Fitch: Outlook for Brazilian Banks Remains Negative

Brazil's challenging operating environment and economic recession are driving Fitch Ratings' negative outlook on the country's banking sector. Higher interest rates and inflation, combined with further economic slowdown and rising unemployment will materially pressure asset quality metrics, credit costs and, ultimately, overall earnings. Local banks will likely further constrain risk appetites in 2016. Together, these factors will increase credit pressure across each of Brazil's bank segments.

Fitch's October downgrade of Brazil's sovereign rating (long-term IDR BBB-/ Negative) is a driver of current downward rating pressure on nearly four of five Fitch-rated Brazilian banks. The sovereign's rating constrains 79% of the banks operating in the country.

Asset quality in the Brazilian banking system remains stronger than its last peak weakness in 2011; however, the deterioration of Brazil's economy, especially during second-half 2015, is driving up nonperforming loans (NPLs) in many portfolios. Lower corporate cash flow generation and cautious retail borrowers will continue the weakening trend in asset quality.

Among the three large federal government-owned banks (BNDES, Banco do Brasil and Caixa), Caixa remains the most vulnerable bank as its high credit growth during the last four years (averaging 35% a year) will pose challenges as its loan book matures.

The large private bank segment will be affected by higher credit expenses, likely equally across retail and corporate borrowers.

Among small and midtier banks, those that are highly dependent on a single product line or client segment will likely suffer from the challenging operating environment facing many of their small and medium enterprise customers, as well as from increased competition from larger banks.

On a positive note, the liquidity positioning and capitalization levels of Brazil's banks are good. The weakening economic conditions have slowed several years of very high loan growth, which resulted in a buildup of liquidity at many banks. While withdrawals of savings have begun to pick up, time deposits and other deposit-like instruments, such as LCIs and LCAs (real-estate and agricultural letters of credit, respectively), have diversified funding sources. These instruments helped to uphold capitalization levels. Finally, recent changes in banks' retail loan mix, such as longer tenor payroll lending, and strong provisioning by some banks in anticipation of weaker macro conditions should help banks offset the downward effect on earnings from rising NPLs. As of September 2015, total provisions covered a healthy 68% of impaired loans across the Brazilian banking system.

Brazilian bank ratings will remain very sensitive to further sovereign rating pressure. Further economic deterioration could also trigger downward rating actions. The weak operating environment likely will improve with further resolution of corporate investigations -- including Petrobras and recent developments involving Banco BTG Pactual. Such investigations can significantly lower expectations for loan growth and constrain risk appetites across markets. Those banks that have established a greater diversity of products and have boosted noncredit-related revenues through more fee-based products should be better positioned to withstand a continuation of the current economic trajectory.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

2016 Outlook: Brazilian Banks (Capitalization and Liquidity Support Banks in Harsh Operating Environment)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=874059

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