Local banks’ stranglehold on the Brazilian market is coming under threat from acquisition-hungry international banks and investors.
Brazilian central bank governor Henrique Meirelles's steady hand has helped instill growing confidence in prospects for the country's financial sector.
The Brazilian banking market is awash with growth. Credit has been expanding by more than 20% a year over the past few years. In particular, escalation in consumer lending has been boosted by historically low interest rates and the development of new products under an improved institutional framework. With strong domestic demand and stable labor markets, this expansion looks set to continue, which should drive continued organic growth and M&A within the Brazilian banking sector.
The big story in Brazilian banking, though, is the sizable growth seen in payroll loan products. This has driven not just organic expansion but also both domestic and international M&A. Tamara Berenholc, associate director in financial service ratings at Standard & Poor’s, says, “When you look at growth in individual lending in Brazil, it really came in two major sectors: secure lending for auto loans and payroll discount lending.”
IPOs Draw Foreign Investment
The technology and market share for payroll lending was dominated by some of the mid-size banks in Brazil, which has led to an interesting dynamic as this market grew over the past few years. The mid-size banks have the skill set and infrastructure to manage this growth but lack the balance sheet to back expansion. As a result, large domestic Brazilian banks, Brazilian subsidiaries of foreign banks and some large foreign banks themselves have all set up agreements with the smaller banks in the payroll discount lending market. It has also driven much foreign investment in the Brazilian market over the past year.
Brazil's banks are increasingly attractive to foreign providers looking to gain a foothold in the lucrative market, which saw a number of IPOs in 2007.
The growth spurt seen by these banks also set off a wave of IPOs in 2007, with nine banks going public over the course of the year. International financial services providers and other investors took advantage of the IPOs to get a foothold in the lucrative Brazilian market, with particular interest coming from sovereign wealth funds from Asia and the Middle East. Mid-size bank Banco Pine raised R$517 million in March 2007, while Banco Sofisa raised R$439 million through its IPO. Banco Cruzeiro do Sul and Banco Daycoval followed suit, and Paraná Banco raised R$529 million in June on the São Paulo stock exchange, Bovespa. Banco Indusval raised R$3.2 billion through an IPO, and Arab Banking Corp. subsidiary Banco ABC Brasil raised $90 million from its IPO, which diluted Arab Banking Corp.’s holdings from 84% to 56%. Banco Industrial e Comercial and Banco Bonsucesso also launched IPOs in 2007.
Berenholc at Standard & Poor’s says the IPOs are positive for the niche banks as they reinforce the banks’ funding base, provide space for sustainable growth and improve industry transparency. “Nevertheless,” she adds, “it also poses greater challenges as banks will have to deliver stronger results to remunerate this capital and prove that they are capable of growing their credit portfolio while keeping good asset quality indicators.”
Competition is fierce in the Brazilian banking market and has increased dramatically in the past two years as a result of the incredible growth in consumer lending. The mid-size banks that were in the payroll lending market when the upsurge began are now playing in the market on a scale that they had not before, and by not being in the payroll lending market when this wave of growth started, some big banks have risked losing both customer loyalty and the opportunity to deal in such a profitable space. Celina Vansetti-Hutchins, senior vice president and head of the Latin American banking team at Moody's Investors Service, says, “Some banks are consequently now paying high prices for payroll products to ensure the loyalty of their client base.”
International M&A on a Grand Scale
The big international M&A transactions dominating the market over the past year were Brazilian Banco Itaú’s $2.85 billion purchase of BankBoston assets in Brazil, Chile and Uruguay—for which BankBoston owner Bank of America took a 6% stake in Banco Itaú—and the much-touted purchase of ABN AMRO’s Brazilian operations by Spain’s Banco Santander, which took place as part of the larger purchase of ABN AMRO holdings by a consortium including the Spanish bank.
With combined assets of R$278 billion, ABN AMRO-Santander becomes the second-largest publicly owned bank in Brazil behind Bradesco, which holds R$291 billion in total assets. State-owned Banco do Brasil is the largest bank in the country, with R$333 billion in assets. “The ABN AMRO-Santander deal is already steering the whole market dynamic,” says one market participant. “They will be a bigger player with a more solid position, so they are threatening the competitive position of Brazilian banks.”
The other big news on Brazil’s M&A front is the state decision allowing Banco do Brasil to incorporate other state-owned banks, rather than expanding through its traditional organic growth model. This could signal that the Brazilian government is looking to strengthen its hold on the banking market. “Banco do Brasil always grew organically because it couldn’t make acquisitions,” says Vansetti-Hutchins. “This change does not add tremendously in terms of market share or geographic position, but it makes one wonder to what extent the government will use this to look at bigger targets to ensure that Banco do Brasil maintains its leading position in the market.”
If the government is indeed looking to strengthen its hold on the banking market—as indicated by the Banco do Brasil acquisitional policy change—then state approvals on foreign acquisition of domestic assets could be few and far between. But regardless of the government’s stance, there is little other M&A activity in the pipeline for Brazilian banks this year anyway, as market growth has raised prices for most banking assets.
Credit Market Matures
With growth likely to continue in the payroll lending space and some positive growth in other lending products, such as auto loans, credit cards and corporate loans, the Brazilian banking market does look strong on fundamentals. In addition, new measures are under discussion that have the potential to further advance credit extension in Brazil. “[New measures] include, among others, the creation of a positive credit bureau, the introduction of the salary account and loan portability,” says Vansetti-Hutchins. “As shown in developed markets, all of these measures tend to boost competition while benefiting the consumer segment by reducing uncertainties on credit quality and thus borrowing costs.”
However, tightening capital ratios, some weakening asset quality and the fallout of the global credit market crunch could affect the profitability of domestic banks in the coming years. An environment of sustained low interest rates will challenge Brazilian banks, and competition just keeps growing. Vansetti-Hutchins explains: “Banks will need to deploy their domestic expertise while maximizing capital resources and allocation to defend and, especially, to advance their respective market positions. Partnering with deep-pocketed international institutions may be an alternative to execute on the banks’ plans in such a scenario.”
International institutional partnering is a very real option for Brazilian banks, particularly with high-priced assets discouraging acquisition. As the IPO market heated up last year, so, too, did the price for acquisitions. As a result, those foreign financial institutions that are looking to get a foothold in Brazil will need to partner with local banks to do so.
In addition, any foreign bank looking to make an acquisition in Brazil faces an additional hurdle, as one analyst notes: “It is still a closed market, still subject to approvals, and you need a special decree by the president for foreign banks to participate.”
“The ABN AMRO-Santander deal shows they are willing to have more foreign competition here, but we don’t know the extent to which dominance of foreign banks is attractive to the government,” Vansetti-Hutchins says. “I don’t think it is. Giving Banco do Brasil the okay to acquire state-owned banks seems to indicate that they are not ready to allow that loss of control. Even if regulators are in favor of more competition, I have the impression that the government is not ready to open the market up completely.”