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Brazil's big banks find refuge from pandemic in agribusiness lending

Brazil's largest banks are counting on agribusiness lending to help soften the blow of operating in a coronavirus-battered economy that has left other sectors teetering.

Agricultural activity has not been as badly hit by the pandemic as other sectors in Brazil, ticking up 0.4% in the second quarter while the economy overall slumped 9.7% year over year, its worst quarterly performance since the country's statistics agency began tracking the figure in 1996.

While demand for credit weakened across most sectors, total disbursement of new agribusiness loans rose 9.82% year over year to 42.64 billion reais in the second quarter, in stark contrast to the 4.92% drop seen in total loan disbursements.

Brazil's agribusiness exports, driven mainly by the soybean complex, reached $61.19 billion during the first half of 2020, a 9.2% increase over the year-ago period, according to the Brazilian Trade and Investment Promotion Agency. Agriculture and livestock represented 50.6% of Brazil's total exports, the highest proportion on record for the period.

Against this backdrop, Itaú Unibanco Holding SA, Banco Bradesco SA and Banco Santander (Brasil) SA, the country's three largest non-state-controlled lenders by assets, expanded their agribusiness loan portfolios by 22.1%, 46% and 18.1%, respectively, from the year-ago period.

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"It's logical for these banks to take a defensive stance in agribusiness loans, because the sector is outperforming the overall economy, they have structurally a lower delinquency ratio, a stable interest margin, and are usually tied to guarantees," Sao Paulo-based Marcel Campos, an equity research analyst at XP Inc told S&P Global Market Intelligence.

The three majors made inroads into a market traditionally dominated by the state-run Banco do Brasil SA, whose market share of rural credit has decreased slightly in the last year but was still 55.7% of the total market in June. In fact, Banco do Brasil's 182.4 million reais agribusiness loan portfolio was three times larger than those of Itaú, Bradesco and Santander combined at the end of the quarter.

Prior to the pandemic, Brazilian majors tended to limit their lending to the sector due to its comparatively low interest rates — the average interest rate on agribusiness loans was 7.35% in the second quarter, compared to a system-wide average of 20% —, but the factors Campos highlights by Campos are making agribusiness attractive.

Although under less unusual circumstances "it would be costly for them to enter a less profitable market ... banks should look at this sector with a little more respect" in the coming quarters, Campos said, adding that rural credit brings significant tax benefits. Rural-focused Banco do Brasil had an effective tax rate of 16% in 2019, while those of its peers hover around 30%.

Banks have resources that are not being directed to other industries, and in the current climate it makes sense for banks to continue directing resources to agribusiness lending, said Claudia Yoshinaga, a professor of finance at Getulio Vargas Foundation's School of Business Administration in Sao Paulo.

"Why would they have focused on this segment if they had other profitable opportunities? But now, things have changed," she added.

The combination of strong demand from the segment and lower delinquencies than in other sectors is only part of the attraction, said Claudio Gallina, Fitch Ratings' head of financial institutions in Brazil. Regulation is another factor. Under national law, banks in the country are required to channel 30% of their demand deposits into loans for the sector. And, as the flight to quality deepened in the country during the second quarter, banks' funding soared.

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A short-term move

Despite the sharp uptick in disbursements, Gallina noted that banks are not considering a long-term shift in their portfolio mix. Although the sector's delinquency has been low, "this is a relatively volatile sector due to dependence on the foreign exchange market, which has led to losses for banks in the past."

"There may be some specific opportunities [to boost profits] in this context, but from our conversations with financial institutions, it won't lead to a structural change in lending [strategy]," Gallina concluded. As of the second quarter, rural credit represented 5.4%, 3.6% and 3.3% of Itaú, Bradesco and Santander Brasil's total loan book, respectively.

For XP's Campos, it will be tough for these banks to eat away at Banco do Brasil's market share in the long term, as the latter has a longstanding and solid relationship with farmers and producers. "That translates into entry barriers for competitors." The analyst also pointed to Banco do Brasil's specialized risk models, which have incorporated predictive agricultural technology, allowing for more informed credit decisions based, for example, on expected harvest sizes.

As of Sept. 4, US$1 was equivalent to 5.30 Brazilian reais.