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Moody's: Brazilian law allowing Caixa, Banco do Brasil deals could compound challenges

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Moody's: Brazilian law allowing Caixa, Banco do Brasil deals could compound challenges

A recently passed law in Brazil that allows and to acquireequity participation in public and private companies could put a further burdenon those state-owned banks, Moody's said March 31.

"While the banks have not announced any specificacquisition plans, the authorization could give the government additionalflexibility to use Caixa and [Banco do Brasil] to meet policy goals," therating agency said. "This comes at a time when the two banks are alreadyconfronting a deterioration in their asset quality and earnings, and any plansto purchase equity in other companies would likely drain capital, reducingtheir capacity to absorb unexpected losses."

Moody's noted that while the government has yet to provideclarity around the purpose of the new law, which is in effect until the end of2018, the government could use the law to allow the banks to take equityparticipation in corporations in exchange for restructured corporate debt. Suchdebt-for-equity swaps involving financially distressed corporate borrowerscould reduce both banks' need for provisions, while still supportingcorporations' solvency.

"However, neither lender is in a strong position tomake acquisitions at the moment," the rating agency added. It noted thatCaixa has continued to grow its loan book at a faster pace compared to thebanking system on the whole, increasing its vulnerability to further creditdeterioration, while Banco do Brasil already has the lowest core equityposition among its main peers. "In addition, the banks willface progressively higher capital requirements over the next three years as Brazilphases in Basel III standards and prudential adjustments," it added.

It also predicted that sourcing attractive acquisitiontargets will be a challenge, noting that similar measures enacted in 2009resulted in deals by both banks that added little to their bottom line."The current operating environment is more challenging [compared to 2009],and any bank that Caixa or [Banco do Brasil] acquires will likely be sufferingfrom falling business volumes and rising loan loss provisions, which would createan additional drag on their earnings," Moody's said.

On a separate note, however, Moody's noted that Caixa coulduse the authorization to help reorganize its insurance unit, Caixa Seguridade,following the cancellationof the unit's planned IPO, as it could purchased stakes in small, privatecompanies associated with the business.

"This restructuring could allow the bank to eventuallymove forward with the IPO," Moody's said.