Financials & FinTech research, Galliano’s Financials Research

Victor Galliano

Financials & FinTech research

Financials & FinTech, EM & Developed Markets

Galliano’s Financials Research

Galliano's Financials Research provides fundamental research in Emerging Markets financials, including FinTech, as well as financials in select Developed Markets.

The investment style applied is generally value oriented, although Growth At Reasonable Price (GARP) strategies can also be used where appropriate. 

Our investment research approach aim is often contrarian, looking to capitalise on overly sceptical or optimistic consensus views. In terms of valuation techniques, the focus is on PBV ratio to ROE, PE multiples and dividend yield, as well as the application of PEG ratios and, where appropriate, Sum of the Parts (SOTP) valuations.

Equity Bottom-Up

<ul>
<li>The macro-economic and political backdrop for Brazil is a challenging one, which has driven the poor performance of Brazil assets and the BRL</li>
<li>Governance concerns re <a href="https://www.smartkarma.com/entities/banco-do-brasil-sa" target="_blank" data-smartkarma-citation="entities:24564:1" rel="noopener">Banco Do Brasil Sa (BBAS3 BZ)</a>, in the wake of the removal of the Petrobras CEO, have added to the negative share price impact, yet we see cause for optimism</li>
<li>Attractive absolute valuations, as well as relatively low PBV ratios, are discounting a lot of the bad news</li>
<li>Banco do Brasil’s balance sheet is much improved at YE 2020, in terms of capital adequacy as well as NPL coverage, and its exposure to higher risk loan segments is limited</li>
<li>The prospect of rising benchmark interest rates is already leading to better new loan pricing sector-wide and the potential of recovering credit spreads contributes to the bull case</li>
<li>Risks to our positive view on Banco do Brasil include the removal of its market oriented CEO, worse than expected credit delinquency going forward as well as a less than expected positive impact from rising spreads</li>
</ul>


The macro-economic and political backdrop for Brazil is a challenging one, which has driven the poor performance of Brazil assets and the BRL
Governance concerns re Banco Do Brasil Sa (BBAS3 BZ), in the wake of the removal of the Petrobras CEO, have added to the negative share price impact, yet we see cause for optimism
Attractive absolute valuations, as well as relatively low PBV ratios, are discounting a lot of the bad news
Banco do Brasil’s balance sheet is much improved at YE 2020, in terms of capital adequacy as well as NPL coverage, and its exposure to higher risk loan segments is limited
The prospect of rising benchmark interest rates is already leading to better new loan pricing sector-wide and the potential of recovering credit spreads contributes to the bull case
Risks to our positive view on Banco do Brasil include the removal of its market oriented CEO, worse than expected credit delinquency going forward as well as a less than expected positive impact from rising spreads


Brazil Banks - Market Concerns Overdone, with the Banco Do Brasil (BBAS3 BZ) Strengths Under-Rated

Financials Credit Analyst

Hank Calenti, CFA

CreditContinuum

Credit

Asia headquartered banks fared well despite the global tantrum without taper in the Treasury markets. Asia headquartered bond prices fell by less than their benchmark Treasury market notes, resulting in a bout of credit outperformance. Almost all bonds tightened in credit spread terms as investors remained anchored to banks as an economic recovery play. Moderate duration, lower risk, bonds continued to outperform, although there were pockets of outperformance in China-headquartered Additional Tier 1 bonds.Bonds in the belly of the curve, that is those maturing or callable in five-years, outperformed longer dated notes. Moderate duration bonds led as investors lost faith in an inflation free economic recovery which would cap market rate rises. This is the opposite of last weeks’ performance, wherein even longer-duration note outperformed. That seemed odd given policymakers repeated statements that they would let the US economy run hot at the risk of stoking inflation. The rapid sell-off in US Treasuries during the week is evidence of market jitters regarding eventual inflation expectations.The pressure on U.S. Treasuries is largely in-line with what we have been cautioning on since the Senate run-off results in Georgia last month. Friday’s correction at the long end may be tested again.Admittedly, however, we are surprised by the credit strength of Asia-headquartered financials during the global rates rout. We attribute this to two items. First, China is further along the Covid-19 curve in recovery and will clearly benefit as the rest of the world catches-up. Second, financials are a leverage play on the global recovery. Taken together, Asia financials overall are well placed to continue outperforming other markets over the near term.Given the rate of change over the last two weeks, things are moving fast. We identify potential opportunities within. <a href="https://www.smartkarma.com/entities/state-bank-of-india" target="_blank" data-smartkarma-citation="entities:160:1" rel="noopener">State Bank of India (SBIN IN)</a> represents one credit curve where better opportunities exist in shorter duration bonds, however, <a href="https://www.smartkarma.com/entities/bank-mandiri-persero-tbk-pt" target="_blank" data-smartkarma-citation="entities:441:1" rel="noopener">Bank Mandiri (BMRI IJ)</a> may offer even better values, as we note within.Market Outlook: This week’s Treasury market tantrum was not induced by Fed tapering, but it is a reminder of what it may look like when the Fed does dial back its asset purchases. Combined with the strength of the risk-on moves, this makes us uneasy. Financial repression creates a market, which in its nature, is always a one-sided bet with the Fed / ECB/ BOJ.  There is limited price discover as the market is simply sentiment driven. Credit value should remain driven by larger market forces. However, we may be fast approaching a point where the market outpaces the rate of expected economic recovery, and / or the market outpaces the rate that can be achieved without incurring substantial financial stability concerns. Our preference is for lower duration bonds, preferably in the belly of the curve. Please see our recent <a href="https://www.smartkarma.com/insights/bank-macro-manifest-risk-rally-gathers-steam-as-bad-news-more-stimulus" target="_blank" rel="noopener">Bank Macro Manifest</a> and <a href="https://www.smartkarma.com/insights/bank-credit-strategy-melt-up-before-meltdown-where-to-position" target="_blank" rel="noopener">Bank Credit Strategy</a> notes for more details.

Asia headquartered banks fared well despite the global tantrum without taper in the Treasury markets. Asia headquartered bond prices fell by less than their benchmark Treasury market notes, resulting in a bout of credit outperformance. Almost all bonds tightened in credit spread terms as investors remained anchored to banks as an economic recovery play. Moderate duration, lower risk, bonds continued to outperform, although there were pockets of outperformance in China-headquartered Additional Tier 1 bonds.Bonds in the belly of the curve, that is those maturing or callable in five-years, outperformed longer dated notes. Moderate duration bonds led as investors lost faith in an inflation free economic recovery which would cap market rate rises. This is the opposite of last weeks’ performance, wherein even longer-duration note outperformed. That seemed odd given policymakers repeated statements that they would let the US economy run hot at the risk of stoking inflation. The rapid sell-off in US Treasuries during the week is evidence of market jitters regarding eventual inflation expectations.The pressure on U.S. Treasuries is largely in-line with what we have been cautioning on since the Senate run-off results in Georgia last month. Friday’s correction at the long end may be tested again.Admittedly, however, we are surprised by the credit strength of Asia-headquartered financials during the global rates rout. We attribute this to two items. First, China is further along the Covid-19 curve in recovery and will clearly benefit as the rest of the world catches-up. Second, financials are a leverage play on the global recovery. Taken together, Asia financials overall are well placed to continue outperforming other markets over the near term.Given the rate of change over the last two weeks, things are moving fast. We identify potential opportunities within. State Bank of India (SBIN IN) represents one credit curve where better opportunities exist in shorter duration bonds, however, Bank Mandiri (BMRI IJ) may offer even better values, as we note within.Market Outlook: This week’s Treasury market tantrum was not induced by Fed tapering, but it is a reminder of what it may look like when the Fed does dial back its asset purchases. Combined with the strength of the risk-on moves, this makes us uneasy. Financial repression creates a market, which in its nature, is always a one-sided bet with the Fed / ECB/ BOJ.  There is limited price discover as the market is simply sentiment driven. Credit value should remain driven by larger market forces. However, we may be fast approaching a point where the market outpaces the rate of expected economic recovery, and / or the market outpaces the rate that can be achieved without incurring substantial financial stability concerns. Our preference is for lower duration bonds, preferably in the belly of the curve. Please see our recent Bank Macro Manifest and Bank Credit Strategy notes for more details.

Bank Credit Weekly: Asia Credit Outperforms Despite Treasury Tantrum

<ul>
<li>We screen the 4Q20 results for credit quality and value, of those GEM banks that have reported to date</li>
<li>Specifically we identify <a href="https://www.smartkarma.com/entities/credicorp-ltd" target="_blank" data-smartkarma-citation="entities:25963:1" rel="noopener">Credicorp Ltd (BAP US)</a> in Peru as a banking group well placed to benefit from recovery in 2021; its credit quality metrics are sound and high quality, and it is an attractive GARP choice</li>
<li>
<a href="https://www.smartkarma.com/entities/grupo-financiero-banorte-o" target="_blank" data-smartkarma-citation="entities:24780:1" rel="noopener">Grupo Financiero Banorte-O (GFNORTEO MF)</a> screens well, in our view, from both credit quality metrics and value parameters</li>
<li>Despite <a href="https://www.smartkarma.com/entities/banco-do-brasil-sa" target="_blank" data-smartkarma-citation="entities:24564:1" rel="noopener">Banco Do Brasil Sa (BBAS3 BZ)</a>’s healthy credit quality metrics, this is now overshadowed by corporate governance concerns for Brazil SOEs following the Petrobras CEO’s abrupt removal</li>
<li>Outside LatAm, select private sector Indian banks seem to screen well on credit quality, but valuations are demanding; public sector bank <a href="https://www.smartkarma.com/entities/state-bank-of-india" target="_blank" data-smartkarma-citation="entities:160:1" rel="noopener">State Bank Of India (SBIN IN)</a> is the deep value but relatively high risk name in India. An alternative higher risk GEM bank on attractive valuations is <a href="https://www.smartkarma.com/entities/turkiye-garanti-bankasi-as" target="_blank" data-smartkarma-citation="entities:25026:1" rel="noopener">Turkiye Garanti Bankasi As (GARAN TI)</a> in Turkey</li>
<li>Risks to our positive view on Credicorp include increased political uncertainty in Peru, as well as a weaker than expected recovery leading to worsen than expected credit quality  and weak loan growth</li>
</ul>


We screen the 4Q20 results for credit quality and value, of those GEM banks that have reported to date
Specifically we identify Credicorp Ltd (BAP US) in Peru as a banking group well placed to benefit from recovery in 2021; its credit quality metrics are sound and high quality, and it is an attractive GARP choice

Grupo Financiero Banorte-O (GFNORTEO MF) screens well, in our view, from both credit quality metrics and value parameters
Despite Banco Do Brasil Sa (BBAS3 BZ)’s healthy credit quality metrics, this is now overshadowed by corporate governance concerns for Brazil SOEs following the Petrobras CEO’s abrupt removal
Outside LatAm, select private sector Indian banks seem to screen well on credit quality, but valuations are demanding; public sector bank State Bank Of India (SBIN IN) is the deep value but relatively high risk name in India. An alternative higher risk GEM bank on attractive valuations is Turkiye Garanti Bankasi As (GARAN TI) in Turkey
Risks to our positive view on Credicorp include increased political uncertainty in Peru, as well as a weaker than expected recovery leading to worsen than expected credit quality  and weak loan growth


GEM Bank Credit Quality and Value Screens; the 4Q20 Story so Far

<ul>
<li>
<a href="https://www.smartkarma.com/entities/banco-do-brasil-sa" target="_blank" data-smartkarma-citation="entities:24564:1" rel="noopener">Banco Do Brasil Sa (BBAS3 BZ)</a> screens reasonably well relative to its peers on credit quality, even if its problem loan (D-H) coverage is relatively low</li>
<li>It has the lowest level of renegotiations as a share of total loans among the big-cap listed banks</li>
<li>More importantly, Banco do Brasil surprised positively in the quarter on capital adequacy</li>
<li>At YE 2020, Banco do Brasil ranks as the strongest of the big-cap listed banks by core capital (CET1) ratio, a total reversal from its weakest position in YE 2019</li>
<li>Despite <a href="https://www.smartkarma.com/entities/itau-unibanco-holding-sa-9d47d196-e503-471b-a84e-ca4401033062" target="_blank" data-smartkarma-citation="entities:24550:1" rel="noopener">Itau Unibanco Holding Sa (ITUB4 BZ)</a> screening best on problem loan (D-H) level and coverage, Banco do Brasil is now strong on capital, and also compelling on its attractive valuation</li>
<li>Risks to our positive view on Banco do Brasil include worse than expected delinquency trends going forward, putting downward pressure on earnings through higher credit costs</li>
</ul>



Banco Do Brasil Sa (BBAS3 BZ) screens reasonably well relative to its peers on credit quality, even if its problem loan (D-H) coverage is relatively low
It has the lowest level of renegotiations as a share of total loans among the big-cap listed banks
More importantly, Banco do Brasil surprised positively in the quarter on capital adequacy
At YE 2020, Banco do Brasil ranks as the strongest of the big-cap listed banks by core capital (CET1) ratio, a total reversal from its weakest position in YE 2019
Despite Itau Unibanco Holding Sa (ITUB4 BZ) screening best on problem loan (D-H) level and coverage, Banco do Brasil is now strong on capital, and also compelling on its attractive valuation
Risks to our positive view on Banco do Brasil include worse than expected delinquency trends going forward, putting downward pressure on earnings through higher credit costs


Brazil Banks YE2020 Snapshot II: Banco Do Brasil (BBAS3 BZ) Fair Credit Quality, Positive on Capital

Itau Unibanco Holding  / Equity Bottom-Up

<ul>
<li>The system ended the year with an NPL ratio of 2.1% and NPL coverage of 295%, in Brazilian GAAP terms, as shown in Figures 5 and 10 in this report</li>
<li>Although these headline NPL ratios and coverage for the bank sector at December 2020 look reassuring, they are, in our view, not the optimal metric for credit risk going forward</li>
<li>We note that early delinquency indicators, which often act as a leading indicator for headline NPLs, are starting to rise as the pandemic mandated grace period ends for the bulk of renegotiated loans, as seen in Figure 9</li>
<li>System data to December 2020 shows that household loan renegotiations have risen sharply, and in 4Q20 delinquencies on renegotiated loans have, as shown in Figure 8, started to rise</li>
<li>The Brazilian household debt service ratio is rising and the debt burden is at a 13 year high, as shown in Figures 13 and 14</li>
<li>The largest three private sector banks in Brazil have reported 4Q20 results, and we compare some credit quality metrics; in the cases of <a href="https://www.smartkarma.com/entities/itau-unibanco-holding-sa-9d47d196-e503-471b-a84e-ca4401033062" target="_blank" data-smartkarma-citation="entities:24550:1" rel="noopener">Itau Unibanco Holding Sa (ITUB4 BZ)</a>, <a href="https://www.smartkarma.com/entities/banco-santander-brasil-sa" target="_blank" data-smartkarma-citation="entities:27709:1" rel="noopener">Banco Santander Brasil SA (SANB11 BZ)</a> and <a href="https://www.smartkarma.com/entities/banco-bradesco-sa" target="_blank" data-smartkarma-citation="entities:24569:1" rel="noopener">Banco Bradesco Sa (BBDC4 BZ)</a>, we believe that the low domestic GAAP NPL ratios may not be an accurate reflection of the credit risk outlook, so we compare these with the central bank defined D-H poor credit quality “buckets” in Figure 2, and the D-H coverage ratio</li>
<li>We conclude that on D-H share of total loans and coverage, Itau Unibanco’s Brazilian operations screen best, despite having the highest Brazil GAAP NPL ratio in 4Q20; Bradesco has the highest D-H share of total loans, and the lowest D-H coverage along with Santander Brasil</li>
<li>Risks to our positive view on Itau Unibanco include a worse than expected outcome on Brazilian credit quality for Itau in Brazil and its non-Brazilian LatAm operations, thereby raising pressure on their cost of risk outlook</li>
</ul>


The system ended the year with an NPL ratio of 2.1% and NPL coverage of 295%, in Brazilian GAAP terms, as shown in Figures 5 and 10 in this report
Although these headline NPL ratios and coverage for the bank sector at December 2020 look reassuring, they are, in our view, not the optimal metric for credit risk going forward
We note that early delinquency indicators, which often act as a leading indicator for headline NPLs, are starting to rise as the pandemic mandated grace period ends for the bulk of renegotiated loans, as seen in Figure 9
System data to December 2020 shows that household loan renegotiations have risen sharply, and in 4Q20 delinquencies on renegotiated loans have, as shown in Figure 8, started to rise
The Brazilian household debt service ratio is rising and the debt burden is at a 13 year high, as shown in Figures 13 and 14
The largest three private sector banks in Brazil have reported 4Q20 results, and we compare some credit quality metrics; in the cases of Itau Unibanco Holding Sa (ITUB4 BZ), Banco Santander Brasil SA (SANB11 BZ) and Banco Bradesco Sa (BBDC4 BZ), we believe that the low domestic GAAP NPL ratios may not be an accurate reflection of the credit risk outlook, so we compare these with the central bank defined D-H poor credit quality “buckets” in Figure 2, and the D-H coverage ratio
We conclude that on D-H share of total loans and coverage, Itau Unibanco’s Brazilian operations screen best, despite having the highest Brazil GAAP NPL ratio in 4Q20; Bradesco has the highest D-H share of total loans, and the lowest D-H coverage along with Santander Brasil
Risks to our positive view on Itau Unibanco include a worse than expected outcome on Brazilian credit quality for Itau in Brazil and its non-Brazilian LatAm operations, thereby raising pressure on their cost of risk outlook


Brazil Banks YE 2020 Snapshot: Itau (ITUB4 BZ) Well Positioned to Confront Tougher Credit Quality

Brazil

Banco do Brasil S.A. attracts deposits and offers retail and commercial banking services.  The Bank offers consumer, commercial, and agribusiness loans, asset management, foreign exchange, private pension, insurance, lease financing, credit cards, and Internet banking services.

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Banco do Brasil (BBAS3 BZ)

Brazil Banks - Market Concerns Overdone, with the Banco Do Brasil (BBAS3 BZ) Strengths Under-Rated

Concerns re Brazil macro and governance has hit the Banco do Brasil share price hard; we think the high PBV discount to its core peers is...

Victor Galliano

Bank Credit Weekly: Asia Credit Outperforms Despite Treasury Tantrum

Global bank bond prices fell by less than their benchmark notes, resulting in a bout of credit outperformance. Given the rate of change, there are...

Hank Calenti, CFA

GEM Bank Credit Quality and Value Screens; the 4Q20 Story so Far

Screening GEM banks for sound credit quality and capital metrics among those that have reported 4Q20; of the standouts, we highlight Credicorp for...

Victor Galliano

Brazil Banks YE2020 Snapshot II: Banco Do Brasil (BBAS3 BZ) Fair Credit Quality, Positive on Capital

Banco do Brasil screens fairly on credit quality, but has strengthened capital more than its peers in 2020, and remains a clear value option, with...

Victor Galliano

Brazil Banks YE 2020 Snapshot: Itau (ITUB4 BZ) Well Positioned to Confront Tougher Credit Quality

Investors should look beyond the headline NPL ratios and coverage for Brazilian banks; we conclude that on the D-H share of loans and coverage,...

Victor Galliano

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