HSBC agreed to sell its Brazilian business to Banco Bradesco for $5.2 billion in August, adding yet another tombstone for global financial players in Latin America’s largest economy. Société Générale, GE Capital, CitiFinancial, C&A Financial and BBVA are among the other international lenders that have stepped out of Brazil over the past few years. Only Santander has managed to compete with the big locals, ranking in the top five banks by assets in the country.

Some of the challenges for non-Brazilian players were already apparent when they started pouring into Brazil in the mid-1990s. Size matters of course — only four banks account for more than 70% of credit activities in this sprawling country. However, as these lenders looked to take their slice of the consumer credit boom in the country, the less tangential elements of doing business in Brazil and accurately assessing the risks in the country’s particular credit culture have proved difficult and, in many cases, insurmountable.

Multinationals arriving in Brazil in the last decade of the century saw ahead an easy road. Many local banks were still trying to adjust to the end of hyperinflation, which had spelled easy gains due to stratospheric overnight rates, and several fell like ripe fruit into the arms of foreign buyers when that phenomenon came to a halt. Many of these foreign acquirers came with a simple vision: they would bring some capital, take advantage of extremely high interest rates that were clocking in at over 200% per year, and reap the benefits. Others were impressed by Brazil’s crazed shopping and credit culture, which allows consumers to pay for everything in instalments, from a pair of socks to a luxury watch.

“Just one in four Brazilians has a current account. Brazil is the world’s fifth largest country and is going to offer us a great growth potential,” said Michael Geoghegan, then HSBC’s Brazil chief executive, shortly after completing the $940 million acquisition of Bamerindus in 1997. 

HSBC rolled out a strategy focused on low-income consumers well before the approach became fashionable under Luiz Inácio Lula da Silva, Brazil’s president between 2003 and 2011. Once Lula took office, the credit boom continued to surge. Banking inclusion and real income gains pushed Brazil’s credit-to-GDP ratio from 26% in 2004 to 55% 10 years later.

Other non-Brazilians had entered the country’s consumer credit market by 2007. But, even as local bank profits rose, Geoghegan and other foreign bankers found that profits were more elusive than they originally presumed due to the lack of flexibility of local labor laws and other market specifics. “Some came to Brazil confident that their model was the appropriate one. But they faced strong headwinds and a bad credit harvest,” says a banker who has returned to Europe after heading up his lender’s unit in Brazil.

Société Générale is one example. It pulled out less than a decade after its initial foray into Brazil. The French bank had entered the Brazilian consumer credit market with two small acquisitions, paying an undisclosed amount for Banco Pecúnia in 2006 and $407 million for Banco Cacique in 2007, both of which registered losses for at least four consecutive years after the purchases. Although Pecúnia and Cacique came close to breakeven in 2014, says Francis Repka, chief executive of Société Générale Brasil, he began negotiating with investors to sell its consumer credit portfolios last year. “I consider this as a reflection of a product life cycle, of a type of player and activity in a changing Brazil,” he tells LatinFinance.

Société Générale announced that it was closing Cacique and Pecunia in February this year, booking a $229 million charge in fourth quarter earnings in 2014 as a result.

Profit skids

Société Générale cited the competitive global financial environment and scarcity of capital behind its decision to exit Brazil’s consumer market. Basel III accords that require financial institutions to put aside more capital to cover risks have European banks reconsidering the efficiency of some of their investments. Very low returns that may have been acceptable in the past, are now subject to greater discipline because of those allocation requirements, Repka says.

“[Our] activities suffered in 2011 to 2012 due to the rise in the cost of risk, like all our peers, and returning to the breakeven point is no longer good enough,” Repka says. Société Générale will focus its consumer credit activities in markets where it owns a retail network, such as Europe and Africa, Repka says, adding that in Brazil the bank will concentrate on corporate and institutional clients.

Foreign lenders also had difficulty accounting for some unique changes in Brazilian consumer credit. Originally, high real interest rates allowed banks to take on a higher level of risk than they might in other activities, says Repka. However, the Lula government launched a new form of credit in the mid-2000s, known as payroll loans, that changed the game with much smaller interest rates and margins, since installments are directly deducted from wages or pension benefits.

Meanwhile, consumer credit became a competitive tool that large retail banks wielded to attract new customers. “It helped them boost customer loyalty and sell consumers other products at preferential terms,” says Repka.

Small- and mid-sized banks were struggling to reach the critical mass of their larger competitors who enjoyed economies of scale with fixed-cost services, such as call centers and information technology support. “In Brazil, we could not operate in this niche activity due to the competition and scale-related issues,” Repka says.

HSBC made a run at size when it acquired Losango, the former local consumer credit arm of Lloyds Bank, for $815 million in 2003. By 2014 it ranked sixth in assets in banking league tables tracked by the central bank in Brazil.

HSBC never issued separate financial statements for Losango, but bankers say its performance was disappointing due to a high level of non-performing loans and the lack of real guarantees in case of default. HSBC was working with JPMorgan in 2011 to sell Losango, but the unit attracted little interest, says Luis Miguel Santacreu, a bank analyst at Austin Ratings, a local credit rating agency in São Paulo. “It looked like an attractive asset when HSBC bought it, but Losango is currently a great headache. You need to scrutinize the books to find out who the good clients are.”

HSBC’s Brazilian subsidiary reported losses of 549 million reais ($171 million) in 2014. Santacreu acknowledged a small deterioration in non-performing loans last year, but says that was offset by a decline in financial margins and a relatively high cost structure. “If they had experienced a greater expansion in credit activities and had been active in areas where they could have enjoyed larger spreads, maybe they would not have registered any losses last year,” he says.

Other issues have also eaten into HSBC Brasil’s bottom line. Pecúnia, for instance, specialized in used car financing, which is a risky business in Brazil. “Credit is also a bit of a cultural issue… There is a different relationship with customers in Pernambuco [in the Northeast] than in Paraná [in the South]. It would not help to turn everything into a Big Mac or a centralized operation,” says Santacreu.

Moreover, the credit boom has all but petered out as the Brazilian central bank has tightened its monetary policy. The central bank raised its benchmark Selic rate to 14.25% in late July. Standard & Poor’s has forecast that Brazil’s credit growth will be between 8% and 12% in 2015 in nominal terms (inflation may hit 9%), after an 11.3% expansion in 2014. In real terms, the value of non-earmarked loans actually fell by 1.7% last year, and is expected to decline by a further 3.5% in 2015, according to Goldman Sachs.

Surveying the remains

While notable global players have been making headlines with exits en masse, international lenders may be compounding their mistakes by giving up completely on what has been the world’s second largest emerging market economy. “Banks have been forced to make some hard choices. But there is still some room for those who can position themselves in good niches,” says another banker, pointing to investment banking, trade finance and asset management as potential areas for growth.

There is no sugar-coating the lessons learned from consumer credit, however. “They committed a strategic mistake,” says Santacreu of international lenders in Brazil. “They combined a small scale with high level of payment arrears and high operational costs. In the end, it has not been a lucrative business for them.” LF