For Brazil Banks, Is Worst Is Yet to Come -- Barron's Blog

        By Dimitra DeFotis
        As Brazil's currency weakens and the iShares MSCI Brazil Capped ETF ( EWZ) falls another 3% today, heed the observations of the RBS credit team who think the worst is yet to come for Brazil's economy.
        Analysts Alberto Gallo, head of macro credit research at RBS, along with Tao Pan, Mateja Popovic, Imogen Bachra and Ashleigh Gran write:
        "Brazil is dealing with the aftermath of past excesses: corruption scandals and political risk. Risk premia have held on so far, but fundamentals continue to deteriorate. We think the worst is yet to come ... Growth is likely to slow further, on lower public support. Private and public indebtedness rose as a result of stimulus programmes and easy credit. While this fuelled consumption and asset price growth, Brazil must now deal with a combination of stagflation and cost reductions to achieve fiscal targets. Adding to this is rising political risk: consumer and business confidence have declined in line with President Dilma Rousseff's approval rating (8% in July, the lowest on record since 1992)."
        But there is a way to play the situation, even though banks in Brazil have not fared well: Itau Unibanco Holding ( ITUB), whose shares are down 3.6% today, is down nearly 7% in July and the stock has fallen more than 20% this year. But there are ways for investors to profit. RBS writes:
        "Brazilian banks have so far been resilient, but with a weaker economy, we expect asset quality to deteriorate. Brazilian state banks are particularly vulnerable to a deteriorating economy, due to their exposure to SME loans and high loan-to-value mortgages, and weaker capitalisation.
        New trade: Short dollar-subordinated Banco do Brazil 5.875% 2022 vs long dollar-subordinated Intesa 5.017% 2024. Banco do Brazil ( BDORY) is vulnerable to the domestic slowdown and political uncertainty, given its high loan exposure to SMEs [small and mid-size enterprises] and sectors linked to the Petrobras ( PBR) scandal. Intesa Sanpaolo ( ISP.Italy) is a Europe-focused bank, with 95.2% of its operating income generated in Europe (FY 2014). In addition to being more isolated from emerging markets, Intesa is likely to benefit from on-going structural reforms in the Italian banking system and a domestic cyclical recovery, supported by continued European Central Bank easing."
        (END) Dow Jones Newswires

        July 22, 2015 15:13 ET (19:13 GMT)

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