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Indusval in capital crisis as small Brazilian banks struggle for market share

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Indusval in capital crisis as small Brazilian banks struggle for market share

Seven years after Banco Indusval SA laid out plans to focus its business on agricultural lending, the small Brazilian bank is still paying for the decision.

The company has reported 13 straight quarterly losses, and its capital ratios are deep into negative territory. Its share price has slumped nearly 42% so far this year, spurring a 1-for-10 reverse stock split. It is selling a majority stake in its most valuable asset, and recently announced that it would seek even more capital as it combats a shifting banking landscape that is squeezing smaller lenders.

Co-CEO Jair Ribeiro da Silva Neto said the root cause of Banco Indusval's issues is Ceagro, an agribusiness trader the bank partnered with in 2012. Amid a widespread dip in commodity prices, Ceagro defaulted on its loans in May 2015, leaving several banks exposed to an estimated 800 million reais of debt.

"We were hit by a 'tsunami' in 2015," Ribeiro, who owns 10% of the bank's common shares and is part of a controlling group that owns nearly 66.5%, told S&P Global Market Intelligence. "And that kind of created the problem that has ... affected us up to now."

While Banco Indusval did not disclose its exact exposure to Ceagro, the bank booked a 200 million reais loan loss provision in the 2015 second quarter and launched an 80 million reais stock issuance soon after to bolster its capital position.

The bank has not reported a profit since.

"Its operations were very concentrated in Ceagro," said Luiz Santa Creu, a bank analyst at Austin Ratings. "When Indusval realized this, it found itself exposed to a single sector and to a particular troubled company."

While analysts stress that Banco Indusval's situation is unique, they also note that its lack of diversification is common across Brazil's smaller banks, and that the issue is becoming more pronounced in a post-recession Brazil where lower interest rates are driving financial behemoths to encroach on their business segments.

Big bank competition

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As Brazil struggled to emerge from a multiyear recession, the country's central bank in October 2016 began lowering its Selic monetary policy rate — falling to 6.5% currently from 14.25% two years ago — which in turn pressured banks' profit margins. The Selic is now at its lowest level since 1996.

"When rates were high and the economy grew strongly, there was room for every bank to earn money," said Miguel Ribeiro de Oliveira, an economist at the National Association of Financial Executives, or ANEFAC. But with margins now pressured by lower rates and an economy still in recovery, "large financial institutions have turned to the niche businesses of medium-sized banks, which makes their situation even more difficult."

Over the past decade, Brazil's major banks have become even bigger, leaving their small and medium-sized competitors with a shrinking piece of the proverbial pie. The country's four biggest banks — Itaú Unibanco Holding SA, Banco do Brasil SA, Caixa Econômica Federal and Banco Bradesco SA — now hold nearly 80% of Brazil's banking market share according to central bank data, up from 55% in 2008.

Part of that growth has come by moving into product segments that big banks historically ceded to their smaller rivals.

"In the past, top banks didn't have an appetite for products like payroll deductible loans, which were almost exclusively offered by medium-sized banks," said Claudio Gallina, Fitch Ratings' head of financial institutions for South America and the Caribbean. "Over the last years, however, larger banks acquired some midsize banks and/or have internally developed these products."

That has further complicated the legacy issues that banks like Banco Indusval are working through. The "challenges become higher ... since they are still in the process of cleaning up their credit portfolios," Gallina noted.

Sunken capital ratio

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In Banco Indusval's case, the combination of current pressures and legacy issues have bled into its capital ratios. The bank's Tier 1 capital ratio, which was solidly above the regulatory minimum at 9.25% just a year ago, slipped into the red earlier this year and hit -12.5% in the second quarter, suggesting a capital shortfall of more than 256 million reais.

A substandard capital ratio "is one of the main factors [that would lead to] a central bank intervention, and Indusval has not been attending to it," ANEFAC's Oliveira said. "It needs either a large capitalization to meet these requirements or a sale of the institution to avoid liquidation."

Banco Indusval responded by agreeing to sell a 70% stake in its most prized asset, Guide Investimentos SA Corretora de Valores, an institutional brokerage and wealth management firm with more than 60,000 clients. The sale, which should be finalized by September's end, will garner the bank an initial 170 million reais, with the potential for an additional payment of up to 120 million reais in 2020 depending upon performance.

The sale of the brokerage unit, announced at the end of 2017, may be why Brazil's central bank has yet to intervene, Austin Ratings' Santa Creu said, noting that the regulator "will always favor a market solution before taking control." Banco Central do Brasil declined to comment.

"Without Guide, the situation would have been much more complicated," Santa Creu said. "They had to sell their best asset because capital was needed to compensate for the increases in loan provisions, and there are no other financial activities within the group that the market would be interested in."

The bank also has been actively shrinking its risk-weighted assets, the denominator in capital ratio calculations; they have dropped to 1.36 billion reais at June 30 from 4.58 billion reais in 2014.

CEO Ribeiro maintained that the proceeds from the Guide Investimentos sale will be enough to bring the bank's capital ratios back up to 2018 regulatory minimums, which includes a Tier 1 ratio of at least 6.375% including a capital conservation buffer.

"It will be enough [to meet minimum capital requirements], but not sufficient to promote new growth," Ribeiro said. The company is hoping to gain more capital in order to help pivot its business model toward digital banking. At the end of 2017, the company announced it was developing a digital banking platform called Banco Intercap to take advantage of the "new disruptive mega trend of the banking sector around the world."

"We are very keen on our digital bank and we are growing that a lot," he added.

Seeking digital salvation

The planned shift to digital is not unique among Brazil's newer and smaller financial institutions, and some warn that the space soon may become overcrowded.

Online-based Banco Inter recently raised nearly 722 million reais in an initial public offering, while Banco Agibank SA and Banco BMG SA have plans for their own public offerings to raise funds for digitally focused growth.

"There is a trend of medium-sized banks [repositioning] their strategies to digital banking products," Fitch's Gallina said. "However, we need to take a look on how those banks have been able to monetize this strategy. ... Competition is increasing, [and] larger banks with deeper pockets can invest large amounts of money in the same business."

Despite the attempts to change tact, several industry experts believe that Brazil's smaller banks eventually will be forced to sell to larger players or merge among themselves as the struggle against the country's banking giants continues.

"We are inevitably going to see mergers among some banks as a way of surviving," ANEFAC's Oliveira said.

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See a section for capital adequacy for your bank. To do so, go to the company's profile on the website and then select "Capital Adequacy" under the Templated Financials section on the left-hand panel. Here is an example for Banco Indusval
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