RIO DE JANEIRO, BRAZIL – The second quarter, the peak of the coronavirus pandemic in Brazil – and also the worst economic moment in the country’s history – was highlighted by Itaú Unibanco Executive Vice President Milton Maluhy.
Thus, it was expected that, as in the first quarter, banks would also suffer a sharp drop in their profits in the period, amid increased provisions to address the economic impact of the pandemic.
According to the recurring criteria, the four largest banks listed in the B3 stock exchange – Banco do Brasil (BBAS3), Bradesco (BBDC3; BBDC4), Itaú Unibanco (ITUB4) and Santander Brasil (SANB11) – recorded an accumulated decline of 37 percent in profit in Q2 in the annual comparison.
Although together they profited R$13.4 billion (US$2.7 billion), the provisions for future losses were more than double that figure, at around R$30 billion.
However, albeit with a sharp drop in profits, the results were highlighted by analysis institutions as evidence of these financial institutions’ resilience, as they managed to sustain sound figures, although some lines in the balance sheet may have displeased investors.
Those who stood out positively among the banks were precisely the first to report their financial statements: Santander Brasil and Bradesco.
About the Brazilian subsidiary of the Spanish bank, it should be noted that its result was greatly impacted by the increase in provisions that had not been made in the first quarter (and which, strangely, caused the bank’s profit to rise in the first three months of the year).
However, the high net expense with bad debt provisions, which totaled R$ 6.53 billion, 91 percent higher than the preceding quarter, was well accepted by investors. The bank reported that it set aside R$3.2 billion in extraordinary provisioning expenses in the quarter due to the novel coronavirus pandemic.
According to Bradesco BBI, although this may seem counter-intuitive, given that the rising provision can be viewed as an indication of deteriorating asset quality, the substantial increase recorded in Q2 should bring Santander Brasil closer to its peers when it comes to recording recoverable gains in coming periods.
However, this was not all: the financial result’s performance was stronger than expected, with greater resilience of the gross financial margin (NII), driven mainly by the cash result, which benefited from the drop in the fixed-income (ALM) interest rate and a lower funding cost.
Bradesco, on the other hand, despite not achieving a positive result, had its numbers viewed favorably by investors. For the second consecutive quarter, the bank reinforced its provisions with credit losses of R$3.8 billion. In Q1, Bradesco had already set aside R$2.7 billion in provisions to protect itself from the impact of the coronavirus crisis on customers.
As a result, total provisions reached R$8.89 billion, up 155 percent from the same period last year and 32.5 percent from the first three months of the year (R$6.7 billion). The total protection cushion thus reached R$15.6 billion, higher than expected and strengthening the bank’s balance sheet.
Credit Suisse analysts also reinforced that, before the impact of provisions, the profit was 15 percent higher than the bank’s analysts’ estimates. “Bradesco leveraged the strong operating performance in NII, opex [operating expenses] and insurance to strengthen its provisions, also creating extra provisions in the amount of R$747 million to offset the low coverage ratio in the insurance subsidiary,” evaluated Marcelo Telles, Otavio Tanganelli and Alonso Garcia, analysts at the Swiss bank.
As a result, the bank succeeded in showing positive data, particularly after the first quarter result, which had displeased the market amid deteriorating asset quality, notably the increase in loan defaults. This line of the balance sheet was “definitely” the greatest positive highlight of the quarter, said Marcel Campos, an analyst at XP Investments. The default rate for over 90 days fell to three percent at the end of the second quarter, from 3.7 percent in March and 3.2 percent in June 2019.
The default rate, incidentally, was kept tightly under control among the four major banks on the Exchange. In this scenario, it should be noted that the banks have conducted debt renegotiation and extension programs. However, once these programs are over, asset quality may also deteriorate – an important point to be monitored in the coming quarters.
Next in sequence came Itaú’s figures that, often claimed to perform above its peers, disappointed investors in some lines of the balance when compared to Santander and Bradesco, although their numbers cannot be considered negative, as highlighted by BBI.
While the growth of its total credit portfolio (adjusted for exchange variation) was similar, between zero and one percent in the quarterly variation, Itaú reported a greater change in its composition, with a sharper reduction in exposure to the retail segment (individuals).
Consequently, the result from financial intermediation with customers was weaker on a relative basis (down sequentially, while Bradesco and Santander Brasil recorded better figures in the quarterly variation). In terms of tariffs, Itaú’s performance was also weaker, with revenues dropping 11.8 percent quarter-on-quarter (+11.6 percent quarter-on-quarter when insurance commissions are added), while Santander Brasil’s tariff revenues contracted 8.5 percent on the same comparison basis and Bradesco dropped 7.9 percent quarter-on-quarter.
“However, in terms of operating expenses, Itaú was among the best performers, particularly given its already strong efficiency,” assess the bank’s analysts.
Itaú recorded a net income of R$4.2 billion in Q2, down 40.2 percent from the same period last year, but a 7.5 percent increase in the quarterly comparison. Expenses with provisions reached R$7.77 billion, an increase of 92.1 percent year-on-year, but a 23 percent drop compared to the first three months of the year when provisions totaled R$10.1 billion.
Despite Itaú’s outstanding performance, expense control was also pointed out as positive by the sector analysts in general, an important point at this time of pandemic, which also served to catalyze the digital transformation processes of financial institutions as a whole.
In this respect, Banco do Brasil also reported expenditure control, with operating expenses, adjusted for profit share, dropping one percent in the quarter. Staff expenses increased by nearly two percent in the quarter but were offset by general and administrative expenses (down 0.3 percent in the quarter).
However, despite the positive results, some analysts point out that other factors should continue to weigh on Banco do Brasil stocks, limiting the potential for a more pronounced rebound. Among them are the recent departure of CEO Rubem Novaes and the state-owned bank’s risk of being forced to play a more anticyclical role during the crisis.
But even on his way out, Novaes gave some indications as to what the new CEO’s next steps might be (so far, even though the name has not yet been confirmed, everything suggests that it will be HSBC’s André Brandão). In parallel to the result, the BB announced that it will invest an additional R$2.3 billion in technology in the next three years and also confirmed the launching of a plan to invest in new technology.
During the teleconference on results, the BB’s resigning CEO pointed out that discussions are in progress with Bradesco on the division of assets in the cards sector. The two banks share control of the payment method company Cielo (CIEL3), the largest in the country, and the sale of BB’s stake has been discussed previously and could be expedited under the new management.
As a result, the institution is undergoing a management transition period while facing a number of challenges that the sector as a whole is experiencing – and which is leading to strong asset volatility in the year (even before the pandemic).
Sector challenges continue
“There is no doubt that the Brazilian banking sector is experiencing one of its most difficult moments in history, if not the most difficult. Even before the coronavirus outbreak, the banks were already dealing with the uncertainties arising from discussions about open banking and its impact on competition. Now, as banks needed to prepare for a likely growing default in the coming months, the results were heavily impacted by rising provisions during the first half of the year,” Bradesco BBI analysts point out.
On the other hand, the good news is that, given the current outlook, the provisions made over the last few quarters should be sufficient to tackle the highest default rates in years. As a result, provisioning expenses are expected to drop in the coming quarters, allowing banks to return to increasing profits and regain profitability.
However, analysts point out that the recent news flow is not “friendly” for the sector. “If recent weaker results were not enough, yesterday’s concerns about regulatory changes are back on the scene,” they point out.
It is worth noting that last Thursday, coinciding with the day the Banco do Brasil figures came out, the Senate passed a bill establishing a 30 percent cap on interest charged on credit cards and overdraft per year during the state of public calamity.
The senators also passed a PT (Worker’s Party) amendment permitting permanent interest rates caps on credit card transactions after the public calamity period next year. The measure provides for the National Monetary Council (CMN) to regulate the interest limit on cards, as it did with overdrafts, after the period of public calamity.
The CMN comprises two representatives of the Ministry of Economy (the Minister and the Special Secretary of Finance) and the President of the Central Bank.
Although the bill still needs to be passed by the Chamber and sanctioned by President Jair Bolsonaro, it is a concern for financial institutions. The reason is that, in a country marked by high interest rates, a limit has strong popular appeal, even more so at a time of crisis.
According to FEBRABAN (Brazilian Federation of Banks) the “limit, rather than promoting financial relief, may worsen the crisis by distorting price setting, creating bottlenecks and generating legal insecurity.” As a result, the organization “views with concern proposals that promote artificial intervention in economic activity and contracts.” “Situations like these have occurred in the past and history has shown that they have not been effective,” added the federation.
In an interview with O Estado de S. Paulo newspaper, Chamber president Rodrigo Maia signaled that he would not put the bill passed by senators to a vote in the Chamber, which caused a surge in the sector’s shares during Friday’s trading session, showing clear signs of greater resistance in voting for the bill in the Chamber. However, the sector’s shares soon dropped again.
It should be noted that, according to JPMorgan’s analysis, the interest limit could lower bank profits by between eight and 12 percent, even if it is only applicable until the end of the year. They will not consider the retroactive effect, until March, as passed in the bill.
According to analysts, Santander Brasil would be the most impacted, with a drop of up to 11.5 percent in profit, Itaú could experience a negative impact on profit of up to 10.9 percent, followed by Banco do Brasil (8.1 percent) and Bradesco (7.8 percent). On the other hand, they point out that should the bill become law, banks could promote changes in the so-called “interest-free installment plan”, which would impact buyers and somewhat mitigate the impact for banks.
In any event, any indication as to whether or not the bill will be adopted, now in the hands of the Chamber of Deputies, should be another factor of volatility for the sector’s shares.
“Considering the levels at which banks’ shares are being traded, we believe that most of the risks are already priced. Unfortunately, the negative news flow has prevailed over the expected improvement in profits. Once investors feel more comfortable with future earnings trends, we believe stocks may experience some reevaluation process,” BBI notes.
According to the analysis team, it is unlikely to return to pre-crisis levels, but rather more reasonable valuations, pricing a sustainable return on equity (ROE) of between 16 and 19 percent over the long term.
For their part, Credit Suisse analysts point out that the results can be a catalyst pointing to a more consistent rebound ahead – analysts have a recommendation equivalent to buying for all four banks’ shares.
However, while concerns over: i) increased competition; ii) the new payment system (PIX) developed by the Central Bank; and iii) potential tax increases to be discussed in Congress are not dispelled, expectations are still strong for the sector’s assets, despite proven resilience in the difficult first half of 2020.
Source: InfoMoney