Shares in Bradesco fell by 17.4% after its third-quarter results and have failed to find a foothold since. Investors didn’t like what they saw, but is there something deeper at play?
The initial headlines earlier this month focused on the fact that Bradesco reported a 40 basis point quarter-on-quarter jump in its non-performing loans (NPLs), to 3.9%. And the truth is that the underlying trend is higher, with this figure masked by a sale of overdue loans and higher levels of renegotiated loans.
Goldman Sachs’ financial institutions analyst Tito Labarta believes the normalized result would have been 4.2% – equal to a 100bp jump in a single quarter. The financial impact was large: even with a 37% quarterly rise in provisions, Bradesco’s NPL coverage ratio fell to 201% – from 128% in the second quarter of 2022 – and the bank added a further $8 billion in guidance for 2022 provisions.
On the conference call, chief executive Octavio de Lazari blamed the weak results – earnings fell 26% to R$5.2 billion and return on equity (RoE) fell to 13.5% (compared with 18.5% in 2Q22) – on the macro environment. Higher inflation and interest rates are eroding retail clients’ ability to service debt. It was surprising the NPLs corporate loan book was just 0.1% in the quarter – which raises another set of questions.
This macroeconomic weakness is a justifiable reason – as is the fact that Bradesco’s natural client base tends towards the lower socio-economic groups in Brazil. Loan portfolios from lower-income individuals are the first to show distress through upticks in delinquency rates.
However, even in the middle of Brazil’s deepest-ever recession, the bank’s RoE hovered around 18%, while the lowest-reported level in the past 12 years was still above 17%. So, why has a relatively modest rise in NPLs in the past quarter had such a big impact – on both earnings and the share price?
Lack of cover
There are many contributing factors, but the biggest issue at play is that in previous cycles Bradesco generated sufficient revenues to offset increased delinquency. Not only did net interest income (NII) and net interest margin (NIM) cover bad loans, but the bank was generating revenues elsewhere through fees and – in Bradesco’s case, particularly – through insurance premium.
Now, not so much: fees and insurance income declined during the quarter. On the top line, revenues fell 2%. There’s so much less room for manoeuvre as the digital banks and fintechs nibble at Bradesco’s core client base and hugely restrict its ability to charge fees for services that used to generate substantial cash flows.
The bank’s culture of promoting from within and deliberately eschewing senior hires from outside the organization could be adding stasis at a time when the bank most needs agility
In August, after Bradesco’s second-quarter result, I pointed out the pressure that Lazari must be feeling. Not only had RoE dipped to 18.5% but Banco do Brasil had thrown that performance into stark relief by reporting RoE of 20.6%.
I didn’t know the half of it. What I thought might be a cyclically wide contrast between the two banks has now completely blown out. Unhelpfully, Banco do Brasil increased its RoE again in this quarter – to 21.8%, a 10-year high – and boosted net income to R$8.4 billion, a 7% increase on the quarter and up a whopping 63% compared with a year earlier.
Itaú’s results didn’t help Lazari either – with the largest bank in the country reporting stable NPLs over the quarter.
No wonder Bradesco’s share price fell so quickly. There are serious questions about the bank’s ability to pull out of its slump. Bradesco’s valuation is now equal to its book value – a clear sign that investors are losing faith in the management’s ability to add value.
Areas of weakness
The truth is that with the advance of new competitors – and Brazil has seen many impressive digital banks launch in recent years – not all of the large incumbents can retain their dominant market share. Bradesco – with its large physical cost base and its questionable approach to digital banking – is showing the biggest signs of institutional weakness.
Also, the bank’s culture of promoting from within and deliberately eschewing senior hires from outside the organization could be adding stasis at a time when the bank most needs agility.
For example, when Bradesco’s digital bank Next needed a new chief executive at the beginning of 2021, who did Lazari recruit? A chief technology officer at a leading competitor? No. Renato Ejnisman, an internal transfer from investment banking, whose main qualification for the role appeared to be relative youth. Ejnisman departed in September last year, to be replaced by another internal candidate, albeit one with a background in digital banking: Curt Zimmermann.
And so, if the dramatic reaction to Bradesco’s recent results shows one thing, it is that it needs to find new skills, fresh perspectives, new ideas. The window of opportunity to avoid becoming the first large incumbent bank to fall from the top tier of Brazilian banking is closing – and quickly.
