LONDON & NEW YORK--(BUSINESS WIRE)--Fitch Ratings has taken rating actions on three Brazilian payroll deductible loan banks. Banco BMG S.A.'s (BMG) Viability Rating (VR) was upgraded to 'B' and the Outlook on long-term (LT) Issuer Default Rating (IDR) was revised to Positive from Stable; Banco Bonsucesso S.A.'s (Bonsucesso) ratings were affirmed with a Negative Outlook, while Parana Banco S.A.'s (Parana) ratings were affirmed with a Stable Outlook. A full list of rating actions follows at the end of this rating action commentary.
The rating actions reflect Fitch's view of these issuers within the highly competitive environment for payroll deductible loans in Brazil in 2014, dominated by stronger, larger and better-capitalized banks. The rapid increase in loans in Brazil in the last years (17% per year, between 2010 and 2013, reaching 55% of GDP in September 2013) was mainly driven by public banks, which accounted for 45.2% of outstanding loans in the system in September 2013. Rapid growth has led to generally higher delinquency levels, which peaked in 2012. In order to improve the overall quality of its credit portfolios, most large retail banks put greater emphasis on expanding their lower-risk lending segments such as mortgage and payroll deductible loans in the last years. This has resulted in an improvement in system asset quality indicators (past-due loans over 90 days fell to 3.0% in January 2014, from an average of 3.8% in the second half of 2012), but has led to a more difficult competitive environment for smaller wholesale-funded payroll lenders.
The enhanced growth in the payroll lending segment during 2013 at BMG and Itau Unibanco S.A. (IU; LT Foreign Currency [FC] IDR 'BBB+'/Outlook Stable, part of Itau Unibanco Holding S.A., the largest private financial institution in Brazil), along with the greater competition from the other large banks, such as Banco do Brasil, Caixa Economica Federal, Banco Bradesco and Banco Santander (Brasil), has put further pressure on players with smaller market shares in this segment. These smaller institutions also face other considerable challenges such as higher commission costs and rate restrictions such as fixed rates and other government-determined rate ceilings for the most profitable contracts (e.g. INSS - the Brazilian social security agency) while funding remains wholesale in nature and hence exposed to sudden changes in market sentiment as seen in 2008-2010 .
Among the three banks, BMG is the largest by equity (BRL3.4 billion in 2013), followed by Parana (BRL1.3 billion) and Bonsucesso (BRL386 million). Payroll deductible loans remain the core product for each bank. In 2013, Parana's asset quality, performance and capitalization ratios remained better than those of BMG and Bonsucesso. In the same year, past-due loans over 90 days were 2.7%, 3.8% and 7.0% for Parana, BMG and Bonsucesso, respectively, while ROAs were 2.95%, 1.60% and 1.06%, respectively. Bonsucesso's higher delinquency ratios reflect the problems it had in its SME loans book, whereas the quality of its payroll loans is closer to its peers. Parana also had the highest Fitch Core Capital (FCC) ratio at 14.4%, compared to 12.4% and 5.1% for Bonsucesso and BMG, respectively. Parana's profitability has been underpinned by the above-average diversification of its revenue sources derived from its successful insurance operations, which mitigates the challenges on their main bank business niche.
The funding strategies of the three banks differ significantly, as BMG and Bonsucesso rely heavily on loan portfolio sales, while Parana has not used this source of funding since 2008. At end-2013, BMG utilized 73% of its limit of deposits with special guarantees (DPGE I and II) with the Fundo Garantidor de Credito (FGC), Bonsucesso utilized 56%, while Parana utilized only 23% of its DPGE I limit and does not plan to realize any funding through DPGE I or II. All three banks, similar to most mid-sized Brazilian banks, face the continuous challenge of diversifying and prolonging their funding base.
Fitch recognizes these institutions' efforts in improving their funding structures and searching for alternatives to reduce the dependence on payroll deductible loans. Among the three banks, Fitch views Bonsucesso as the bank that will face the most severe difficulties in achieving its targets, although all three banks will continue to operate in a challenging operating environment in Brazil in 2014. This is expected due to the persistence of modest economic growth, relatively high volatility (exacerbated by the upcoming presidential elections in October 2014), increased competition from larger institutions pressuring margins, and asset quality indicators susceptible to adverse economic developments and a potential rise in unemployment.
KEY RATING DRIVERS - IDRS, VRs, SUPPORT RATINGS, NATIONAL RATINGS AND SENIOR DEBT
BMG's VR, and National Ratings have been upgraded because of the bank's improved capital position, its significant increase in profitability, improved asset quality, and enhanced funding position which has benefited from its association with IU and other diversifications to its funding over the past few years. It also reflects its continued expertise as one of the founding banks in the development of this segment along with its improved corporate governance in 2013 as BMG added several new members to its senior management team and also more independent members to its board of directors. These new team members are highly respected in the industry and have vast experience, as most were previously senior managers at some of the largest private sector retail banks. The rating also considers BMG's challenge to improve its FCC, which has improved since its low point in 2012, but still is pressured by its large goodwill amount of BRL1.1 billion. BMG saw a sharp turnaround in its profitability during 2013 through a combination of lower funding and credit costs and the continued high demand for its services during a period of favorable net interest margins. The bank recognizes that margins have become less favorable and plans to mitigate this by increasing its focus on cross-selling, increasing fee revenue from its credit card and other businesses, and cost control.
BMG was one of the founding banks in the payroll lending segment and this form of secured lending represents nearly 89% of its business. As a result of its wholesale funding model, changes in regulatory and economic environment, combined with problems with other payroll lenders, inexpensive funding became more difficult to source and the bank posted significant losses in 2012. Also, the purchase of a smaller payroll lending bank, Banco Schahin in 2011, resulted in most of the aforementioned goodwill amount that Fitch excludes from its FCC calculation, even though goodwill is still mostly included in the Total Regulatory Capital ratio.
In mid-2012 BMG entered into a very favorable funding agreement with IU. The agreement provides for asset purchases, which enables funding stability and lower funding costs. This, in turn, resulted in other institutions also providing funding at more favorable rates. Despite the agreement, BMG limits its dependence on the IU agreement by also selling to other large well-known banks. Other funding sources have also grown and include FIDCs, financial bills (letras financeiras), subordinated debt and external funding.
In addition to the funding agreement with IU, BMG and IU also formed a payroll lending joint venture, known as Banco Itau BMG Consignado S.A., with BMG as a 30% participant which allowed for a substantial reduction in expenses and additional equity earnings since it began operating in early 2013. The combination of these adjustments and the strong demand for their product resulted in a significant turnaround in earnings resulting in a stronger capital position that Fitch expects will continue in 2014.
The affirmation of the support rating reflects Fitch's belief that the Brazilian government would provide support if needed given the relevancy of BMG in the payroll-deductible loan market in Brazil. The Support Floor of 'B' means that BMG's IDRs would not fall below 'B' as long the assessment of support does not change.
The affirmation of Bonsucesso's IDRs, National and senior debt ratings is driven by the affirmation of its VR. This, in turn, considers the bank's dependence on payroll and deductible lending, the still improving asset quality, as well as the bank's still low profitability. In addition, it also contemplates Bonsucesso's relatively modest size - limiting potential support from the government - and FCC ratio, as well as its still limited revenue generating capacity. This combination accentuates specific vulnerabilities, revealing a bank more susceptible to fluctuations of the economy when compared to peers.
Overall, Bonsucesso's strategy is to change its business model to a lighter structure as a service provider and to focus on deleveraging. Efforts are underway to review the organization of the bank and bolster its performance. Although the bank has been able to quickly develop new products and implement them, revenues originating from these new products may take some time to stabilize. Currently, the bank's main earning generators are still payroll deductible loans (88% of total revenues).
Bonsucesso has had relative success in its strategy of selling payroll loans so far. However, the positive result of this strategy has been partially offset by the large loan loss provisions made for problematic loans in the middle market. As a result the bank's profitability still compares poorly with peers.
Overall, Bonsucesso's asset quality slightly worsened in the last quarter of 2013. Nevertheless, Fitch continues to closely monitor it, since the bank's total impaired loans "D-H" to total loans ratio remains relatively high (10.2% in Dec. 2013 up from 9.6% in Dec. 2012), as does the ratio of past-due loans over 90 days-to-total loans (at 7.0% by the end of 2013). This, however, was already expected as a result of the reduction of the total credit portfolio - from BRL2.2 billion by end 2012 to BRL 1.9 billion by end 2013. In absolute terms, loans classified between "D-H", as per the central bank's definitions, fell by 13.5% from BRL 235.5 million in Dec.2012 to BRL 203.7 million in Dec. 2013. Also, reserves-to-total loans classified in the D to H categories improved to 65% in FYE13 from 54% in FYE12.
The Negative Outlook reflects the bank's still tight profitability (which is expected to continue in 2014), higher competition in its main business line, and still high delinquency levels compared to peers in a more challenging operating environment.
The affirmation of Parana's National ratings and Stable Outlook reflects its proven track record of maintaining good performance, even during periods of economic deceleration, driven by its conservative risk appetite and relatively diversified revenue base supported by its insurance subsidiaries and the growing SME lending business. The ratings also take into account the bank's adequate liquidity and capitalization, as well as its relatively concentrated funding base.
On the lending side, payroll deductible loans remain as the bank's core product, notwithstanding the gradual growth of the SME loans and the recent entry into the home equity loans segment in October 2013. In 2013, payroll deductible and SME loans made up 78.4% and 17.4% of Parana's total loans (79.9% and 16.5%, in 2012, respectively), while home equity loans corresponded to less than 0.05% of the total. The bank plans to grow cautiously in all segments with continued focus on asset quality. In 2013, asset quality remained good, with PDLs over 90 days at 2.7% (3.0% in 2012) and loans classified between D-H, as per the central bank's definitions, at 3.91% (3.83% in 2012).
On the insurance side, Parana is active in the surety segment through its 50.5% share in the holding company: J. Malucelli Participacoes em Seguros e Resseguros (JMPSR), which, in turn, controls J. Malucelli Seguradora S.A. (JM) e J. Malucelli Resseguradora S.A. (JM Re) (both with National Insurer Financial Strength rating of 'AA-(bra)'/Outlook Stable). In 2013, 47% of Parana's capital was deployed in the insurance operations.
In 2013, Parana's performance ratios remained solid, despite the challenging operating environment. The insurance operations accounted for 23% of Parana's net income in 2013 (28% in 2012).
Parana's capitalization ratios remain adequate, despite strong loan growth in the recent years (22% between 2010 and 2013). Its FCC ratio (14.42% and 14.00% in 2013 and 2012, respectively) is significantly lower than its regulatory capital ratio (27.40% and 27.08% in 2013 and 2012, respectively), as the former deducts the investment in the insurance operations from the equity base. The agency believes that the bank`s capital base is sufficient for continued growth and absorption of potential losses.
In 2013, Parana continued to diversify its funding base in terms of products, particularly through the issue of financial bills (letras financeiras), but concentration per investor remains high. The top 20 investors made up 55% and 58% of total funding in 2013 and 2012, respectively. The bank plans to fund its home equity loans portfolio through credit linked funding (letras de credito imobiliario, LCIs) in 2014 and through securitization possibly from 4Q'14 onwards, which would benefit the bank's asset liability management ALM.
RATING SENSITIVITIES - IDRS, VRs, SUPPORT RATINGS, NATIONAL RATINGS AND SENIOR DEBT
BMG's IDRs, VR, National and senior debt ratings are sensitive to further improvements or an unexpected deterioration in their FCC ratio and other leverage and asset quality indicators. An increase in the FCC ratio to over 7% or a decrease below 5% could lead to a review of the ratings, which would take into account other factors such asset quality and liquidity. Fitch expects that BMG's profitability will continue to be aligned with the current trends.
Bonsucesso's IDRs, VR, National and senior debt ratings are sensitive to a change in Fitch's considerations around profitability and asset quality. Should ROA and ROE remain lower than 1.5% and 10%, respectively, the bank's ratings could be downgraded. A key focus of the review will be the bank's ability to stabilize asset quality, which has deteriorated considerably during the last fiscal years. A more robust recovery of operating profits and better expense' balance could result in a new review of its Outlook.
Parana's National ratings are sensitive to a change in Fitch's assumptions around performance, capitalization, asset quality and liquidity. They could be upgraded if Parana diversifies and extends the maturity of its funding base and improves the asset and liability maturity mismatches. They could be downgraded if there is a sustained and substantial worsening in performance, asset quality and capitalization (ROA remaining below 1.5%, D-H loans remaining above 4.5%, and FCC ratio falling below 11% for a prolonged period). In addition, a significant change in the performance or ratings of the insurance companies could also lead to a parallel change in Parana's ratings.
The rating actions are as follows:
--Long-term Foreign Currency IDR affirmed at 'B'; Outlook Positive
--Short-term Foreign Currency IDR affirmed at 'B'
--Long-term Local Currency IDR affirmed at 'B'; Outlook Positive
--Short-term Local Currency IDR affirmed at 'B'
--Viability Rating upgraded to 'b' from 'b-'
--Support rating affirmed at '4'
--Support Rating Floor at 'B'
--National Long Term Rating upgraded to 'BBB+(bra)' from 'BBB(bra)', Outlook Positive
--National Short Term Rating upgraded to 'F2(bra)' from 'F3(bra)'
--Subordinated notes due 2019
--Long-Term foreign currency rating affirmed at 'CCC/RR6'
--Subordinated notes due 2020
--LT FC rating affirmed at 'CCC/RR6'
--Long-term IDR affirmed at 'B'; Outlook Negative
--Short-term IDR affirmed at 'B'
--Long-term Local Currency IDR affirmed at 'B'; Outlook Negative
--Short-term Local Currency IDR affirmed at 'B'
--Viability Rating affirmed at 'b'
--Support Rating affirmed at '5'
--Support Rating Floor affirmed at 'NF'
--National Long-term Rating affirmed at 'BBB(bra)', Outlook Negative
--National Short-term Rating affirmed at 'F3(bra)'
--National Long-term Rating affirmed at 'A+(bra)', Outlook Stable
--National Short-term Rating affirmed at 'F1(bra)'
Additional information is available on www.fitchratings.com
Applicable criteria, Global Financial Institutions Rating Criteria, dated Jan. 31, 2014 and National Rating Criteria, dated Oct. 30, 2013 are available at www.fitchratings.com.
Applicable Criteria and Related Research:
-- 'Global Financial Institutions Rating Criteria' (Jan. 31, 2014);
-- 'National Ratings Criteria' (Oct. 30, 2013);
-- Full rating report: 'J. Malucelli Seguradora S.A.' (Dec. 20, 2013);
-- Full rating report: 'J. Malucelli Resseguradora S.A.' (Dec. 20, 2013).
Applicable Criteria and Related Research:
J. Malucelli Resseguradora S.A.