RIO DE JANEIRO, BRAZIL – In terms of profit increases, the highlight was Bradesco (BBDC3; BBDC4), with a positive variation of 74%, followed by Itaú (ITUB4) with gains of almost 64%, followed by Banco do Brasil (BBAS3), with a 45% increase, while Santander (SANB11) posted the lowest profit increase, at 4%.
A recovery in profits after last year and a more positive estimate ahead with vaccination are guiding the positive sentiment of the market, yet concerns about default and increased competition are still on the radar.
Market analysts remain cautiously optimistic about Brazil’s largest publicly traded banks, which together posted a net profit of about R$21.84 billion, up 46.44% year-on-year in the first quarter.
The profit hike was largely driven by the drop in provisions for doubtful debts: in the quarter, the provisioning of the largest banks totaled R$13.8 billion, down 51.1% from the same period in 2020. However, higher profits and lower provisions do not always translate into good quality results.
As highlighted by Marcel Campos, banking sector analyst at XP, Santander Brasil posted the best result among private banks, although it still has low provisions and is now showing signs of increasing default, which leads to doubts about what the bank’s action will be when it actually comes. The return on average equity (ROAE) in the period reached 20.9%.
Among the positive points is the higher net interest income (NII), as the company was able to deliver growth over the previous quarter in net interest income on profitable assets (NIM). Secondly, revenue from banking services and fees, which increased 8% year-on-year to R$4.9 billion, a figure considered impressive by XP’s analysis team.
As pointed out by Victor Schabbel, Bradesco BBI analyst, “the overall quality of the results was positive, mainly due to revenue recovery as well as greater expense control. The company’s total expenses dropped 0.5% year-on-year, reaching R$5.3 billion, a good result attributed mainly to a 4.4% reduction in personnel expenses.”
Campos and Matheus Odaguil, analysts at XP, also point out the announced payment of R$3 billion in dividends, in addition to the R$512 million previously announced. The sum implies a dividend yield (ratio between the dividend over the share price) of 2.5% (10% if annualized) and 88% of dividend payout (dividend in relation to net income) in the quarter.
The 90-day default rates were virtually stable at 2.1%, with a quarterly default rate of 0.8% (virtually stable in the quarter). However, Bradesco BBI stresses that the 15 to 90 day default rate has shown signs of deterioration, advancing rapidly from December onwards. When comparing the first quarter of 2021 with the fourth quarter of 2020, there was a rise of 80 basis points, to 3.6%.
For Schabbel, although expected to a certain extent, this can be a point of attention for the near future, particularly considering the weaker than expected performance of the economy at the start of the year. Santander set aside R$3.16 billion in provisions for doubtful loans, a drop of 7.7% in relation to the previous year. Still, the volume rose 9.7% on a sequential basis.
A positive surprise for the market, but still warranting caution, is Banco do Brasil: profit exceeded market consensus estimates by 20%, largely due to lower provisions. And, as BBI points out, strong sequential NII and low provisioning expenses offset weaker fee income.
NII rose 3.1% in the quarter, much better than the performance of its peers, with spreads broadly stable on a sequential basis, while cash flow was also resilient in the quarter and supported the strong performance. On the provisioning front, Banco do Brasil delivered R$2.5 billion of net charge-offs (lowest nominal level in at least 7 years), entailing coverage of new loan defaults (NPLs) of 74% and reducing total 90-day default balance coverage to 328% (from 348% in Q4 2020).
However, analysts remain cautious on the stock, pointing out that despite strong net income outperforming consensus, first quarter results should not trigger upward profit revisions at this time, they assess.
“While there are still 3 quarters ahead, the midpoint of guidance (at least on the operating front) implies an acceleration in fee revenues and maintenance of its cost discipline. In addition, provisions in the quarter look quite low and may worsen in the coming months as defaults start to increase. With earnings visibility still limited – particularly as Banco do Brasil has seen most of its loans restructured (with R$26 billion still outstanding as of March 2022) – we believe the stock does not yet have the trigger to reprice in the short term,” reinforce BBI analysts, maintaining a neutral recommendation for the assets.
Good operational performance, but…
Bradesco, on the other hand, is in the “middle ground,” with a good operational performance; but once again the deterioration in defaults was an issue, particularly impacting Brazil’s second largest private bank.
The institution’s result was mainly driven by a strong operating performance, with improvements in its net interest margin, insurance, and costs. After a dismal 2020, in which the insurance business accounted for only 26% of the bank’s weak profit (versus 29% in 2019’s R$26 billion earnings), and implying 13.4% profitability (versus 19% in 2019), 2021 began well with the segment achieving 25% of a 74% higher profit on a year-over-year basis, entailing 20% profitability, its best result since the fourth quarter 2019, as financial revenues improved in the quarter jumping 90% year-over-year to R$1.4 billion.
Bradesco saw its expanded portfolio increase 2.6% in the first three months this year and reach R$705.2 billion, a balance 7.6% higher than at the end of March 2020.
XP analysts assess that they need more clarity on the seasonal increase in defaults, since the 90-day default index deteriorated 28 basis points in the quarter, to 2.5% (and standing 8 basis points above XP’s forecast), significantly affected by renegotiated loans already provisioned. Default had remained stable at 1.9% since September, after peaking at 4.5% in the first quarter of last year.
With the rise in defaults, the bank used up 50 percentage points in coverage ratio – the ratio between non-performing loans and provisions – in 90 days to 350%. Although still at a comfortable level, analysts expect defaults to rise considerably.
Banks, it should be noted, have carried out debt renegotiations amid the crisis with the coronavirus pandemic, so the level of defaults is expected to increase in the coming quarters.
Finally, and with the worst performance, despite the positive figures at first glance, is Itaú Unibanco, whose shares fell 4% after the results were announced. The assessment is negative mainly due to the low probability of results recurring, among other points in the balance sheet, as pointed out by XP.
A figure shows the difference in results, particularly between Santander and Itaú: the behavior of the financial margin of operations with customers, which reflects the result of credit operations in retail banking. While the former increased more than 6% in this item, the latter decreased more than 5% in this part of the balance sheet, between January and March this year.
“Itaú disclosed several non-sustainable items, which helped the result, while relevant areas such as tariff income, net interest margin with clients and costs performed below expectations. As competition increases and regulators become more aggressive, we believe that coverage consumption [for losses] and cash flow results will be less relevant for the sector’s perspectives,” assesses XP.
Campos and Odaguil also highlight that Itaú is lagging behind its private peers in terms of cost cutting, as the bank increased its total expenses by 3.2% annually to R$12.5 billion. They assess that Itaú could perform better, particularly in personnel expenses, which rose 6% annually to R$6 billion. Because digital competitors have a lower service and customer acquisition cost than Itaú, market players should look at costs carefully, they point out.
“In all, we have analyzed R$3 billion in results that we believe investors should look at carefully. On the other hand, the bank’s 41% effective tax rate also seems unique, as the bank had to reassess deferred tax assets that negatively impacted the line,” they stress.
The so-called “cautious optimism” dominated the executives’ message in their earnings release and analysts’ conference calls with the market. Octavio de Lazari, Bradesco’s president, pointed out that the banks’ balance sheets reveal a business horizon starting to clear up, after the storm caused by the Covid-19 pandemic.
In its balance sheet, Bradesco passed the message that operations may become more profitable. The institution’s financial margin remained virtually stable in relation to that seen over the past 3 months.
For Lazari, there is room for Bradesco to “come out of the defensive” and seek new business to expand its operational volume. This notion, however, continues to be based on a provision coverage for doubtful loans, known by the acronym PDD, equivalent to 350% of the balance of the bank’s overdue loans over 90 days.
Milton Maluhy, Itaú’s CEO, considered that, given the crisis, the mix of the client portfolio has changed, with more wholesale operations, with lower spreads, and less with retail clients, with a migration to loans with grace periods, longer terms and contained rates for the latter group. But he also said that in April he noticed the resumption of lines that guarantee more gains for the bank, which could lead to better results later on.
At Itaú, which a year ago set the conservative tone that would be adopted in the pandemic, the excess provisions will not be reversed, according to Maluhy. Reserves did not need to be used in this first quarter, with still behaved default rates, but will remain available in case of a worsening scenario, he pointed out.
Fausto Ribeiro, BB’s new CEO, pointed out that he sees the possibility of this year’s profit exceeding the bank’s projections. He said that the cost reduction plan announced in January by his predecessor, André Brandão (the trigger for Brandão’s departure), which includes the closing of 361 business units and voluntary dismissal programs, has been maintained. In the first quarter, 447 branches and service posts were closed and 3,797 people were dismissed, which displeased president Jair Bolsonaro.
Ribeiro made positive statements for the market, although they rival the latest signals given by the government about what it expects for the company’s new management. The CEO told journalists that Bolsonaro asked for an increase in the institution’s profitability: “President Bolsonaro told me to seek higher profitability, to increase efficiency,” he said, adding that his management will be technical. “There is no political interference, the bank is only approaching the Minister of Economy,” he added.
Thus, despite the feeling that the worst may be behind us, a deteriorated credit scenario is still being considered, with defaults likely to worsen with the end of renegotiations, new entrants that are more competitive and capitalized, in addition to the measures taken by the Central Bank to increase the competitiveness of institutions.
As a result, whoever is ahead in terms of cost cutting and digitalization will ultimately be preferred by investors.
During the post-balance-sheet speeches, institutions stressed their focus on accelerating digitalization and seeking partnerships. Itaú’s IT has currently reached 6 million users and is projected to reach 15 million by the end of the year, while Bradesco’s Next has 4.4 million users and is projected to reach 7 million by the end of the year. Santander is reinforcing its investment platform and Banco do Brasil is analyzing the prospect of having a partner for its BB DTVM management company.
After the balance sheet release, Bradesco remains the favorite among analysts, with 15 buy recommendations, although the result is not as well evaluated. XP reiterated its buy recommendation and target price of R$27 for the bank, as it believes that its results are more sustainable over the long term. The projections of numbers, coupled with the cost reduction strategy and expectations of a more efficient bank in the digital age, drive the good outlook, while its multiples seem discounted for private peers.
XP also has a buy recommendation for Banco do Brasil and a target price of R$43, as it considers the bank’s multiples to be attractive, while the bank is operationally well supported with good coverage ratios/capital adequacy and a defensive portfolio. The recommendation for Santander Brazil is neutral, with a target price of R$32, as it believes the bank may have to make more provisions in the medium term; this is the same recommendation for Itaú, with a target price of R$29.
Credit Suisse has a neutral recommendation for Banco do Brasil, with a target price of R$38; for the other three major banks, the recommendation is outperform (performance above market average): Itaú with a target price of R$39, Bradesco with a target price of R$30.91 and Santander with a target price of R$51. Despite higher competition and the unfolding of the coronavirus crisis in the profit, a cycle of increased profits is expected in 2021.