Investors have looked for signs of a credit bubble in Brazil in recent months, putting pressure on the country’s financials, though that could now be changing.
“Brazilian banks have been badly punished because there’s a feeling that there’s inflation and a hiking pattern by the central bank,” says Tim Seymour, partner at hedge fund Triogem Asset Management and founder of Emergingmoney.com. “But we’re getting into the middle to the late innings of that.
“Industrial production numbers are cooling, and that will help the interest-rate-sensitive sectors—banks are obviously a big part of that.”
UBS recently upgraded Brazilian financials, disparaging concerns of eroding bank asset quality. The bank also maintained its Buy recommendation on Brazilian financials, with a preference for Itau Unibanco , followed by Bradesco , Santander Brasil and Banco do Brasil .
“We do not agree with the argument that the Brazilian banks will face a new cycle of substantial and consistent asset quality deterioration,” wrote analysts Alcir Freitas and Domingos Falavina in their research note. “This is completely unrelated with what is happening in the real economy, and particularly in the labor market.”
Although inflation might have taken a toll on the lower-income population, they said, purchasing power in Brazil should recover in the second half of the year when most unions conduct annual salary increase negotiations.
Seymour echoes similar bullishness on Brazil's employment prospects and its positive impact on Brazilian financials.
“You don’t have consumer credit problems when people have jobs,” he says. “In Brazil, you’ve got unemployment at historical lows, wages are going up and there’s a shortage of quality labor, but that’s a big offset to the credit concern.”
Ultimately, investing in Brazilian financials comes down to valuation, Seymour points out.
“These are some of the best banks in the emerging world, and certain banks, like Itau is one of the best banks in the world,” he says. “Itau is actually at a bottom of a range that you can feel comfortable buying, even if there’s some choppiness for the markets.”
Will Landers, who runs BlackRock’s Latin American portfolio, says Itau and Bradesco cover 15 percent of the firm’s entire Latin American holdings. BlackRock has owned Brazilian banks since 2002, and they have become their biggest overweight in the last six months.
“They have very good controls, are well capitalized, and have strong ROE [return on equity],” he says.
But not all the investing community shares that view.
According to the MSCI Brazil Large Financials Index, worries that Brazil’s credit boom is losing steam have triggered a 10 percent drop in shares of Brazil’s largest banks since their earnings season started April 26.
Morgan Stanley also offered some sober comments May 30, saying it will be a challenging year for Brazilian bank earnings.
"Banks are facing slower credit growth, asset quality deterioration, margin compression, and regulatory pressure on credit card and other fees,” wrote Morgan Stanley's Jorge Kuri. “We see 12-13 percent EPS growth, with more downside than upside risk, not conducive to stock outperformance."
