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Morningstar | Bradesco's Strong Forecast and Improving Near-Term Results Lead Us to Place It Under Review

While political uncertainty remains a constant in Brazil, no-moat Banco Bradesco posted strong results in fourth-quarter 2018, with ROAE and earnings growth reaching multi-year highs. For the fourth quarter, recurring net income grew 6.6% on a sequential basis to BRL 5.83 billion, up 19.9% year over year. Net interest income also grew on both a sequential and yearly basis, up 6.6% from the previous quarter to BRL 16.78 billion. By our calculation, annualized loan losses were 2.8% of total loans, about the same as the prior quarter. Economic growth in Brazil is expected to be 2.4% in 2019, which would be the third year of higher GDP growth. We are placing Banco Bradesco under review as we digest management’s 2019 guidance and full-year results. We expect the outcome of our review to have some positive effect on our current $5 fair value estimate.

For the period, Bradesco’s total loans grew 1.6% from the previous quarter and are up 7.8% from the previous year, the third consecutive quarter of positive loan growth. While loans declined in the large corporate segment, the payroll-deductible, credit card, and vehicle leasing segments all experienced growth over 4%. Though credit losses ticked up slightly this quarter, from 2.7% to 2.8%, overall 2018 credit losses of 2.9% are significantly lower than historical averages. We are modelling higher levels of credit losses in the coming years, as we believe losses cannot remain this low indefinitely. We view somewhat higher losses in the fourth quarter as a potential sign of reversion to historical loss rates.

As it relates to digital offerings, we take note of the growth potential of Next, a digital bank targeted to a younger clientele launched by Bradesco in late 2017. While many banks are competing in the digital space, nearly 90% of Next customers were not previously clients. Bradesco expects to gain over 1 million new customers from Next in 2019, a lofty goal that will serve as a good benchmark for further success.

Banco Bradesco’s net interest income is highly sensitive to interest rate changes. For example, the bank’s net interest income in 2017 due to interest rate changes declined 15% year over year as the SELIC rate fell from 14% down to 7%. The Brazilian Central Bank’s overnight SELIC rate was unchanged at 6.50% during fourth-quarter 2018. In the medium term, with regards to inflation factors, ongoing emerging market economic challenges will put downward pressure on inflation. This is somewhat mitigated by the uncertainty over economic reforms, as political ambiguity can push inflation upward. In the long term, we believe that the SELIC rate is likely to rise as Brazil’s economy continues its gradual recovery from the deep recession the country experienced from 2014 through 2016. The moderate likelihood of pension reform passing during Bolsonaro’s tenure as president may contribute to a higher neutral SELIC rate resulting from stronger and more stable economic growth. As Brazil continues to climb out from its recession, we expect Banco Bradesco’s net interest income to increase accordingly and for overall long-term economic growth to have a positive effect on future earnings.

Markets reacted favorably to far-right Social Liberal Party presidential candidate Jair Bolsonaro taking office on Jan. 1 after winning the second-round election run-off in late October, due to the expectation of pension and tax reform and potential improvements to government efficiency. There has been some indication that pension reform won’t be as robust as previously thought. To the surprise of political observers, Bolsonaro publicly mentioned minimum retirement ages lower than what has been proposed by centrist ex-president Michel Temer. While the implementation of pension reform has the potential to lead to stronger longer-term growth and budget stability, it’s unclear how successful the Bolsonaro administration will be in its overall reform endeavors. We believe Bolsonaro has the political capital to move forward on pension changes and is likely to get some version of pension reform through Brazil’s highly fragmented congress, particularly if he acts on the issue early in his term. We have some doubts about whether these changes, if they occur, will meet the market’s high expectations and ultimately drive higher growth in the country.