil’s economy slowed from 7% growth in 2010 to 2.7% in 2011 and the administration is lowering the SELIC to stimulate growth, a common monetary policy move. Second, high interest rates have been widely criticized by Brazilians as a rent transfer from consumers and entrepreneurs to big banks. Third, the high SELIC rate is an antiquated political maneuver that benefits wealthier Brazilians with savings accounts. As Brazil consolidates its position as a dynamic democracy with a large market of (lower) middle class consumers, cutting the SELIC down to international standards makes political and economic sense.
The banks tried to protect their cash cows by taking loans at lower rates from the government and each other while keeping consumer rates high, but the administration changed the rules. The Brazilian banks may finally charge rates that resemble the regional and global norm. For shareholders, this means an end to easy profits and high dividends, and a dive in shares’ fair value.
Following increased pressure from the government, Itau lowered interest rates and released a public statement in support of the administration’s policies. Itau stated that lowered interest rates help new and old businesses alike, boosting Itau’s bottom line through sustained demand for loans, according to the Wall Street Journal. There is plenty of truth to this statement and Itau, as the largest private bank in Brazil, stands to gain from growing domestic businesses. However, federal lender Caixa Economica and parastatal Banco do Brasil’s rate cuts forced Itau to also cut its consumer finance rates. CEO Roberto Setubal told Reuters on May 28th that the bank would likely restrict new consumer finance and require more collateral. These moves will reduce the bank’s loan and credit portfolio growth.
Bradesco also reduced interest rates on loans this month after Caixa and Banco do Brasil cut their rates. The Wall Street Journal expects Bradesco to follow Itau in reducing new loans and requiring more collateral. This move would add only high quality borrowers to Bradesco’s portfolio and most likely reduce nonperforming loans going forward, which have increased by 15% over the last year. However, restricting loan growth reduces Bradesco’s profits as well as risk.
Banco Santander Brasil reported low profit margins in 2011 compared to Itau and Bradesco, at 13% as opposed to 26% and 24%, respectively. Banco Santander Brasil could be looking at a particularly disappointing earnings report if rate cuts keep digging into profits. The SELIC started going down in October, thus the fourth quarter results offer some guidance on future results. Income from interest actually increased 10% in the fourth quarter, but profits were down slightly at .2%.
The Brazilian banks’ decline doesn’t just affect direct shareholders. All three banks are substantial parts of Brazilian ETFs; for example, Itau, Bradesco, and Banco Santander Brasil account for over 20% of iShares MSCI Brazil Index’s (NYSEMKT: EWZ). iShares Brazil -- the largest Brazil ETF and one of the largest of emerging market ETFs -- has fallen from $70 in March to just above $50 in May as Brazilian commodity and financial stocks continue to get pummeled. Additionally, bulls on Banco Santander’s (NYSE: SAN) global business keep pointing to last year’s profits in Brazil as a sign that the bank has been unduly punished by the Europe mess. I beg to differ, and recommend that shareholders of other banks with Brazilian holdings take a closer look instead of blithely assuming that those profits will continue to trend up.
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