Environment: In defence of economic ideology

Many Euromoney readers were alive in more ideological times. They will remember the collapse of the socialist command economy model and the fall of the Berlin wall.

They will also remember Margaret Thatcher’s aggressive application of liberal economic forces and Ronald Reagan’s belief in trickle down.

Those bruising, chaotic times gave political ideologies and the economic theories that flowed from them a bad name. They seemed extreme, antagonistic and created as many losers as winners. Applied in the extreme they also always contained some economic flaws that could be highlighted and used to discredit the broader aims.

Ideologies are, of course, extremely dangerous when they do not accommodate opposition and attempts to moderate excesses. But they also contain a belief in progress; that politics and economics can bring about change for the better.

Nowadays politics and economics are more about management and this, in the absence of a long-term ideological framework, necessarily means a short-term horizon.

This, too, can be destructive. In the absence of a driving ideology, politics becomes interest-based. A good example is Brazil. This month saw the owners of businesses (represented by, among others, the Sao Paulo business federation FIESP) trying to kill a bill that would eliminate the subsidies these companies enjoy by receiving below-market financing from state development bank BNDES.

No matter that Brazil has just reported its worst-ever primary deficit for July, which has left economists wondering whether the government will hit its target, which it has only just this month revised downwards. No matter that S&P explicitly linked a failure to pass this reform to a likely downgrade. No matter that it is not morally justifiable – why should large companies receive cheaper finance than the rest of the economy, especially when they generally have access to the international markets?

The problem with interest based politics and economics is that those interests always define themselves narrowly. It is why leaders choose cheap loans today over a healthy economic environment for the whole country tomorrow. It is why in Costa Rica the government has continually to impress upon the transport sector that the real cost of burning fossil fuels is higher than the market rate – once you have factored in the cost of climate change. And it is why the UK and the US have reached for morally bankrupt and economically-inefficient policies that seek to protect the interests of their communities – rather than seeking to trade and partner with others, which is in all of our interests.

The good news, if we choose to accept it, is that there is an ideology that is neatly waiting to be adopted that will define interests globally. Building environmentalism into the politics of democracy and the market economy could add long-term balance and a framework to a world that is otherwise appearing to fragment.

Recent events in Houston and the Caribbean have shown the cost of climate events. That is in no one’s interests.

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Argentina’s delicate balancing

President Mauricio Macri’s economic inheritance was toxic; his policy of gradual fiscal realignment looks like it will lead to success in this year’s crucial mid-term elections, but the country desperately needs investment to maintain the transition.

Let me answer in the words of a financial investor I was talking to last month,” says Rodrigo Park, head of economics research for Santander Rio.

“He asked me why FDI [foreign direct investment] was so low and I said: ‘You should tell me.’ And he did, and I agree with what he told me. ‘One reason is fear. And the other is the fiscal deficit. If there is no fiscal consolidation there is no stabilization in the economy. These are the two main reasons why there has been no significant increase in FDI.’”

That is why direct investment has failed to materialize – abroad or domestically, Park tells Euromoney. And that investment is critical for Argentina. Without it the economy will, at best, stutter along in low-but-positive growth and will fail to attain the level that is needed for economic rebalancing and for the government to reduce its sizeable financial deficit (currently close to 7% of GDP).

But, as Park points out, many investors are waiting for a fiscal adjustment before committing capital. Solving this economic contradiction will need skill, patience and luck. And as ever in Argentina, politics will make the government’s attempts to untangle the economic mess it inherited difficult.

Former president Cristina Kirchner will win a seat in the senate in the coming mid-term elections on October 22. But the broader picture is positive for president Mauricio Macri to the point where Cristina’s presence in the senate should become almost an irrelevance.

The country held primary elections on August 13 that effectively serve as a national opinion poll for the mid-terms; Macri’s Cambiemos party did better than had been predicted. Macri won the important province of Buenos Aires by a whisker, but there are many reasons why Cambiemos should fare better in October.

First, the economic recovery is finally being felt in the industrial, employment-heavy industries that are prominent in Buenos Aires.

Second, higher turnout in the proper elections should favour Cambiemos (historically Peronists are more likely to vote in early-round or primary elections).

Third, the low recognition levels of the leading Cambiemos candidate, Esteban Bullrich, will be less of a factor after two more months of electioneering.

And, finally, the distant third place of Sergio Massa of the Judicialist Party in the August poll is likely to encourage his supporters to vote tactically and more of Massa’s supporters are expected to drift to Cambiemos than vote for Kirchner.

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BBVA tempted to sell its Chilean retail bank

BBVA’s decision to open talks about selling its Chilean retail bank to Scotiabank could lead to a notable retrenchment of its Latin American operations.

BBVA has a large presence in Latin America, with significant banks in Argentina, Colombia, Mexico, Peru and Venezuela – as well as Chile where it is the country’s sixth largest.

However BBVA’s management has in the past indicated that it believes its Chilean retail bank – valued at around €1.2 billion – lacks sufficient scale. That has led analysts to believe that the bank would look to merge with another bank or sell. BBVA has a 68% stake in BBVA Chile, while 29% belongs to the Chilean Said family and the rest of the shares are in free float.

A combination of very high valuations for potential targets (an opportunity for an attractive sale price) and a new banking law that could require a capital injection may be behind BBVA’s apparent decision to sell.  The bank is not understood to be looking to sell its consumer finance operation in the country.

Chilean banks have been trading at very high valuations for some time: as an average the NTM (next 12 months) is trading two standard deviations above the five year average of between 12.7x and 12.9x.

“This is a significant re-rating,” says a JPMorgan report on Chilean banks that concluded the high valuations in the Chilean market required downgrading Banco de Chile to neutral.

Chilean valuations certainly appear stretched in regional terms: Banco de Chile’s 14.3x and Santander Chile’s 15.1x expected 2018 P/E is above leading banks in Mexico (Banorte at 12.6x and Santander Mexico at 12.1x) Brazil (Bradesco at 10.8x, Itau at 11.0x and Santander Brasil at 10.6x) and Colombia (Bancolombia at 10.7x).

Meanwhile, the country’s new banking law that adopts Basel III requirements for Chilean banks has been presented to Congress. The Ministry of Finance estimates that the system will require an additional $2.7 billion of capital. The additional capital requirement is expected to be concentrated to a small number of banks and Moody’s suggests that the banks with the largest need for extra capital are BancoEstado, Itau, Corpbanca and BBVA Chile.

The law allows for a phasing in of the additional capital until 2024 and a sale of BBVA’s retail bank would pre-empt that requirement. BBVA may also have concluded that the valuations prevented them targeting another Chilean bank to build sufficient scale.

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Costa Rica’s ambitious commitment to reducing carbon emissions places it at the forefront of the fight against climate change. But its politicians worry that, with financial aid being focused elsewhere, it could effectively be punished for its early adopter status.

Euromoney’s meeting is in Puriscal, the eponymous town of the fourth-largest canton in the province of San José, close to a large, crumbling cathedral that is being reclaimed by nature.

The building is still an imposing sight, but trees now take advantage by growing in (and widening) the cracks in the walls that were opened by a series of earthquakes in the 1990s. In 2009, a health notice ordered its demolition, but there has been no movement to either its destruction or rehabilitation in the following years.

From the nearby headquarters of Cooperpuriscal, a farming cooperative that was established by the ministry of environment and energy (Minae) and is financed by a mix of public funds and local private businesses, we head further up the mountain.  We are driving to a finca – a smallholding, which in this case has 26 cows. The finca’s residential building sits at the side of the road and does not hint at the modern construction to the back: brushed steel gates and fences contain healthy-looking cows that mill around on a perfectly-level concrete floor that drains down to a sluice.

The representative from Cooperpuriscal explains the overall structure that has recently been installed and (after another visit to a neighbouring finca) is clearly created to a template. All of the cows’ waste is captured in solid form in a structured production chain that produces organic, rich compost for use on the farm and for sale. The slurry gets washed into a polythene-covered tank that generates enough gas for the farmer to power the whole site.  The retained compost boosts the yield on the farm’s crops, which now supplement the cows’ grazing on pastures, which increases and stabilizes milk production. Meanwhile, the milking process uses modern equipment and feeds directly into a hygienic, on-site tank that is emptied every two days by the cooperative’s dairy lorry.
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Brazil’s banks face paradox of worsening asset quality in a deleveraging corporate sector

Brazil’s banks are facing an apparent paradox: the level of corporate leverage has improved markedly in the past year while delinquency levels have risen and non-performing loan (NPL) formation remains at high levels.

These are the main findings of a report into the Brazilian banking sector by Credit Suisse. Lead analyst Marcelo Telles says the main characteristics of Brazil’s credit crunch peaked a year ago. For example, net debt to last-12-month ebitda improved to 2.2 times for the system – excluding Petrobras debt – in 1Q17 from 3.0 times one year earlier. Interest coverage also improved to 2.7 times, from 1.4 times in 1Q16.

The report says that analysis of the Brazilian banks’ 1Q17 results show that “asset quality in the large corporate segment remains on a deteriorating trend”.

However, while the leverage in the corporate sector has been improving, there has been a deterioration in asset quality in the large corporate sector – with higher delinquency, still-high NPL formation and high provisions. Telles believes the reason behind this apparent contradiction between these main findings lies in the performance of renegotiated and restricted loans than have been agreed in the past couple of years, and that lengthened the NPL cycle and is now translating into higher NPLs.

“Despite improvement in corporate leverage, delinquency in the corporate sector has been deteriorating constantly since early 2015, while that of the retail sector has stabilized many months ago,” argues Telles.

“Since 2015, corporate delinquency increased by 120 basis points, but retail delinquency actually improved by 20bp, despite the economic deterioration since then.

“In our view, one of the reasons for the discrepancy between better corporate leverage and worse delinquency indicators stems mainly from the increase in the volume of restructurings and renegotiations, which ended up creating a backlog of future potential NPLs and making the NPL cycle longer.”

Data from the Brazilian central bank support this interpretation: the size of renegotiated and restructured corporate debt has more than doubled since 2015 to 2016, reaching 9.9% and 1.9% of total loans – from 4.2% and 0.9% at the beginning of 2015 – respectively.

However, the banks have been reacting well to the deterioration in asset quality and increased provisions to improve the coverage of these ‘troubled’ loans. Coverage now stands at 21.8% for the system (up from 13.2% in 1Q2016) – with private banks having a 35% coverage ratio – which is approaching cyclical norms; in line with 2011’s coverage ratio and close to the 10-year average of 25.8%. This suggests there could be an improvement in the cost of risk in the coming quarters, albeit gradually given the still-high leverage ratios.

Credit Suisse expects that “the cost of risk should normalize gradually and probably returning to 2013 and 2014 [levels] by 2019”.

Increased corporate leverage in Brazil in the couple of years up to 1Q16 led to a significant increase in the cost of risk of commercial loans during that period. The main component of this increased cost of risk was the need for increased provisioning by the Brazilian banks since the end of 2014. In 2016, provisions for commercial loans comprised 44.5% of total provisions for Itaú – compared with 31.3% in 2014.

For Banco do Brasil, provisions for commercial loans jumped from 58.8% in 2014 to 74.7% in 2016. The wide discrepancy in the size of provisions needed to cover troubled loans to the corporate sector means that the recent improvement will also lead to uneven improvements among Brazil’s largest banks.

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Brazilian government to press ahead with reform of TJLP

The Brazilian government is resisting pressure to reconsider its proposal to change how BNDES, the state development bank, charges interest rates to lenders.

The government has written a bill that will phase out the current long-term TJLP rate – which is set by committee and is currently 7%, below the country’s Selic base rate of 10.25% – and replace it with a new TLP rate, which will be linked to the yield on inflation-indexed government debt.

However, in a recent interview with local financial newspaper Valor, Paulo Rabello de Castro, the new chief executive officer of BNDES, suggested the TLP rate could instead be linked to the consumer price index. Two senior BNDES vice-presidents resigned after Rabello’s comments about possible changes to the new TLP rate were reported, showing the sensitivity in Brazil about the new financing rate.

There has also been an uptick in local criticism about the changes, with trade associations beginning to lobby against the changes. For example, José Velloso, chief executive of the Brazilian Machinery Builders’ Association (Abimaq), said the changes to TJLP would increase the cost of long-term funding.

According to local media reports, he said: “The new TLP will make the cost much greater than in other countries, taking the competitiveness of the industry, of buyers of capital goods.”

However, finance minister Henrique Meirelles and planning minister Dyogo Oliveira were both quoted by Reuters this week as dismissing any changes to the calculation of the new BNDES lending rate. This steadfastness is due to the fact that this change is a key part of the government’s reform programme for the financial sector – and is backed by Ilan Goldfajn, the central bank’s president.

A report from the World Bank earlier this year, titled Brazil Financial Intermediation Costs and Credit Allocation, highlights the negative impact on fiscal and monetary policy of the current TJLP rates.

According to the report, the TJLP rate in Brazil is responsible for 72% of all “earmarked” lending. Earmarked lending is credit extended by the government at subsidized, below-market rates. At the end of 2015, half of total credit in Brazil was earmarked, which was back to the levels seen in the late 1990s after it had fallen to one-third of total credit in 2007, just before the financial crisis hit.

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UBS rebuilds in Brazil with acquisition of Consenso

The acquisition by UBS of a majority stake in Consenso, Brazil’s largest multi-family office, is a significant step in the Swiss bank’s growth strategy in the country.

Since 2010, UBS has been plotting its return in Brazil, following its sale of Pactual in 2009, and this transaction is the most notable since its acquisition of leading local brokerage Link – which was finalized in 2013 after UBS obtained a banking licence in 2012.

Consenso has R$20 billion in assets under management (AUM) – considerably more than UBS’s R$8 billion.

The new wealth management operation will merge and be run by a combination of UBS management and Consenso founding partners, including Heinz Gruber, Luiz Borges, Maria Alice Gouvêa, Daniel Auerbach and Valéria Milani Pierini – who created the firm after leading Banco BBA Creditanstalt when that bank was bought by Itaú in 2002.

Consenso has offices in São Paulo, Rio de Janeiro, Curitiba and Belo Horizonte, and 60 employees. UBS says it has around 250 staff in Brazil. Deal pricing isn’t be revealed.

Alejandro Velez, UBS Alejandro Velez, head of Latin America wealth management at UBS, tells Euromoney that the deal will ” accelerate our expansion in Brazil”.

That expansion appears well timed: according to local banking organization Anbima, AUM of the wealth management industry increased by nearly 20% in the year to February 2017 to R$863 billion.

“We continue to believe in Brazil’s long-term prospects, as evidenced by this acquisition,” says Velez. “Brazil [is] a market that continues to be strategically important for us. Consenso has a strong track record with strong historic growth. It provides access to a large number of families in the high-net worth and upper-high net worth space.

“By combining Consenso local expertise and reputation with UBS’s standing and strengths, and maintaining the successful open platform strategy currently run by both firms in Brazil, we believe we can significantly enhance our value proposition and widen our appeal to a larger number of private clients in the country.”

Velez says UBS “continuously reviews” opportunities for further acquisitions and in 2013 Edinardo Figueiredo, then managing director of UBS, outlined to Euromoney UBS’s strategy for growing its wealth management business in Brazil. “We want to grow through acquisition,” he said. “We are in talks with a lot of family offices in order to aggregate them in our operations, possibly to do acquisitions, but there are also some asset managers in the country that are open to work together.

“But the main idea is to grow through acquisition.”

Despite the current political uncertainty, Velez says he is positive about Brazil’s longer-term outlook. “In the current climate, we think Brazil’s reform process will be delayed but not derailed,” he says and adds that the current easing cycle in Brazil – with the Brazilian central bank lowering the base rate to 10.25% from 11.25% at the previous meeting, is the key market issue for determining asset allocation strategies for clients.

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