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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Investment One seeks niche in busy Brazilian finance space

Bernardo Parnes, co-founder and CEO of financial boutique Investment One Partners, says there is “clearly space” in the Brazilian market for independent consultancies such as his, which opened its doors at the beginning of this year.

Parnes, who was CEO of Deutsche Bank’s Latin American investment banking franchise until the German bank decided on wholesale withdrawal from the region, decided to establish his own firm after leaving in August.

His new firm will focus on two areas: financial consultancy for corporates looking to restructure, move through M&A transactions or who want independent advice on other transformational transactions such as IPOs.

The other “lateral” will be a wealth management service focused on ultra-high net-worth individuals and families – those with a minimum of R$50 million. Investment One will offer aggregation management advice for these clients who typically have their assets at multiple onshore and offshore banks.

Investment One Partners is based on Faria Lima in São Paulo and has 12 full-time employees. It has completed its first mandate, advising União Química Farmacêutica in its acquisition of Zoetis’ (formerly Pfizer) plant in Brazil, and Parnes says the bank is talking to other companies about potential M&A transactions, both on the buy side and the sell side, and he says he has one potential pre-IPO mandate.

“We have some IB mandates and we have closed one in the wealth management advisory,” says Parnes. “But we want to develop slowly – our biggest asset is our name and reputation. We offer a personalized boutique with senior advisers – we don’t have any kind of conflict because we don’t offer financing.”

However, the firm does plan to run a small private equity group that will focus on the healthcare sector – aided by the sector speciality of partner Fabio Jung, who joins from Bank of America Merrill Lynch. Parnes says he is relishing returning to client work on a daily basis. “I have just been to a site visit,” he says when welcoming Euromoney to his new office. “I think the last one before today was in 1997 for the Vale privatization.”

Parnes declines to talk in depth about Deutsche Bank’s decision to leave Latin America and says his departure was amicable and logical following that decision. He believes that the bank should have retained its presence in Mexico, Argentina and Brazil – the bank retains a slimmed down São Paulo office – but that ultimately the withdrawal was part of a wider strategic rationalization of the bank’s global presence.

Parnes says there will be synergies between the IB consulting side of the business and the wealth management service, which is being headed by Raphael Zagury, who also joins as partner from Deutsche Bank and had previously worked for Bank of America Merrill Lynch and Goldman Sachs.

Brazil has a competitive wealth management market, but Zagury believes there is a need for an aggregation advisory service for the country’s richest families.

“These people almost always have assets at multiple banks in Brazil – and usually a couple of international banks as well,” he says. “There can be a lack of awareness of the risks that he or she is running in particular asset classes.

“This is particularly true when you add in corporate assets to the full picture: often risks within a business are too closely correlated with family assets and even in international portfolios – Brazilians can quite often buy international bonds for their offshore portfolios instead of diversifying in a broader manner.”

Zagury says Investment One will charge a flat management fee. “We had a lot of discussions about our business model, but ultimately we wanted to align our interests to the client and a flat fee based on the assets is the best way to do this,” he says.

Zagury argues performance fees align interests in the upside of performance, but a lot of his service will be protecting on the downside – encouraging reach for return doesn’t reflect this wealth-preservation aspect.

“A portfolio return should only be a consequence of a certain level of risk,” he says. “Our duty to clients is on managing their risk, first and foremost. A flat fee allows us to purely focus on this mandate.”

One investment banker at a full-service firm queries whether the Brazilian market has the scale for independents to thrive. “I was in New York last week and they had three IPOs on the day I visited the exchange,” he said. “There were hundreds last year. This year, Brazil would be happy if we did six, so I think the markets are very different.

“In the US, the top banks focus on the deals they want and there is still room for second-tier banks and independents. That simply isn’t the case in Brazil – there isn’t the scale for us all to generate enough fees to sustain these independents.”

However, Parnes takes comfort from the growth of independent investment banks in the US, such as Moelis, which has now opened an office in Brazil. “We see the existence of other independent banks as proof that there is room for these type of services in Brazil – and that will only grow as the economy recovers,” says Parnes.

“Our aim is to give clients the assurance that they will be discussing transformational ideas with senior bankers, who will then be the same people who lead them through negotiations.

“We want to make a lot of money, but we are not desperate for fees. Our aim in starting this firm was to build very deep technical expertise to deliver a top-tier job for our clients – but also one that isn’t political and has a fun working ambiance.”

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Four is company at Grupo Aval

Banking consolidation is often cited as a challenge in Latin America. In the past, banking crises have led to acquisitive growth opportunities for those banks that have been relatively less stricken, while customers have sought out the strongest banks for fear of the smaller ones failing. These factors have been supplemented by others, such as costs of regulation and technology for smaller entities, to drive an increase in the market share of the leading players.

This has led to some very large banks, such as Itaú in Brazil and BCP in Peru. But the model is slightly different in Colombia.

Consolidation of market share is evident here, too, but less conspicuously. A quick look at the market reveals banking plurality, but this is something of an illusion. Grupo Aval has majority holdings in four of Colombia’s banks. Banco de Bogotá (68.7%), Occidente (72.3%), Popular (93.7%) and AV Villas (79.9%) – quite apart from its 100% holding of BAC Credomatic, the leading central American bank.

According to Maria Francisca Barriga, financial analyst at Davivienda Corredores, the bank is the leader in the consumer and commercial portfolios. As of February, Grupo Aval had 26.5% of net loans in the Colombian financial system ($33.1 billion) and 27.6% of deposits ($31.5 billion). It had 26.6% of all assets ($48.7 billion), while its $1.7 billion of net income for 2016 was 44.6% of that for the whole Colombian financial system.

There are historical reasons for the multi-brand strategy – they had all been standalone banks and to this day each bank has a different sector and strategy. For example, Banco de Bogotá, the third-largest bank in Colombia, is a commercial bank (76% of its loan portfolio), whereas Banco Popular operates mainly in consumer and public-sector business and is heavily concentrated on payroll loans. AV Villas is the smallest of Grupo Aval’s banks and is mostly focused on mortgages. However, each bank is evolving its strategy. AV Villas has broadened into commercial and consumer loans. Banco de Bogotá’s main strategic aim is to win market share in mortgages.

As each of the banks broadens its business mix, analysts increasingly question the utility of operating independent banks, with the replication of senior management and other costs. Would it not make sense to pull down the internal walls within Aval?

“It is important to remember that we currently operate under four banks that are the result of multiple mergers,” says Luis Carlos Sarmiento Gutiérrez, who has been president of Grupo Aval Acciones Y Valores since 2000. “We still operate them separately because from a strategic standpoint it works as they focus on different segments with distinct products.”

However, Sarmiento says that the bank is still chasing operational efficiencies and he can see a point where the value generated by operating multiple brands is exhausted. “We have been working behind the scenes to have all the banks running in the same core system and with the same ERP [enterprise resource planning]. We have made advances, but it is a multi-year project. We are not in a rush to merge, and if the decision of merging is taken, it will be done after we have completely minimized the potential risk of value destruction.”

This cautious approach sometimes frustrates analysts who argue that it will be hard to reduce the cost-to-income ratio to the industry standard by back-office simplification. Frederic de Mariz, banking analyst at UBS, initiated coverage on Grupo Aval in January this year with a buy rating, but highlighted that the group’s “efficiency is worse than Colombian peers”, saying he does “not expect Aval to merge its four banking subsidiaries into one [and that] we expect the cost-to-income ratio to remain around 51% in the coming years [versus 44% for Davivienda and 47% for CIB].”

“Our cost-to-income ratio is actually well below 51% and currently stands between 47% and 48%,” responds Sarmiento. “So I guess we have proved analysts wrong on that. But to be fair, there will be cost synergies that we will not be able to achieve with our current structure. In the meantime, however, we will continue to work on implementing strategies to control cost increases while we continue to expand our business. We expect to be below 45% on a cost-to-income basis in two to three years.”

Sarmiento is more in agreement with the analysts who point out that it will be tough to maintain its current level of profitability – the last few years have seen returns on equity of around 15%.

“This is a tough challenge as capital regulation constantly requires financial institutions to retain more capital,” says Sarmiento. “Having said this, we will have a boost in returns thanks to the fiscal reform, which will help us improve, or in the worst scenario, maintain our returns. On a more strategic discussion, the ability of banks to remain profitable will depend on how fast are they able to migrate to cost-efficient channels and how good they are at defending their products versus new ways of doing banking.”

‘Cost-efficient channels’ and ‘new ways of doing banking’ mean, of course, digital banking. And Grupo Aval’s banks are no different to the rest of those in Latin America. The large footprint the bank has (with 1,543 the Group comfortably has the most branches, compared with 817 at Bancolombia and 592 for Davivienda) is both an opportunity and a challenge.

Sarmiento says that digital investment allows the group to completely “re-imagine our processes and operations” to reduce operational costs. “In short, digital should help us to serve our clients more efficiently and, more importantly, the way they want. There’s no trade-off between customer experience and efficiency. Digital should allow us to do both.”

Aval has been redesigning its products and services for digital implantation. For example, AvalPay is a digital wallet that offers benefits to clients in the places they transact, ranging from discounts at restaurants to being able to buy tickets at the exclusive pre-sale of concerts through ‘Experiencias Aval’. The Aval master brand is becoming more visible in the Colombian market. “We’re also working on the efficiency front,” says Sarmiento. “We’re starting to work in the digitalization of the key banking processes – or ‘journeys’ as consultants are now calling them – which should result in faster and more efficient solutions for the banking needs of our clients.”

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Bradesco BBI aims to become regional investment bank

Bradesco BBI is aiming to become a regional investment bank in Latin America over the next couple of years, according to its managing director Leandro Miranda.

Leandro Miranda, Bradesco BBI Miranda, who has headed Bradesco’s investment banking unit since late 2014, laid out the bank’s new expansion strategy exclusively to Euromoney. Miranda says he expects to grow rapidly its offices in New York, Mexico City and Buenos Aires to become a truly regional investment and commercial banking platform.

Miranda says the decision to become a regional player solidified after BBI’s recent experiment of expanding its trading desks to cover other Latin American bonds.

“For the past five years we have had one of the largest trading desks in Brazil and we frequently got enquiries to trade Mexican, Argentine or Chilean bonds,” he says. “We had to say no, but then we decided to broaden into these products and the surprising thing was that our portion of these clients’ Brazilian business also increased.

“This is because these counterparties like to have a single bank of choice where they can concentrate their business. They would rather have regional bank rather than single country banks.”

The decision to grow Bradesco BBI into a regional player is a marked departure from the division’s previous Brazil-only strategy. How far does Miranda think he can move to the regional model?

“A lot! I see Bradesco going LatAm very, very fast,” he replies. “We have just started to cover LatAm in research and trading in LatAm bonds. I foresee the same for equities in the very near future. ”

And then last, but not least, we will need to approve credit lines as we push to be a truly Latin American bank.”

The push to developing the investment bank will precede the development of a regional commercial bank – complete with a significant balance sheet – resulting in a CIB franchise. The development of a regional retail banking operation is not part of the bank’s new Latin American strategy.

This development strategy is similar to the approach taken by the bank when growing its Brazilian investment bank. “I came to Bradesco in 2011 [from Credit Suisse] when were ranked second or third in the league tables. In two years we had become number one,” he says. “When I became head of the investment bank we were ranked 12 in M&A. Last year we were number one. And now I am backing equity – that is the build.”

Miranda’s growth model fits with his view of global investment banking. “There is a major trend for universal banks around the world,” he says. “Unless you are Goldman Sachs, which has been an independent investment bank for a long time, then there is no room for standalone investment banks in the future.

“The model needs to be: be a great investment bank as part of a great financial conglomerate. That’s the only way to become the trusted adviser and bank of choice [for corporates].”

Miranda says he has been using this strategy to build its equity business, which is now one of the top-ranked banks in the league tables. He argues that winning IPO mandates requires banks to provide capital, combined with having the credibility from league-table rankings and being able to provide clients with ideas and market insight.

“If you only have ideas and the league table, it won’t guarantee [your franchise] mandates,” he says. “And if you aren’t guaranteed mandates at some point you will lose your league-table position and then you will be left with just ideas – in which case you should be an adviser and not a bank.”

Miranda’s approach unashamedly leverages the large corporate balance sheet of Bradesco. He also says the investment bank’s traditional weakness – lower-ranked research – has been bolstered by its acquisition of HSBC’s Brazilian unit.

“The HSBC acquisition was very complementary on the research side – around 50% of our research comes from HSBC and some of them are top-ranked,” says Miranda. “It has made a major difference and we have been able to use this to increase our sales effort, as well as other recent hires of bankers from competitors such as Bank of America, Goldman Sachs and Morgan Stanley.”

Meanwhile, Miranda says stability on the origination side has helped developed trust with the senior managers of their corporate clients. “Most of our origination bankers have been at the bank for the last five years and have made these companies a lot of money through fixed income and M&A transactions, and are now well placed to extend that into equity mandates,” he says.

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Was Brazil’s crash an opportunity or the end of a bull run?

Bargain hunters came into the market for shares in the Brazilian banks at the end of last week as investors bought the crash that immediately followed a scandal that threatens to end Michel Temer’s presidency.

However, while the subsequent recovery appeared to put a floor on the sector’s equities, there are some analysts who caution that Temer’s desire to cling on to power could see a slow reversal in what has been one of the world’s best performing asset classes in 2017 – for dollar-denominated investors.

On Wednesday evening, Brazilian newspaper O Globo reported that Joesley Batista, the co-owner of meatpacker JBS, had secretly recorded conversations with politicians as part of the Lava Jato investigation. The newspaper said it had heard recordings of Temer agreeing a plan to pay the jailed ex-speaker of congress, Eduardo Cunha, to maintain his silence and not cooperate with the ongoing investigations. The news story led to cabinet resignations and some of the smaller parties in his coalition announced they would be leaving the government. Impeachment proceedings were also filed by opposition congressmen.

The next morning the markets crashed and the so-called circuit-breaker was enforced when the Bovespa fell by 10%. By the end of the day, the Bovespa was down 9% and the financial sector performed significantly below that dismal benchmark – at an average of a 14% fall – non-bank financials fell by an average of 5%. The worst performer was Banco do Brasil, which fell by 19%.

Furthermore, Brazil’s currency depreciated 8% to R$3.38 to the US dollar and CDS spreads widened almost 10 basis points to just over 300bp.

However, after the markets closed on Thursday, a visibly angry Temer addressed the country and vowed that he would never resign. Later that evening, the audio was released and proved to be less definitive than O Globo had reported – though it was still damning and appears to show that Temer was at least aware of monthly bribes being paid to Cunha.

The next day bids returned for Brazilian bank equities and, while the previous session’s falls were far from erased, there were significant increases: Banco do Brasil rose 9.7% from its lowest point on Thursday by the market’s close on Friday; Bradesco by 7.2%, Itaú by 11.2% and Santander Brasil by 11.1% A positive view of the outlook for Brazilian bank shares is based on the view that this scandal might not blow the country’s economic recovery completely off course.

This, from a UBS report, encapsulates this outlook:

“We believe the macro fundamentals, BCB [Brazil’s central bank] credibility and tools like the FX swaps, as well as lower positioning from foreigners could attenuate the impact of the shock this time around compared to late 2015. “Inflation is en route to the lowest level in a decade below the mid-level of the target range, the current account deficit is low and more than financed with (as of now) booming FDI. “It is also not clear at all that pension reform is completely dead even if the current government is compromised. A lot of the work would in any case have fallen in the lap of the next government post-elections in 2018.”

However, UBS acknowledges this is an optimistic view and the more consensus view within Brazil is that pension reform is almost certainly dead if Temer doesn’t resign. Even if he does, Brazilian politics might still be too volatile in the run up to 2018 for significant reform.

Deutsche Bank is one of the many banks that see more downside risk than upside. The rally in the credit markets has been based on the assumption of a reasonable fiscal reform. With that reform agenda significantly delayed – at best – or halted due to political uncertainty, Deutsche says “the support for Brazil credit could dissipate rather quickly”.

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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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