Brazil’s XP chooses a road often travelled: selling to Itaú

Brazilian brokerage firm XP Holding Investimentos has pulled its IPO in favour of selling a large minority stake to Itaú.

The announcement came just days after XP had filed for an IPO that was expected to raise between $1.5 billion and $2 billion. The São Paulo-based brokerage had hired JPMorgan, Banco do Brasil, Bank of America Merrill Lynch, Bradesco, BTG Pactual, Goldman Sachs, Morgan Stanley and Safra to lead the primary equity offering.

Speaking to Euromoney in New York, one of the bankers working on the deal says its cancellation was a loss to the nascent recovery in the Brazilian equity markets.

“It was going to be a good story in the development of the Brazilian equity market,” he says. “Investors were very interested and this deal ticked a lot of the boxes for the type of company that they are looking for.

“Also, had XP been successful – which I am confident that it would have been – it would have helped others come to market. But I understand why XP decided to take the certainty of Itau’s offer because there is always a risk when conducting an IPO.”

Meanwhile, the decision was welcomed by banking analysts as a potentially significant transaction for Itaú – albeit dilutive, as the deal assumes XP’s value at R$12 billion ($3.86 billion) with an estimated 2018 price-to-earnings multiple of 20.0-times, compared with Itau’s 9.2-times valuation multiple for estimated 2018 P/E.

However, XP’s potential, given the macro outlook for asset managers in Brazil in an environment of falling interest rates and its market-leading position as an innovative and tech-savvy retail stockbroker, is one of fast growth. XP had net income of R$240 million in 2016, which is expected to grow to R$600 million by 2018, implying a compound annual growth rate of 58%.

Deutsche Bank’s Tito Labarta, equity analyst for financial institutions, says although the deal only represents an initial 2% of Itaú market cap – and is equivalent to only 1% of 2018 earnings – it could be a significant development if the brokerage maintains its recent growth record, though he cautions that maintaining XP’s recent results will be tough. According to the terms of the staggered transaction, Itaú will acquire a 49% stake (30% of voting shares) of XP for R$5.7 billion plus a R$600 million capital increase. Itaú will then buy a further 12.5% stake in 2020, reaching a 62.4% stake (40% of voting shares) at 19-times P/E, and another 12.5% stake in 2022, reaching a 74.9% stake (49.9% of voting shares) based on XP’s fair market value at that time.

As a minority shareholder, Itaú will receive the right to appoint two out of seven members of the board of XP Investimentos. Furthermore, XP reserves the right to exercise a put option to sell 100% of its shares in XP Investimentos to Itaú as of 2024, while Itaú might exercise a call option to purchase 100% of equity in XP Investimentos as of 2033. If these options are exercised, Itaú will have acquired full control and all of XP Investimentos’s equity.

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NPLs point to credit quality recovery in Brazil

The Q1 2017 results of the Brazilian banks might mark the beginning of an inflection point for the country’s credit performance, according to Fitch Ratings.

The rating agency believes that the signs of stabilization of the banks’ non-performing loans (NPLs) in the first quarter of this year could be the beginning of a turnaround in the country’s hitherto long-deteriorating credit performance and depressed credit demand. Data from the Brazilian central bank, published in May, show that the system’s NPL ratio increased only marginally (3.8% from 3.7%) in the three months to March 17.

Meanwhile, early NPLs – those that are overdue for between 15 days and 90 days – actually declined, by 0.5 percentage points to 4.3%. Raphael Nascimento, Fitch banking analyst in São Paulo, believes this second statistic “could indicate a broader turning point for the segment”.

He also points out that the retail portfolio NPLs remained flat “which is notable as seasonal factors tend to weigh on this segment in the first quarter. “NPL ratios are stabilizing at a time when loan portfolios continue to contract, meaning that the improvement is not due to an expansion in lending but to factors affecting the ratio’s remunerator.”

Deutsche Bank’s research analyst Tito Labarta agrees with Fitch’s assessment, adding: “Early corporate NPLs improved significantly, which could indicate a turning point for the segment.”

However, despite the signs of green shoots, Fitch’s Nascimento adds a note of caution: “Whether this will translate into a sustained trend remains highly uncertain. Fitch maintains that the operational environment will stay deeply challenging, with asset quality deterioration continuing to be a big risk in 2017.

“There will also be continued performance differentiation between the public and private banks.”

The private banks continue to impress despite the difficult operating environment. Their aggregated improved credit performance boosted the banks’ return on equity (ROE) despite weaker revenue generation from lower lending volumes.

Average ROE for Bradesco, Itaú and Santander rose to 18.7% on Q1 2017 compared with 16.6% one year earlier. Much of this is because the private banks have already provisioned for the bulk of their bad loans in 2015 and 2016, which helped earnings even as aggregate NPLs rose slightly in Q1 2017. And as lower provisioning has been a key driver of recent results, this earnings trend should hold true even if NPLs see a slight uptick in coming quarters.

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Santander Brasil begins to win converts to its turnaround story

Credit Suisse believes 2017 will be seen as “a defining year” in the history of Santander Brasil.

Marcelo Telles, the Swiss bank’s equity analyst for the Brazil-listed bank, believes the perennially underperforming bank is achieving a strategic turnaround – and he expects that to feed into improving results this year and next.

“We remain confident with our bullish stance on Santander Brasil’s earnings outlook and the bank’s ability to finally narrow the profitability gap to private sector peers, mainly on the back of NII [net interest income] and fee revenue growth and revamped credit risk policies,” writes Telles in client report.

In an interview for Euromoney’s March issue, Santander Brasil’s CFO Angel Santodomingo outlined the bank’s multi-year turnaround strategy. That turnaround has been translating into stronger results – the bank has reported an increase in net profits in 11 of the past 12 quarters, with the rogue quarterly fall down to an impairment from provisioning.

“We identified where we had gaps in terms of products and we went out and either found good partners or we did acquisitions,” he said. “At the end of the day you need to acknowledge where you need help.”

The main additions were the 2014 acquisition of card payment processor Getnet, the acquisition of 60% of Banco Bonsucesso Consignado (payroll loans) in the same year and digital banking platform ContaSuper in 2016. According to the bank, Getnet has been particularly important: it leads the market in terms of transaction processing speed – two days compared with the competition, which can take more than a week. This has been an effective spearhead to win new corporate clients: Getnet’s market share is now 10%, up from “almost scratch”, and Santodomingo expects it will reach 14% in the short term.

However, many analysts still don’t see the strong and consistent growth from Santander Brasil as the start of a change in the bank’s fortunes. Telles acknowledges his forecasts are “well above consensus” and predicts an increase of earnings of 28.1% for 2017 and 27.6% for 2018.

Telles believes the discrepancy between his forecasts and that of his peers is because “the Street is underestimating the positive impact of the renewed strategy under the new leadership [which will] become clear already in 2017, when we expect ROE to improve from 11.6% in 2016 to 17.3%.”

In March, Euromoney identified that ” Santander Brasil is the momentum story in a tough market” – with a strong valuation level the main challenge for investors looking to gain exposure to the turnaround story.

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Consolidation starting in Argentina as Macro targets Patagonia

Banco Macro has signalled its serious intent to buy Banco Patagonia by proposing an equity sale of up to $750 million to finance the acquisition.

According to a regulatory filing made last week, Macro’s board will seek authorization for the sale of up to 74 million ordinary B-series shares – with an over-allotment option of up to 15%. The statement claimed the sale was “advisable given the favourable outlook for growth of the banking business in the country and the bank in particular”.

However, while not being explicit about the use of proceeds for its proposed equity transaction, Macro is rumoured to be in pole position to acquire Banco Patagonia. The amount of equity being raised is consistent with the bank financing the acquisition of 84% of Patagonia for around $1.9 billion with 50% equity and 50% debt – as the bank currently has $265 million on its balance sheet available for M&A. The remaining 16% of Patagonia is listed and it is expected that this float would remain on the stock exchange.

Banco do Brasil owns 59% of Patagonia, with the other leading shareholders being the Milne and Moreno families (a combined 21%). The Brazilian bank is seeking to sell non-core assets to avoid having to conduct a dilutive equity transaction in its domestic market. Patagonia’s management has been exploring the options for the sale and the most likely strategy is now the sale of the 84% unlisted stake to a single buyer.

Patagonia is the 11th largest bank in the Argentine banking system and offers a strong opportunity for inorganic growth. However, its size – with $4.7 billion in assets and 200 branches – shortens the list of potential buyers. Macro is understood to be the most likely, but Galicia has also expressed an interest and Banco Frances is also a possibility.

If Macro succeeds it would become the country’s largest private bank in terms of deposits – according to data from the Argentine central bank – with Ps134.6 billion, overall behind Nación (Ps350.8 billion) and Provincia (Ps163.1 billion), and pipping Santander Río (which would become fourth largest bank in the country with Ps127 billion and Galicia (fifth, with Ps116.7 billion). Banco Frances would be sixth with deposits of Ps91.9 billion.

The bank isn’t commenting on the M&A rumours, but, according to Debtwire, its management did express its intention to participate in the auction for Patagonia on its 4Q16 conference call.

UBS expects a sale price of about $1.9 billion based on a 20% premium over current price, and implying a 3.8-times book multiple. The bank has strong fundamentals, reporting return on assets of 5% and returns on equity of 38% in 2016.

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Supervielle flying in Argentina

Grupo Supervielle is set to continue its rapid, above-industry-average growth in 2017, according to Milton Migotti, head of international trade and financial institutions.

The banking group was the first Argentine financial institution to take advantage of improved investor sentiment about the country after Mauricio Macri became president. In May 2016, Grupo Supervielle sold a $323 million IPO through a New York listing. The deal was three-times oversubscribed, with all but a handful of the 71 investors being based outside Argentina.

Supervielle followed up that equity transaction by raising $300 million-equivalent – denominated in Argentine pesos – in an international debt transaction in February. Combined, the increased financing has enabled the bank to grow aggressively in its target segments.

“We grew our loan book by 50% last year, which was above the market,” says Migotti, who concedes that inflation of 30% puts the huge nominal growth into context. “We expect to grow at between 40% and 45% this year with inflation at about 25%.”

Supervielle actually accelerated growth at the end of last year while inflation was falling. In the fourth quarter, the bank increased its loan portfolio by 57.5% year-on-year and increased net income by 47.8% year-on-year (22% quarter-on-quarter) and hit a return on equity of 31.3%.

Migotti says the banking sector is finally getting some relief from the central bank’s policy of having positive interest rates – after years of having base rates lower than the inflation rate. “That has been a positive factor for the savings rate at the banks,” he says.

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Political protests could impede Paraguay’s new fiscal responsibility law

The increase in political uncertainty in Paraguay – as demonstrated by protesters setting the country’s Congress building alight during last week’s Inter-American Development Bank (IDB) annual meeting in Asunción – might slow the country’s economic growth, but not derail it.

That is the assessment of senior bankers in the country. Raul Vera Bogado, executive president at Banco Regional, argues that the biggest consequence of the violence will be a slowdown in proposed changes to the country’s fiscal responsibility law.

The current law caps the fiscal deficit to 1.5%, but Paraguay’s finance minister Santiago Peña has been working to increase the law’s flexibility to allow greater investment in infrastructure and give the country an ability to take a counter-cyclical stance.

“The protests [which were sparked by a constitutional amendment to allow president Horacio Cartes to run for a second presidential term] will make the proposed changes to the fiscal discipline law more difficult, which will also slow the growth of investment in infrastructure,” says Bogado in an interview with Euromoney at the bank’s Asunción headquarters.

“Infrastructure investment was going to be classed as structural deficit category – in line with the fiscal discipline rules adopted in Chile. These changes will be more difficult now – as will convincing people to accept higher government debt, which is a very sensitive issue in Paraguay.”

In March, Peña told Euromoney he had been working with Felipe Larrain, once Chile’s finance minister, for a year and a half on a replacement fiscal law that provides counter-cyclical flexibility. Peña argued a simple cap of a 1.5% fiscal deficit is an unnecessary straitjacket on a country with such low debt (18.4% of GDP) and cyclical tax revenues – external revenues related to trade and the Brazilian economy, and internal exposure to weather and agricultural productivity.

“We have exceeded capacity,” Peña told Euromoney. “Not financially, but legally in terms of the fiscal responsibility law. [The law] is extremely tight and doesn’t make any sense for a country like Paraguay that has the lowest debt-to-GDP [in the region] to have a maximum deficit of 1.5%.”

Peña had planned to introduce the new fiscal rules later this year with the intention it will govern the fiscal plans of the next government.  However, Bogado says that despite the likely slower growth in government-led investment, the country should continue to grow strongly – especially when compared with the rest of the region.

For the full article visit Euromoney Magazine

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Has Brazil’s equity rally run out of steam?

Is it time to sell Brazil? Yes, according to the Swiss bank that accurately called the strong rally in equity and FX during the past 12 months.

Credit Suisse and its Swiss competitor UBS have been eyeing the strong equity valuation and FX performance of Brazilian equities and looking to time a withdrawal. And after a 33% US dollar outperformance since moving overweight on Brazilian equities one year previously (March 8, 2016), Credit Suisse is moving underweight Brazil – and allocating those gains to a 10% overweight call on Malaysia.

Since Credit Suisse’s – then contrarian call – into Brazil, the MSCI Brazil index has appreciated by 56% in US dollar terms and 29% in local currency, outperforming the MSCI emerging market (EM) benchmark by 33%.

Alexander Redman, analyst with Credit Suisse in London, notes the market has moved the bank’s way in the past year. In a report called ‘Taking profits after a year overweight Brazil’, he points out that at the time the bank moved overweight Brazil, the median positioning of dedicated EM equity funds was 5% below the benchmark for Brazil. That position has now switched to 6% overweight.

Also pointing to a certain frothiness is the statistic that March 2016 marked the lowest point of analyst sentiment on Brazil, with 18% more sell and hold recommendations than buy calls – the most depressed sell-side view for a decade. In January 2017, the number of buy recommendations increased to the point where they outnumbered holds and sells for the first time since July 2014.

“All that is left is momentum and wishful thinking,” argues Redman. “A year [after the move to overweight Brazil] investor sentiment towards Brazil has recorded a volte-face. EM equity fund positioning is now the highest relative to the benchmark since 2008.”

Redman says Brazil’s currency has now moved to be the second most- expensive EM currency – posing a threat for dollar-denominated returns, especially as the bank argues that external dynamics will become less supportive of the currency in 2017 and 2018 due to its external financing needs. Also, although GDP growth is also forecast to return to positive territory this year, it is expected to be more in line with the 1981 to 2003 period of between 2.2% rather than the 4.4% seen between 2004 and 2011 – due mainly to demographic factors, low productivity and no uplift for commodities.

Redman points to the fact two-thirds of the 48 percentage point cumulative gain in Brazilian GDP since president Luiz Inácio Lula da Silva’s election in 2002 was due to gains in the workforce, with only the remaining third the result of demographics. This demographic boost is now running out – and will turn negative in 2020.

“Reform is critical to Brazil’s growth trajectory, most importantly addressing two key bottlenecks in the economy,” writes Redman.

“First by increasing labour market flexibility as a measure to boost productivity and hence competiveness. Second, the removal of inflation indexation of public sector wages and other administered prices, which would structurally lower inflation, bond yields and hence the corporate cost of capital, and boost equity value creation.”

Aptly, Redman’s call to go underweight Brazil came on the day that the country saw widespread protests to its proposed pension reform and one day after leading politicians – including five ministers – were named in the latest phase of the Lava Jato corruption enquiry. Both suggest a path to deep reforms will be problematic.

Redman’s strategic switch away from Brazilian equities in the financial space is based on the analysis of his financial analyst colleague Marcelo Telles. Telles says the expectations of a gradual improvement in bank asset quality and lower provisioning levels “is widely shared by management teams … and thus we believe is already reflected in asset prices” and the next couple of years will be characterized by limited credit expansion as households concentrate on “measured repair” of their finances – creating little room for outperformance by the banks.

Meanwhile, UBS has also been pondering whether Brazilian banks still offer value. In its client report ‘Is it time to sell Brazilian banks’, UBS points out that “we have seen a major valuation re-rating in Brazilian banks, from 6.0x PE to 10.0 PE as the sector’s cost of equity declined given political changes and prospects of structural reforms.”

However, while the report concludes that “there is limited scope for multiples to expand further [and] we now need to see positive earnings revision to support share prices or risk seeing a reversal in sector performance”, the bank maintains its neutral stance on the sector.

One investor says the valuations of Brazil’s financial sector are finely balanced and cause for caution. On one hand, the Ibovespa’s financial sector is trading slightly above its long-term average – at 10.6-times forward PE versus its historical average of 9.5 times – which suggests room for future outperformance is limited.

However, despite the recent valuation rally, banks on the Bovespa are still trading at around 11% discount to the MSCI Brazil and – bar a few exceptions – a feature of the market has been that the banks tend to trade above the overall market.

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