Bradesco Is Weathering Brazil Storm

| About: Banco Bradesco, (BBD)

Summary

Bradesco results for 2015 show a solid, profitable and well capitalized bank.

Challenges ahead are related to its capacity to grow the deposit base and manage non-performing loans, which are likely to rise in the future.

High interest rate environment in Brazil bodes well for financial sector players, especially dominant and well managed ones. The equity seems attractive given dividend policy and historically low valuation.

Brazilian banks have always proved resilient to adverse macroeconomic environments and currently that doesn't seem to be changing. Pillars of the economy of the largest country in Latin America, Brazilian banks earnings are likely to continue strong.

Bradesco (NYSE:BBD), posted fourth quarter and full year 2015 earnings surprising equity market analysts on the upside. 4Q net income rose 10% and in 2015 grew at double digit pace, rising 16.4% to 17.873 bn BRL, or 4.5 bn USD.

The increase was a quality one. ROE stood above 20% and the Basel ratio calculated according to Basel III principles, was 16.8%, the highest level since 2012. Also relevant is the fact that the fourth quarter core capital ratio rose by 130 bps, when compared to 3Q, mostly explained by accumulated earnings in the period (70 bps). In the end of 2015 core equity ratio stood at 12.7%. High ROE and Basel ratios are signs of fundamental strength because they show that the high ROE is not the result of earnings on a low capital base.

Assets expanded moderately, mostly on the back of an increase in investment in securities and to a lesser extent credit concession, which excluding the foreign exchange effect would have stayed stable. Securities activities have been raising its weight in the financial profile of the bank, expressed by the increase in securities held for trading and available for sale. When looking at financial margin data, trading activities in their pure sense are limited, as most of the earnings were explained by interest gains.

The deposit base has been falling through 2015 and the leverage position of Bradesco has been deteriorating with the ratio of loans to deposits surpassing 150% in the end of the year, which represents a material increase and a somewhat high level in general. Asset expansion has been funded by bond issuance and earnings generation, the first source clearly not sustainable in the long term given rising funding costs for Brazilian banks.

Credit quality seems resilient with loans classified in the three best categories (in a scale of 9 categories) rising, and standing at around 79% of the total credit portfolio, which compares with levels around 70% 5 years ago. The credit portfolio is well diversified by sector and segment, with the largest debtor representing only 2.8% of the portfolio, revealing prudence in credit concession and risk management.

The financial margin rose 12% after provisions to around 10.3 bn USD in 2015, reflecting an improvement in the last quarter of the year, which curiously is coincident with further aggravation of economic conditions. This result was an even contribution from lending and securities and to a lesser extent insurance operations.

Bradesco has been prudently increasing its levels of provisions which reached 8% of total loans in 4Q15 while non-performing loans to total loans (measured by loans in arrears for more than 60 days) rose only slightly to 5% in 4Q15 from 4.7% in 3Q15 and 4.3% in 4Q14, provisions covered 161.7% of those credits, at year-end. Efficiency of operations has been improving throughout time, with the efficiency ratio reaching 37.5% in the last quarter of the year, which compares with levels well above 40% in the past.

Foreign exchange conversion effect on cash and equivalents was negative at 2.911 mn BRL or 746 mn USD in 2015. This represents near 16% of net income. Although international activities are somewhat limited in Bradesco corporate structure profile, this number highlights the magnitude of potential gains once the currency stabilizes.

Bradesco payout ratio reached 37% in 2015, including guaranteed income of preferred shares, a historical high level.

The Brazilian financial system is concentrated in the ten largest banks, among thousands of existing ones, as they stand for around 85% of the systems' assets. Concentration has been reinforced in the last couple of years as large players like Bradesco acquired internal competition, foreign banks exited the country or Brazilian Banks made acquisitions abroad and increased their asset base. Bradesco acquisition of HSBC Bank Brasil is a good example of that.

Increasing concentration in the sector and a rising interest rate environment are positive influences over net interest margins, as long as non performing loans remain manageable and performing ones are profitable enough to allow provision building without jeopardizing profitability. I think the current results of Bradesco show the capacity of the bank to deliver precisely that going forward.

The main risks ahead are related to the credit quality of the loans in Brazil given challenging economic conditions and the capacity of Bradesco to increase its deposit base.

Bradesco is a very well capitalized, well managed bank, used to challenging operating environments such as the current one. Provisioning levels are a conformable buffer, and a raising rates environment is positive for net interest margin and securities interest income.

Bradesco shares have a dividend yield currently reaching 8%, P/E at 8.7 and the equity price is at the lowest level in more than 10 years. Being the financial sector somewhat neutral in terms of cyclicality when compared to alternatives, this could be a good opportunity to gain exposure to the Brazilian banking sector.

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I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.