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Morningstar | Bradesco Sees Some of its Lowest Credit Losses in its History, But How Long Can This Last?

Brazil’s turmoil and political uncertainty over the last few months appear to have had no impact on Brazil’s no-moat Banco Bradesco. For the third quarter, recurring net income grew 6% on a sequential basis to BRL 5.47 billion while advancing 13.7% from last year’s third quarter. Even net interest income grew on a sequential and year-over-year basis growing 4.4% from the previous quarter to BRL 15.75 billion. Bradesco, along with its peers, have been hampered by lower interest rates, as the average Selic rate has declined from 11.6% to 6.7% over the past year, but appear to be managing spreads effectively. What’s more impressive is Bradesco’s drop in credit losses which fell to BRL 3.5 billion. Though markets did react favorably to the election of Jair Bolsonaro, we believe Brazil’s budget problems are bigger than any one man and improvements seen this quarter are unlikely to persist over the medium term. Investors should be prepared for continued volatility. We’ll be maintaining our fair value estimate of $5 per ADR share.

By our math, allowances for loan losses were 2.7% of total average loans during the quarter. With the exception of the first quarter of 2014, this quarter saw the lowest level of annualized credit losses going back to at least 2007, as far back as we have data. Though Brazil is no longer mired in a recession, economic growth is only expected to reach 1.3% in 2018. It’s hard for us to believe that credit losses can remain this low. Even in a stronger economy, we wouldn't expect credit losses to be this low.

For the period, Bradesco’s total loans grew 1.5% from the previous quarter and are up 7.5% from the previous year. This is the second consecutive quarter of positive loan growth. Much of this growth came from loans to small- and medium-size enterprises. Furthermore, during the call, management mentioned year-over-year company loan origination growth of 40.6%. As interest rates rise throughout the rest of the world, we have to wonder what impact this will have on Brazil’s economy and appetite for credit as the country’s government debt now has to compete with Treasuries with improving yields. Though Brazil has seen lower interest rates as the economy has slowed, the country may not have as much freedom to manage interest rates.