Investors are abandoning mid-size lenders in Brazil on concern their financial statements can’t be trusted after the central bank seized Banco Cruzeiro do Sul SA, the sixth intervention in two years.
Banks including Cruzeiro do Sul with market values between 1 billion reais ($483 million) and 5 billion reais fell an average 8.4 percent in Sao Paulo trading since the central bank said on June 4 that it found “unsubstantiated asset items” and had taken control of the company. The nation’s five biggest lenders rose an average 1.1 percent in the same period. In international markets, borrowing costs surged for smaller banks and dropped for their bigger rivals.
“At this point we cannot rely on the financial statements of the mid-size banks in Brazil,” said Chris Wilder, who helps oversee about $40 billion in emerging-market assets at Stone Harbor Investment Partners in London, including Cruzeiro do Sul’s bonds.
Banks that lend to consumers against their paychecks, such as Cruzeiro do Sul, are attracting the most investor scrutiny. The company’s seizure came 17 months after Brazil’s privately owned deposit-insurance fund, known as the FGC, bailed out Banco Panamericano SA, with a market value of about 2.8 billion reais, amid a fraud investigation by the central bank. Regulators liquidated Banco Morada SA in April 2011 after finding “serious financial violations” at the Rio de Janeiro-based firm.
Other banks bailed out or liquidated in the past two years were Banco Schahin SA, Banco Matone SA, and Oboe Credito Financiamento e Investimento SA.
Since June 4, yields on dollar-denominated bonds due in 2020 for Itau Unibanco Holding SA (ITUB4), Brazil’s biggest bank by market value, declined 7 basis points, according to data compiled by Bloomberg. Cruzeiro do Sul’s 2020 dollar bonds soared 22.71 percentage points and Banco BMG SA’s debt with a similar maturity rose 4.67 percentage points.
Shares of Cruzeiro do Sul have dropped 61 percent since the intervention, while Itau’s gained 3.2 percent.
Even before the alleged accounting irregularities came to light, mid-size lenders such as Cruzeiro do Sul were losing market share to bigger rivals in the business of making loans pegged to consumers’ paychecks.
BMG, whose share of the payroll market has held steady at 16 percent, said it still has lost its No. 1 ranking in that business to Banco Bradesco SA. (BBDC4) BMG has 18 billion reais in credit provided by other financial firms in Brazil, said Clive Botelho, executive financial director at the Belo Horizonte- based company.
“The big Brazilian banks are very cautious in giving credit to smaller ones after Panamericano, and if they buy our loan portfolios as they did even after Cruzeiro’s seizure, this means they believe we have good credit and reliable balance sheets,” Botelho said. About 60 percent of BMG’s funding came from interbank lending, he said.
BMG’s payroll-loan portfolio rose almost 14 percent to 25.5 billion reais at the end of the first quarter from a year earlier, Botelho said. The increase, including loans originated by the bank and taken off the balance sheet, was almost 16 percent. That’s the same as for the entire market, which climbed to 165.6 billion reais, central bank data show.
Mid-size banks have “a lot of fundamental challenges already, and now will have to deal with even more limited, expensive funding because of the lack of credibility” in their financial statements, said Luis Miguel Santacreu, an analyst at Sao Paulo-based Austin Rating.
“The business volumes and profitability will fall, mainly for consumer lenders,” Santacreu said in a phone interview.
In payroll lending, known as “consignado,” the Brazilian government allows banks to deduct loan payments directly from employment and pension checks before consumers ever see their money.
The business “seemed seductive for the smaller banks, with lower delinquency rates and no big banks in the market,” Santacreu said. “Then the big banks came with lower funding costs, and took clients from the smallest ones with more attractive interest rates.”
A Cruzeiro do Sul official declined to comment in an e- mail, and asked not to be named in keeping with company policy.
Brazil’s central bank has been offering help to smaller lenders after the Panamericano bailout and Europe’s debt crisis reduced funding options and crimped profit. In November, the authority slowed the implementation of new accounting standards for booking revenue that will force them to post losses.
Payroll lenders previously could book all projected revenue from lending at the time they sold the loan portfolio to other banks. The anticipated revenue became a loss if it didn’t materialize when, for example, customers paid off their loans early. To compensate for the losses, banks made more loans and sold portfolios. Now, revenue from new loan portfolio sales only can be booked when it actually materializes.
The central bank in February also imposed a rule that encourages large banks to help finance smaller ones. The regulator set the reserve requirements on time deposits that won’t earn interest at 27 percent unless the money is used to buy loans or bonds from lenders with equity below 2.2 billion reais. The threshold will increase in steps to 36 percent in August and remain in effect until June 2014.
A central bank official declined to comment.
Brazil’s financial system is “well capitalized” and regulated with “clear” rules, said Claudio Mauch, a former central bank auditing director who headed the intervention of Banco Nacional SA in 1995.
“Internal controls aren’t designed to detect fraud, but to detect losses,” Mauch said in a phone interview from Porto Alegre. “Fraud is created to cheat internal controls.”
“The central bank is doing the best it can and is improving supervision in payroll lending, but people are creative and always find new ways to dribble around the central bank’s supervision,” said Carlos Gribel, director of sales at Tradewire Securities LLC, a Miami-based boutique brokerage specializing in Latin America.
Cruzeiro do Sul, Brazil’s 27th-largest lender by assets, was seized when the central bank found it didn’t provide documentation for a 1.3 billion-real portfolio loan it owns, Antonio Carlos Bueno, head of FGC, told reporters in Sao Paulo on June 4. FGC said that during the intervention the bank will meet all financial obligations and that the goal is to find a “continuity” solution, meaning that it intends to prepare the bank for sale.
The lender, before the intervention, reported that payroll lending climbed 6.4 percent to 7.3 billion reais at the end of the first quarter from a year earlier and dropped 3.7 percent from the fourth quarter of 2011. Cruzeiro do Sul generated 440.8 million reais in loans during the first quarter, down from 1.06 billion reais a year earlier, the lender had said.
Banco Bonsucesso SA, another mid-size Brazilian bank, said its credit portfolio climbed 6 percent to 3.5 billion reais in the first quarter from 3.3 billion reais a year earlier, when the market grew 16 percent.
Bonsucesso has 1.5 million clients and has sought to “preserve its liquidity” by focusing on more profitable businesses such as credit cards for payroll lending, which increased 87 percent to 300 million reais last year from 2010, the company said in an e-mailed statement.
Parana Banco SA, based in Curitiba, reported its payroll- lending portfolio was 1.73 billion reais as of March 31, a 21 percent increase from a year earlier. A Parana official declined to comment, and asked not to be identified in accordance with company policy.
Because Cruzeiro do Sul sold many of its loans to investment funds, including its own proprietary funds, the spillover effects of the intervention in the interbank market probably will be more manageable than the liquidity shock experienced after Panamericano almost collapsed in 2010, Ceres Lisboa, a senior credit officer at Moody’s Investors Service, said in a June 11 report.
“The seizure brings no systemic risk as the total assets of Cruzeiro do Sul represent only 0.22 percent of the total assets of the financial system in Brazil,” Ricardo Mollo, a finance professor at Insper business school in Sao Paulo, said in a phone interview. “But the event will make investors more cautious on buying securities issued by Brazilian mid-size lenders, even if they offer very attractive yields.”
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