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Brazilian banks change tack as corporates rely more heavily on capital markets

Big companies are taking advantage of record low interest rates in Brazil to bypass banks and tap capital markets for funding, relegating financial institutions from the high-end corporate lending segment. In turn, banks have been shifting liquidity to individuals and SMEs, while boosting fee income from their investment banking businesses.

Credit to large corporations in the country has been falling by an average of 6.2% each year since late 2016, according to the latest available figures from Banco Central do Brasil. In contrast, lending to SMEs managed to recover from the credit crunch and began making up for lost ground in late 2018, to post 6.1% growth in the 12 months to June 2019.

"The expansion of bank credit to (SMEs) was not enough to offset the decrease in credit to large companies," Banco Central do Brasil wrote in its financial stability report. However, the bank noted that the capital market was "the highlight of 2019," and has "strengthened its position as an alternative source of funding" for big enterprises.

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About 13.7% of Brazilian corporations' total debt came from capital markets as of last June, up from 9.3% at the start of 2017. Over that same time, bank borrowing has slipped to 44.2% of corporate debt from 53.6%.

Record-low interest rates both in Brazil and abroad have helped "corporate bonds morph into the natural alternative for investors hungry for extra returns," analysts at BTG Pactual wrote in a recent report. And as that growing demand has driven an increase in debt issuances, corporations' need for bank financing has lessened, they noted.

"At this level of interest rates, corporations bypass banks and go to debt markets themselves," Valeria Azconegui, senior analyst with Moody's, said in an interview. "In that way, they diversify [funding sources] and lower their exposure to banks."

The shift has also pushed banks to compete more actively for corporate lending, and many are still "vying for whatever corporate lending there might be," Azconegui noted.

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Banks also are seeking to offset the reduced corporate loan demand by growing their other lending segments, including small and medium-sized enterprises, and individual consumers. At Itaú Unibanco Holding SA, Latin America's largest bank, corporate lending shrank 1.9% year over year in the third quarter of 2019; however, it grew loans to individuals by 14.9% and SME lending by 24.5%.

As the BTG analysts noted, it marks a reversal from Brazilian bank strategies just a few years earlier. In 2015 and 2016, when interest rates were higher, banks "exploited the opportunity" to lend to high-quality companies at "decent spreads," and largely shied away from lending to smaller and riskier companies.

"In the future, you will continue to see more [loan] growth in retail, specifically in individuals and SMEs, compared to corporates," Angel Santodomingo, CFO with Banco Santander (Brasil) SA, said during the bank's latest earnings call.

Investment banking boon

While the corporate debt shift to capital markets may eat away at some bank lending profits, it also offers a growing opportunity for those with investment banking operations.

Brazilian capital markets thrived in 2019, with issuances jumping by 59.3% to 396.06 billion reais. Nearly half of that, 173.61 billion reais, was placed in debentures, up from 153.72 billion reais in 2018 and nearly triple the levels seen in 2015 and 2016. Analysts expect the domestic market to surpass those levels again in 2020.

With that, underwriting fees for banks and brokers that structure and manage those offers also grow substantially. At Itaú, for instance, corporate securities for high-end clients has been growing at a 30% clip, CEO Candido Bracher noted in an earnings call.

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"Investment appetite is really increasing in the economy," Bracher said. Its i-banking unit, Banco Itaú BBA SA, is currently the leading underwriter of fixed income and hybrid instruments in the local market, having lined up as much as 52 billion reais in issuances so far this year through 127 different operations, according to ANBIMA data.

"You see lots of investors willing to take on longer-term debt," Philip Searson, head of fixed income at Banco Bradesco BBI SA, the second-largest underwriter, said in an interview. "Taking on duration is no longer a big issue [for Brazilian investors]."

Booming issuances are having Brazilian majors tune up their investment banking units as well. Banco Santander (Brasil) SA recently revamped its investment banking business with new hires, in an attempt to attain a higher market share in the segment. In addition, Banco do Brasil SA and UBS Group AG announced a joint venture in the segment.

"It shall benefit our fee lines. That's the way we see it," Leandro de Miranda Araujo, head of investor relations with Banco Bradesco SA, said in an earnings call.

As of Jan. 17, US$1 was equivalent to 4.19 Brazilian reais.