Perfect Storm for Brazil Mid-Cap Banks?

These are not particularly sunny days for small, mid-cap banks in Brazil, especially those involved in the payroll lending business. Limited access to liquidity, tougher capital requirements from the country’s central bank and high levels of maturing debt are putting a squeeze on a number of weak banks and weighing on secondary debt levels. This week, Moodys’s downgraded Banco Cruzeiro do Sul, or BCSUL’s, financial strength rating to D- from D and its long-term deposit ratings to Ba3 from Ba2, among other ratings, citing limited financial flexibility and a threat to profits from higher provisioning requirements for long term payroll loans, its core business. “The outlook for both funding and capital is pretty weak and is set to weaken in 2012,” noted MTR Securities in a trading note to clients. “There is a general consensus that many [of these banks] will be bought or cease to exist in their current form.” Brazil’s central bank is demanding higher capitalization for long-term payroll loans and has limited the amount of time deposits smaller banks can issue. Competition in the payroll loan business has also increased, putting downward pressure on bank margins. More importantly, mid-caps must soon address looming maturities after issuing roughly $20bn in debt over the past years, much of it in short-dated instruments with tenors of roughly five years or less. All this has hit secondary trading levels. For instance, BCSUL bonds saw an active session Friday with its 8.25% 2020 bond trading at 81 and yielding 14%. Banco BMG, with a loan portfolio made up of 91% payroll loans, is also giving the market pause for thought, especially following its move to acquire Banco Schahin, another reputed weak bank, for BRL230m. BMG’s 8.875% 2020 bonds stood at 91.9 and were yielding 10.3% on Friday.