Time to Consider Investing in Brazil´s Banks

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Brazil´s economy came crashing to Earth with a resounding thud in 2011 and 2012, with annual GDP growth plummeting from 7.5% in 2010 to 2.7% in 2011 and 0.9% in 2012. This can in part be attributed to Brazil being an export driven economy which is reliant upon global demand for both its commodities and manufactured products. Demand for these exports in two of Brazil´s key export markets; the European Union and China, declined significantly because of the European financial crisis and China´s economic slowdown.

This saw demand for credit particularly among the more profitable commercial banking segment decline and non-performing loans rise. This had a significant impact on credit growth and the profitability of the country´s banks, which saw their share prices fall. However, with the economic outlook now being more positive, with GDP growth forecast to be around 3% for 2013 and 2014, now is time for investors to reconsider gaining exposure to Brazil and the country´s banking sector.

Brazil´s three largest privately controlled banks; Itau Unibanco (NYSE: ITUB), Banco Bradesco (NYSE: BBD) and Banco Santander Brasil (NYSE: BSBR) are currently listed as ADRs on the New York Stock Exchange. An investment in any of those banks will provide investors with exposure to an improving Brazilian economy, which should see demand for credit grow. But the key question is which represents the best opportunity for investors?

Itau Unibanco is Brazil´s largest privately controlled bank by assets and continues deliver impressive results despite the economy slowing. For the full year 2012 the bank reported a 7% decline in net income to $6.8 billion, but this was on the back of growing operating revenue, which increased by 6% to almost $40 billion. The bank also continued to deliver a solid return on equity, which or the full year was 18%, while the return on assets was 1.5%.

More impressively though, is that despite the slowing economy Itau Unibanco´s non-performing loan ratio fell slightly to be at 4.8% by the end of 2012. This indicates that the bank´s asset quality remains high and this should continue to improve as economic activity in Brazil continues to pick-up.

Banco Bradesco is Brazil´s second largest privately controlled bank by assets and for the full year 2012 also reported solid financial results despite the slowing economy. The bank reported an almost 3% increase in net income to $5.8 billion on the back of a 15% increase in operating revenue to around $25 billion.

The bank also delivered a solid return on equity of 19% and return on assets of 1.4%. However, asset quality did decline slightly with the bank´s non-performing loan ratio increasing by 20 basis points to 4.1%. But again I would expect to see asset quality improve and the non-performing loans decline as the economy continues to improve through 2013 and 2014.

Finally, there is Banco Santander Brasil, which is the country´s third largest privately controlled bank by assets. Since the bank´s much hyped IPO in 2009 it has continued to underwhelm investors, with declining asset quality continuing to impact profitability. Of the three largest privately controlled banks, Banco Santander Brasil has been the worst performing, but there are signs of significant improvements in the bank´s performance.

This disappointing performance continued into 2012, with the bank reporting an almost 30% decline in net income, which was reported as $2.7 billion, despite operating revenue growing by 1% to just under $30 billion. The bank also reported a significant decline in asset quality with its non-performing loan ratio increasing by 1.7% to 6.8%. But the bank reported a significantly improved return on equity of almost 18% and a solid return on assets of 1.5%, boding well for increased profitability as Brazil´s economy continues to grow.

Banco Santander Brasil´s poor financial performance has seen it sold down by the market since its IPO, with the share price having fallen by around 43% since then. This I believe has created an opportunity for risk tolerant investors to take advantage of the bank´s depressed share price as it continues to work towards improving its business and risk management practices.

On the back of improving economic growth, along with Brazil hosting the 2014 FIFA World Cup and 2016 Summer Olympics, there will be an uptick in business activity and a growing demand for credit. This will create a favorable operating environment for all three banks, which will see their profitability grow while delivering double digit returns on equity, with improved asset quality.

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