Banco do Brasil
Investors Eyeing Banco do Brasil Yields After Spreads Widen; Political Uncertainty Contributing to ‘Brazil Risk,’ Expected Market Turbulence Amid Broader Emerging Markets Concerns
Tue 07/03/2018 13:30 PM
Relevant Documents:
Prospectus 6.25% Perpetual Junior Subordinated Securities
Prospectus 9% Perpetual Junior Subordinated Securities
Prospectus 9.25% Perpetual Junior Subordinated Securities
Prospectus 8.5% Perpetual Junior Subordinated Securities
Q1 2018 Earnings Release
2017 Financial Statements
Investors are evaluating whether Brazilian state bank Banco do Brasil’s perpetual coco bonds present a buying opportunity, after a sell-off caused by market jitters about currency pressures amid general emerging market weakness, and an uncertain political environment ahead of the October presidential election. Others remain concerned about the company’s relatively weak capitalization compared to its peers, as well as lower growth prospects for the Brazilian economy.
Brazil’s central bank lowered 2018 GDP growth estimates to 1.6% in a June report, compared with 2.6% for the month forecasted in March.
The bank - which describes itself as an “agent for execution of the Brazilian Federal Government’s credit and financial policies,” in its latest annual financials - and is considered quasi-sovereign, has emerged relatively unscathed by the corruption scandal that shook Brazil in 2015. Investors who spoke with Reorg point out that at the height of the scandal - dubbed Lava Jato after a money-laundering business operating out of a Brasilia car wash - the bank’s Tier 1 capital remained above the level that would have triggered a conversion or write-down, based on central bank minimum capital requirements. Banco do Brasil’s systemic importance and state backing provide investors with additional reassurance, even though the bank’s capitalization ratios are below some of its peers. Banco do Brasil’s ownership structure is HERE.
CMN Resolution 4,279, dated Oct. 31, 2013, includes criteria adopted by the central bank for determining when securities accounted as additional principal capital or Tier II capital can be written off or converted into common equity tier 1 capital.
Banco do Brasil’s ratios at fiscal year end 2015, and throughout 2016, are shown below. Brazil’s GDP fell 3.8% in 2015 compared with the previous year and in 2016 GDP fell 3.6%.
At the end of the first quarter of 2018, the bank’s common equity Tier 1 ratio - CET1 - level was at 9.8% and its Tier 1 capital ratio was at 12.8%, increasing 6.1% and 2.9% year over year, respectively. The bank plans to increase its CET1 to 11% by 2022.
The bank’s regulatory adjustments deducted from CET1 were R$31.373 billion (about $8.1 billion), compared with R$23.847 billion in at the end of December and R$24.2054 billion as of March 31, 2017. About 37% of the regulatory adjustments were due to significant investments and tax credits that rely on the generation of future taxable profit or revenue for their realization.
As described below, the prospectuses for the perpetual coco bonds allow Banco do Brasil to write down the securities if the bank’s financial ratios fall below specified thresholds based on Basel III proposals adopted by the Central Bank of Brazil.
Some analysts say the bank will not likely face capital shortfalls. One analyst estimated that the bank would need to report losses upwards of R$30 billion annually, considering the risk-weighted assets, or RWAs, Banco do Brasil reported in the first quarter of 2018, to reach the point of non-viability that would see a bond write-down. The R$686.6 billion RWAs noted in the diagram above represented 48.3% of the lender’s total assets in the first quarter, down from 50.4% in the fourth quarter of 2017.
However, the Banco do Brasil notes may face considerable volatility over the next few months amid uncertain election results when voters go to polls on Oct. 7 and Oct. 28. The bank has about R$32 million in perpetual bond debt as of March 31, 2018, according to its first quarter 2018 report.
Banco do Brasil’s 9% perpetual bonds traded down from the 106/107 level at the end of March to about 92 earlier this month. The 6.25% perps dropped from the 90 level in late March to the 73 level earlier this month. The notes have since rebounded and are trading at the following levels:
A capital structure can be found HERE.
The yield on some of the notes is looking attractive for some investors, considering a spread of over 100 basis points compared with Brazilian treasury notes on some bonds, while some analysts caution that investors should want to limit their Brazil exposure as the election race heats up. As described in further detail below, Banco do Brasil’s bond trading levels partly reflect bond maturities, and call dates on the perpetuals as well as the reset rates.
Brazil’s upcoming elections are likely to be shaped by outsiders: centrist parties are fragmented and their candidates are lagging in voting prospect polls. Former left-wing president Lula da Silva, imprisoned on corruption-related charges earlier this year, holds 30% of voter intentions, according to the latest polls. In a scenario where he does not run, right-wing candidate Jair Bolsonaro leads the race with 19% of voting intentions. The market’s favored candidate, centre-right Geraldo Alckmin, holds only 7% of the votes, in a scenario where Lula does not run, according to the latest opinion polls from research company Datafolha.
The rise of right-wing candidate Jair Bolsonaro and his headline-grabbing views on social issues such as gun control and gay rights has been driven by social media, but political analysts say limited TV and radio time could dent his popularity, as this is seen as a likely influencer for voter intentions.
Some asset managers are already looking ahead to the candidate’s chosen economic policy advisor, former banker and BTG Pactual founder Paulo Guedes, and downplaying market concerns by citing his social security reform policies.
Lesser-known candidates are said to have the potential to attract more voters, while corruption scandals could still weigh on the approvals of ‘traditional’ politicians, as noted by a BNP Paribas research note on the elections.
Discussing corporate credit demand, Candido Botelho Bracher, CEO of Itaú Unibanco Holding SA, said on the company’s first-quarter 2018 earnings call that the company does not expect improvement in corporate credit demand, which was lackluster during the quarter, “especially being an election year.”
NIM, Net Interest Income, Loan Growth, Asset Quality
Banco do Brasil is the main provider of credit for the Brazilian agricultural sector and it has a high interaction with other banks and access to funding. Analysts and investors highlight minority interests in a number of businesses. For example, the bank owns a 9.35% stake in Bahia-based Neoenergia, after a transaction with the electricity firm’s other shareholders last year. After a failed Neoenergia IPO last year Banco do Brasil said in a filing that it would keep its 9.35% stake in the company.
Equity interests are pictured below, as included in the bank’s 2017 financials:
The bank reported that first-quarter 2018 net interest margin, or NIM, was 3.8%, a 61 bps decline from the same period a year ago, and 41 bps lower sequentially. Banco Bradesco’s reported NIM was 6.6%, representing a 20 bps decline sequentially, and 60 bps year over year. Caixa’s NIM was 4.25%, a 10 bps year over year improvement.
Daniel Alves Maria, general manager of investor relations said in the bank’s first-quarter call with analysts that the decline in NIM was due to increased delinquent assets, as well as fewer calendar days. Excluding those effects, he said, NIM would have been 4.09%.
In the first quarter of 2018, Banco do Brasil’s net interest income declined by 11.5% year over year to R$11.962 billion. An analyst on the company’s earnings call noted that net interest income growth was weaker than what the company expects for the full year. CFO Bernardo de Azevedo Silva Rothe said that Banco do Brasil is expecting working capital for very small and small companies to increase, noting that it rose in April. He said said some performance figures were below guidance in the second quarter, but that the bank will “move gradually” to reach 2018 guidance.
For example, in its earnings presentation, Banco do Brasil said the bank expects its domestic loan portfolio to grow between 1% and 4% in 2018 and for net interest income to remain stable or decline by 5% in 2018.
Guidance, as included in the company’s first-quarter earnings presentation is shown below:
A sell side desk noted that the company’s net interest income decline could be a symptom of a low interest rate environment and lower GDP prospects. Brazil’s central bank lowered the benchmark selic rate 25 basis points to 6.5% in March. The central bank maintained the selic rate at that level in June.
A separate analyst on the call questioned the company’s loan growth:
In the latest quarter, loans to companies fell 6.3% year over year and 1.6% sequentially, and loans to individuals declined about 1.1% sequentially, while remaining relatively flat year over year. This compares with a 4.7% decline and 5.7% growth, respectively, reported by Itau, and a 6.7% drop and 3.5% growth reported by Bradesco.
Investor relations manager Alves Maria, in response to the question, noted that although the portfolio shows a decline in business due to the characteristics of new origination being done in the short term, the level of disbursements is growing. The company, he said, is in the process of changing the mix of the portfolio.
Alves Maria said that the company is in the process of writing off some of its small and very small company loans - up to R$25 million in revenue - as management believes that the end of the cycle is approaching.
Regarding nonperforming loans - NPLs - Banco do Brasil’s new NPLs have been increasing sequentially since the third quarter of 2017:
Specifically, there were 40% and 33% sequential new NPL increases in the bank’s individuals segment, and agribusiness segment. Discussing the agribusiness loans on the company’s earnings call, Alves Maria explained that price drops pressured producers. He added that the end of the harvest usually happens in the first quarter of the year, and noted that management expects the NPL cycle to normalize.
Note, however, that 15-day and 90-day NPL trends show a marked improvement in NPLs related to loans to companies:
Banco do Brasil’s allowance for loan losses improved by 3.9% year over year, to R$34.989 billion, and 4.6% sequentially.
In terms of capital requirements, Banco do Brasil’s capitalization ratios suggest that the company could be more vulnerable than some of its peers if the Brazilian economy worsens:
Subordination, Changes Not Requiring Approval
The prospectuses for the company’s perpetual bonds are governed by New York law. Each prospectus has a subordination clause, which is subject to Brazilian law. The 9% prospectus, dated July 2, 2014, is the newest out of the four, followed by the 6.25% prospectus, - Jan 31, 2013 - then the 9.25% prospectus from 2012, and the 8.5% from 2009.
Subordination
All the perpetual bonds are unsecured and subordinated obligations. Each prospectus contains a subordination clause noting that “upon the exhaustion of the Bank's accumulated profits, profit reserves (including legal reserves) and capital reserves, the full value of the securities may be used to offset losses incurred by the Bank in accordance with the subordination provisions of Resolution 3,444.”
Changes Not Requiring Approval
All four prospectuses allow Banco do Brasil to amend certain terms of the notes without the consent of noteholders. The 6.25% and 9.25% notes allow these amendments “at any time, from time to time,” whereas the 9% prospectus specifies “during the period of one year from the Closing Date,” the 8.5% says “to amend once only.”
Banco do Brasil’s 8.5%, 9.25%, 6.25%, and 9% perpetual notes are callable on Oct. 20, 2020, April 15, 2023, April 15 2024, and June 18, 2024, respectively:
On March 19, Banco do Brasil commenced a tender offer for up to $600 million of its 8.5% perpetual notes and $100 million of its 9.25% perpetual notes.
Cash interest on the securities accrues at the stated rate up until the first call date, and then it resets to a rate equal to the ten year U.S. treasury plus a credit spread. If the entire aggregate principal amount outstanding of the 8.5% perpetuals is not redeemed, then following the redemption, at least $150 million in aggregate principal amount must remain outstanding.
The company says that the redemption of the perpetuals “will depend on Banco do Brasil’s [asset liability management] strategy, [and] regulatory approval, taking into account market conditions and Banco do Brasil’s capital needs.”
Loan Book, Funding Sources
Compared with the first quarter of 2018, as a percentage of total funding, financial and development funds increased 10 bps, hybrid capital instruments rose 20 bps, commercial paper increased 30 bps, and foreign borrowing increased by 70 bps, while domestic onlending declined 30 bps:
Moving to the company’s loan book, in the most recent quarter, Agribusiness loans were 27.3% of the total book, compared with 26.2% in the first quarter of 2017. Loans to individuals increased by about 60 bps, while loans to companies declined by 180 bps:
Prospectus 6.25% Perpetual Junior Subordinated Securities
Prospectus 9% Perpetual Junior Subordinated Securities
Prospectus 9.25% Perpetual Junior Subordinated Securities
Prospectus 8.5% Perpetual Junior Subordinated Securities
Q1 2018 Earnings Release
2017 Financial Statements
Investors are evaluating whether Brazilian state bank Banco do Brasil’s perpetual coco bonds present a buying opportunity, after a sell-off caused by market jitters about currency pressures amid general emerging market weakness, and an uncertain political environment ahead of the October presidential election. Others remain concerned about the company’s relatively weak capitalization compared to its peers, as well as lower growth prospects for the Brazilian economy.
Brazil’s central bank lowered 2018 GDP growth estimates to 1.6% in a June report, compared with 2.6% for the month forecasted in March.
The bank - which describes itself as an “agent for execution of the Brazilian Federal Government’s credit and financial policies,” in its latest annual financials - and is considered quasi-sovereign, has emerged relatively unscathed by the corruption scandal that shook Brazil in 2015. Investors who spoke with Reorg point out that at the height of the scandal - dubbed Lava Jato after a money-laundering business operating out of a Brasilia car wash - the bank’s Tier 1 capital remained above the level that would have triggered a conversion or write-down, based on central bank minimum capital requirements. Banco do Brasil’s systemic importance and state backing provide investors with additional reassurance, even though the bank’s capitalization ratios are below some of its peers. Banco do Brasil’s ownership structure is HERE.
CMN Resolution 4,279, dated Oct. 31, 2013, includes criteria adopted by the central bank for determining when securities accounted as additional principal capital or Tier II capital can be written off or converted into common equity tier 1 capital.
Banco do Brasil’s ratios at fiscal year end 2015, and throughout 2016, are shown below. Brazil’s GDP fell 3.8% in 2015 compared with the previous year and in 2016 GDP fell 3.6%.
At the end of the first quarter of 2018, the bank’s common equity Tier 1 ratio - CET1 - level was at 9.8% and its Tier 1 capital ratio was at 12.8%, increasing 6.1% and 2.9% year over year, respectively. The bank plans to increase its CET1 to 11% by 2022.
The bank’s regulatory adjustments deducted from CET1 were R$31.373 billion (about $8.1 billion), compared with R$23.847 billion in at the end of December and R$24.2054 billion as of March 31, 2017. About 37% of the regulatory adjustments were due to significant investments and tax credits that rely on the generation of future taxable profit or revenue for their realization.
As described below, the prospectuses for the perpetual coco bonds allow Banco do Brasil to write down the securities if the bank’s financial ratios fall below specified thresholds based on Basel III proposals adopted by the Central Bank of Brazil.
Some analysts say the bank will not likely face capital shortfalls. One analyst estimated that the bank would need to report losses upwards of R$30 billion annually, considering the risk-weighted assets, or RWAs, Banco do Brasil reported in the first quarter of 2018, to reach the point of non-viability that would see a bond write-down. The R$686.6 billion RWAs noted in the diagram above represented 48.3% of the lender’s total assets in the first quarter, down from 50.4% in the fourth quarter of 2017.
However, the Banco do Brasil notes may face considerable volatility over the next few months amid uncertain election results when voters go to polls on Oct. 7 and Oct. 28. The bank has about R$32 million in perpetual bond debt as of March 31, 2018, according to its first quarter 2018 report.
Banco do Brasil’s 9% perpetual bonds traded down from the 106/107 level at the end of March to about 92 earlier this month. The 6.25% perps dropped from the 90 level in late March to the 73 level earlier this month. The notes have since rebounded and are trading at the following levels:
A capital structure can be found HERE.
The yield on some of the notes is looking attractive for some investors, considering a spread of over 100 basis points compared with Brazilian treasury notes on some bonds, while some analysts caution that investors should want to limit their Brazil exposure as the election race heats up. As described in further detail below, Banco do Brasil’s bond trading levels partly reflect bond maturities, and call dates on the perpetuals as well as the reset rates.
Brazil’s upcoming elections are likely to be shaped by outsiders: centrist parties are fragmented and their candidates are lagging in voting prospect polls. Former left-wing president Lula da Silva, imprisoned on corruption-related charges earlier this year, holds 30% of voter intentions, according to the latest polls. In a scenario where he does not run, right-wing candidate Jair Bolsonaro leads the race with 19% of voting intentions. The market’s favored candidate, centre-right Geraldo Alckmin, holds only 7% of the votes, in a scenario where Lula does not run, according to the latest opinion polls from research company Datafolha.
The rise of right-wing candidate Jair Bolsonaro and his headline-grabbing views on social issues such as gun control and gay rights has been driven by social media, but political analysts say limited TV and radio time could dent his popularity, as this is seen as a likely influencer for voter intentions.
Some asset managers are already looking ahead to the candidate’s chosen economic policy advisor, former banker and BTG Pactual founder Paulo Guedes, and downplaying market concerns by citing his social security reform policies.
Lesser-known candidates are said to have the potential to attract more voters, while corruption scandals could still weigh on the approvals of ‘traditional’ politicians, as noted by a BNP Paribas research note on the elections.
Discussing corporate credit demand, Candido Botelho Bracher, CEO of Itaú Unibanco Holding SA, said on the company’s first-quarter 2018 earnings call that the company does not expect improvement in corporate credit demand, which was lackluster during the quarter, “especially being an election year.”
NIM, Net Interest Income, Loan Growth, Asset Quality
Banco do Brasil is the main provider of credit for the Brazilian agricultural sector and it has a high interaction with other banks and access to funding. Analysts and investors highlight minority interests in a number of businesses. For example, the bank owns a 9.35% stake in Bahia-based Neoenergia, after a transaction with the electricity firm’s other shareholders last year. After a failed Neoenergia IPO last year Banco do Brasil said in a filing that it would keep its 9.35% stake in the company.
Equity interests are pictured below, as included in the bank’s 2017 financials:
The bank reported that first-quarter 2018 net interest margin, or NIM, was 3.8%, a 61 bps decline from the same period a year ago, and 41 bps lower sequentially. Banco Bradesco’s reported NIM was 6.6%, representing a 20 bps decline sequentially, and 60 bps year over year. Caixa’s NIM was 4.25%, a 10 bps year over year improvement.
Daniel Alves Maria, general manager of investor relations said in the bank’s first-quarter call with analysts that the decline in NIM was due to increased delinquent assets, as well as fewer calendar days. Excluding those effects, he said, NIM would have been 4.09%.
In the first quarter of 2018, Banco do Brasil’s net interest income declined by 11.5% year over year to R$11.962 billion. An analyst on the company’s earnings call noted that net interest income growth was weaker than what the company expects for the full year. CFO Bernardo de Azevedo Silva Rothe said that Banco do Brasil is expecting working capital for very small and small companies to increase, noting that it rose in April. He said said some performance figures were below guidance in the second quarter, but that the bank will “move gradually” to reach 2018 guidance.
For example, in its earnings presentation, Banco do Brasil said the bank expects its domestic loan portfolio to grow between 1% and 4% in 2018 and for net interest income to remain stable or decline by 5% in 2018.
Guidance, as included in the company’s first-quarter earnings presentation is shown below:
A sell side desk noted that the company’s net interest income decline could be a symptom of a low interest rate environment and lower GDP prospects. Brazil’s central bank lowered the benchmark selic rate 25 basis points to 6.5% in March. The central bank maintained the selic rate at that level in June.
A separate analyst on the call questioned the company’s loan growth:
In the latest quarter, loans to companies fell 6.3% year over year and 1.6% sequentially, and loans to individuals declined about 1.1% sequentially, while remaining relatively flat year over year. This compares with a 4.7% decline and 5.7% growth, respectively, reported by Itau, and a 6.7% drop and 3.5% growth reported by Bradesco.
Investor relations manager Alves Maria, in response to the question, noted that although the portfolio shows a decline in business due to the characteristics of new origination being done in the short term, the level of disbursements is growing. The company, he said, is in the process of changing the mix of the portfolio.
Alves Maria said that the company is in the process of writing off some of its small and very small company loans - up to R$25 million in revenue - as management believes that the end of the cycle is approaching.
Regarding nonperforming loans - NPLs - Banco do Brasil’s new NPLs have been increasing sequentially since the third quarter of 2017:
Specifically, there were 40% and 33% sequential new NPL increases in the bank’s individuals segment, and agribusiness segment. Discussing the agribusiness loans on the company’s earnings call, Alves Maria explained that price drops pressured producers. He added that the end of the harvest usually happens in the first quarter of the year, and noted that management expects the NPL cycle to normalize.
Note, however, that 15-day and 90-day NPL trends show a marked improvement in NPLs related to loans to companies:
Banco do Brasil’s allowance for loan losses improved by 3.9% year over year, to R$34.989 billion, and 4.6% sequentially.
In terms of capital requirements, Banco do Brasil’s capitalization ratios suggest that the company could be more vulnerable than some of its peers if the Brazilian economy worsens:
Subordination, Changes Not Requiring Approval
The prospectuses for the company’s perpetual bonds are governed by New York law. Each prospectus has a subordination clause, which is subject to Brazilian law. The 9% prospectus, dated July 2, 2014, is the newest out of the four, followed by the 6.25% prospectus, - Jan 31, 2013 - then the 9.25% prospectus from 2012, and the 8.5% from 2009.
Subordination
All the perpetual bonds are unsecured and subordinated obligations. Each prospectus contains a subordination clause noting that “upon the exhaustion of the Bank's accumulated profits, profit reserves (including legal reserves) and capital reserves, the full value of the securities may be used to offset losses incurred by the Bank in accordance with the subordination provisions of Resolution 3,444.”
Changes Not Requiring Approval
All four prospectuses allow Banco do Brasil to amend certain terms of the notes without the consent of noteholders. The 6.25% and 9.25% notes allow these amendments “at any time, from time to time,” whereas the 9% prospectus specifies “during the period of one year from the Closing Date,” the 8.5% says “to amend once only.”
- 6.25%, 9.25% perpetual subordinated notes: in order to comply with any new resolution or written instruction with the central bank “setting forth its requirement to qualify, or maintain the qualification of, the Securities as Tier 1 Capital or Tier 2 Capital,” Banco do Brasil is allowed to make “qualified amendments” or “additional amendments other than qualified amendments,” without the prior consent of securityholders.
- Qualified amendments, the prospectus explains, include “[modifying the terms and conditions of the Securities] to permit the Principal Amount of the Securities to be written down to the extent required by such future regulations if, following the implementation of the Basel III proposals by the Central Bank, the Bank’s Common Equity Tier 1 Ratio has fallen to the lower of” 6.125% or the Basel III threshold
- Qualifying amendments have to be certified by the bank to the trustee and must be accompanied by a written opinion from Brazilian counsel confirming that the amendments were “reasonably required” for the securities to qualify as Tier 1 or Tier 2 Capital, the 6.25% prospectus says. The 9.25% prospectus requires the advice of “legal counsel as necessary.”
- Qualified amendments, the prospectus explains, include “[modifying the terms and conditions of the Securities] to permit the Principal Amount of the Securities to be written down to the extent required by such future regulations if, following the implementation of the Basel III proposals by the Central Bank, the Bank’s Common Equity Tier 1 Ratio has fallen to the lower of” 6.125% or the Basel III threshold
- 9% perpetual subordinated notes: The 9% notes specify that “from time to time, during the period of one year from the Closing Date,” Banco do Brasil is permitted to amend the terms and conditions of the securities “in order to, and only to the extent necessary to, comply with any new resolution or written instruction of the Central Bank setting forth its requirements to qualify, or maintain the qualification of, the securities as Tier 1 Capital.”
- 8.5% perpetual subordinated notes: “[t]he Bank will be permitted to, without the prior consent of securityholders, to amend once only, the terms and conditions of the securities, solely to comply with the requirements of the Central Bank to qualify the Securities as Tier 1 Capital or Tier 2 Capital pursuant to Resolution 3,444.”
Banco do Brasil’s 8.5%, 9.25%, 6.25%, and 9% perpetual notes are callable on Oct. 20, 2020, April 15, 2023, April 15 2024, and June 18, 2024, respectively:
On March 19, Banco do Brasil commenced a tender offer for up to $600 million of its 8.5% perpetual notes and $100 million of its 9.25% perpetual notes.
Cash interest on the securities accrues at the stated rate up until the first call date, and then it resets to a rate equal to the ten year U.S. treasury plus a credit spread. If the entire aggregate principal amount outstanding of the 8.5% perpetuals is not redeemed, then following the redemption, at least $150 million in aggregate principal amount must remain outstanding.
The company says that the redemption of the perpetuals “will depend on Banco do Brasil’s [asset liability management] strategy, [and] regulatory approval, taking into account market conditions and Banco do Brasil’s capital needs.”
Loan Book, Funding Sources
Compared with the first quarter of 2018, as a percentage of total funding, financial and development funds increased 10 bps, hybrid capital instruments rose 20 bps, commercial paper increased 30 bps, and foreign borrowing increased by 70 bps, while domestic onlending declined 30 bps:
Moving to the company’s loan book, in the most recent quarter, Agribusiness loans were 27.3% of the total book, compared with 26.2% in the first quarter of 2017. Loans to individuals increased by about 60 bps, while loans to companies declined by 180 bps:
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