Lula’s bank

Banco do Brasil, the 800-pound gorilla of Brazilian banking, has been throwing its weight around under President Lula. But it’s behaving more like a commercial bank than a development bank. And soon BB may sell a bunch of its soaring shares to foreigners.

IT WAS LATE FALL OF 2002. LUIZ INACIO LULA DA SILVA, A FORMER factory worker with strong union ties, had just been elected Brazil’s president, and markets were jittery at the prospect of the country’s lurching to the left. The outgoing administration of Fernando Henrique Cardoso, responding to fears of economic populism and fiscal disarray under Lula, sought to sell 18 percent of Banco do Brasil on the São Paulo stock exchange.

“The Cardoso government was trying to make a point -- that even in its last moments it was in favor of privatization,” says Luciano Dias, a political analyst with Góes & Consultores Associados, a Brasília-based consulting firm. But, he adds, “it was also a provocation to the Lula administration.”

Not much of a provocation, as it turned out. The deal, slated for December 2002, never came off, because although the bank’s shares had declined just 7 percent for the year, in contrast to the Brazilian stock exchange’s 27 percent plunge, there were virtually no takers. The issue had to be withdrawn.

“Institutional investors were not interested,” says Marco Geovanne, the bank’s executive manager of investor relations. “They wanted to pay a low price because everyone was afraid about the new left-wing government.”

Now, three years into the Lula era, there should be a lot more appetite for Banco do Brasil’s shares as the bank -- the country’s oldest and biggest by far -- again contemplates an offering. Although bank officials won’t comment on the size, the timing or even the likelihood of a stock sale, market rumors suggest it could come sooner rather than later. One reliable observer foresees a $300 million issue pitched to foreign as well as domestic investors.

The bank’s first-half earnings report alluded almost in passing to the possibility of an offering, and BB officials have quietly spoken in recent months of perhaps placing more of the bank’s shares in private hands. One compelling incentive: The shares have been gaining in value, rising 30.4 percent this year through mid-October -- an even better performance than the 11 percent increase for Brazil’s benchmark Bovespa index.

Lula has established credibility in the financial markets by pursuing an unexpectedly orthodox economic policy. His administration has spurred growth but also brought inflation down, from 12.5 percent to 6 percent, and posted a primary budget surplus equal to 5.1 percent of GDP. Tellingly, Brazil launched a hugely successful $1 billion global bond denominated in reais in September.

Although Lula’s administration has become mired in a political scandal that forced the resignation of his chief of staff, José Dirceu, in June, analysts say that the president’s troubles -- even if they prevent him from seeking a second term in October 2006 -- should not have a serious impact on Banco do Brazil or any prospective share offer.

“Banco do Brasil has competitive advantages that allow it to navigate peacefully in this crisis; in any circumstance, it will be a strong bank,” contends Murillo Aragão, director of Arko Advice, a political consulting firm in Brasília that caters to corporate clients. For one thing, he says, “beyond being a state bank, it is the bank of the government of Brazil -- that makes it very lucrative.”

Banco do Brasil has nonetheless been brushed by the scandal. Its marketing and communications director, Henrique Pizzolato, retired prematurely in July after he was allegedly linked in a congressional probe to Marcos Valério, a publicist who is under investigation for passing funds to members of Congress to secure votes for government programs.

IN THE LULA ERA BRAZIL’S DOMINANT BANK HAS become more formidable than ever. Profits hit a record $850 million on revenues of $5.75 billion in this year’s first half. Indeed, BB acts about as much like a sleepy state institution as, well, Lula behaves like a conventional leftist politician.

“The bank is continuing to pursue the strategy of a competitive bank in line with the practices of the international financial market,” its president and CEO, Rossano Maranhão, tells Institutional Investor. For the longtime BB employee, whom Finance Minister Antonio Palocci named acting president and CEO in November 2004 and confirmed in that post six months later, this calls for “consolidating our position as the leader in capturing savings, in asset management, in lending, in our international presence and branches and in our ATM network.”

The Finance minister tapped technocrat Maranhão in part to try to depoliticize the bank job and keep the harder-left members of Lula’s Partido dos Trabalhadores, or Workers Party, at arm’s length. They would have loved to bend as powerful a government tool as BB to their radical agenda, and they resent Palocci for his conservative economic policies.

Yet even as BB, founded in 1808, extends its commercial banking domain and expands its investment management operation (see box, page 70), it is also carrying out Lula’s mandate to be a bank for Brazil’s poor, through its Banco Popular subsidiary (see box, page 69). Lula established a managing director post at the bank specifically to oversee corporate social responsibility. “We will combine being a competitive bank with economic and social development,” Maranhão vows.

Within Brazil’s fast-consolidating banking industry, the most robust in Latin America, BB is an authentic colossus -- and more so now than ever. Its total assets are just shy of $100 billion, more than 20 percent greater than those of Banco Bradesco, Brazil’s biggest private bank, and its $40 billion loan portfolio is 37 percent larger than Bradesco’s. It leads all Brazilian financial institutions in clients (21 million), deposits ($59.9 billion), assets under management ($63.7 billion), domestic distribution (3,800 branches, 10,800 minibranches and 39,000 ATMs), trade finance (a 29 percent market share), online customers (7 million), international network (branches and/or subsidiaries in 21 countries) and employees (86,300). Those big staff and branch totals in part reflect its mandate as a state bank to serve even the remote corners of the country.

The bank’s much-anticipated though still inchoate public offering ought to produce quite a prospectus, given BB’s current return on equity of almost 30 percent; steady increase in share value (some 7 percent is publicly held now); continued vigorous performance by the loan portfolio; nearly 10 percent fee growth; strong client relationships forged by cross-selling; and 23 percent growth in assets under management for the 12 months ended June 2005.

The prospectus also, however, ought to carry one crimson flag: Despite the bank’s efforts to enhance its solvency, rating agencies express concern about its capitalization. Because the bank is allowed to register loan-loss provisions as an expense before it knows what the real losses will be, it reaps tax credits that now make up 60 percent of its $5.3 billion in equity. An intangible asset, the tax credits can only reduce taxable income once a real loss occurs. Both Fitch Ratings and Standard & Poor’s recommend that the tax credits be removed from the bank’s books.

“It is a weak point,” contends Daniel Araújo, director of financial institutions analysis at S&P’s São Paulo office. But he adds that the tax credit component of BB’s equity is “going down fast because the bank is improving its profitability and the amount of its equity base.” As recently as 2001, he says, BB’s tax credits added up to more than 100 percent of its equity. The healthy pattern of declining tax credits should persist as long as the bank has decent profits against which to set the tax credits. Fitch and S&P both rate the bank BB on long-term local currency debt and BB on long-term foreign currency debt.

FROM THE START OF THE LULA ERA, BB’s BOARD HAS set ambitious lending goals, and the bank has regularly exceeded them. Maranhão reports that BB’s credit portfolio is on track to increase 20 to 25 percent this year, bolstered by aggressive lending to consumers and to the country’s booming agribusinesses. Trade finance is slated to swell this year to more than $10 billion, a 10 percent gain for this core business. Maranhão is quick to note, though, that the bank’s loan quality will still top the market average, with 92 percent concentrated in the AA-to-C category.

“Everything we do stems from a strategy of complementarity,” asserts the CEO. For example, he says, BB’s far-flung foreign client base fuels its leadership in trade finance. Another instance of synergy: the strategic linkage between its securities house in London, BB Securities, and Banco do Brasil Securities, the broker-dealer the bank opened in New York in June to serve Brazilian companies using the U.S. capital markets.

Currently, 6.8 percent of the bank -- 5 million shares -- trades freely among individuals and institutions; foreign investors hold 2.8 percentage points of that free float (their share is now capped at 5.6 percent); the remainder is held by the National Treasury, BB’s and other pension funds and the investment fund of Banco Nacional de Desenvolvimento Econômico e Social, the national development bank.

Investor relations chief Geovanne says that the Treasury might sell off part of its holdings to improve the bank’s liquidity. Although Geovanne won’t confirm a number, market watchers predict that a 17 percent chunk of the bank’s shares will be offered, bringing its free float to about 25 percent. Geovanne notes that BB officials have been attending international conferences, holding conference calls in English and embarking on road shows “as part of our strategic plan to increase transparency and start tapping foreign investors.”

Lula’s indirect oversight of BB -- through his close ally Finance Minister Palocci, who chairs the bank’s board -- has generally pleased the market. But the bank has not been without the political turmoil characteristic of so much of Lula’s tenure. Cássio Casseb, appointed CEO of BB in January 2003 when the Partido dos Trabalhadores administration took power, came straight from the market: He had been president of Credicard, Brazil’s leading credit card issuer, and treasurer of Citibank in Brazil. Casseb proved to be a dynamic leader, getting the bank to take a more professional approach to lending; the share price quadrupled during his 23-month tenure.

“He was strategically the right person in the right job,” says Erivelto Rodrigues, a financial institutions analyst at Austin Rating, a São Paulo rating firm.

But in November 2004 the banker had to resign after allegations arose in a congressional investigation that he had illicitly transferred funds offshore years before he joined the bank. At the time, Casseb was quoted as saying that he had declared and registered all the transfers both in Brazil and abroad.

After Casseb’s resignation, Lula chose another banking professional to fill what had traditionally been a political position. Rossano Maranhão, 48, is a 28-year career officer of the bank who had been vice president of international and wholesale business and a member of the board. In the tumultuous run-up to Lula’s October 2002 electoral victory, it was Maranhão who traveled abroad to reassure investors and creditors and preserve BB’s credit and trade finance lines.

“Rossano is not from the political side or [Lula’s] Worker’s Party,” notes S&P’s Araújo. “He’s a technician well prepared in banking, so there is continuation of the focus on the private sector.” The president and CEO holds an MA in economics from the University of Illinois.

That Maranhão pays heed to the business sector is fortunate, because BB faces a challenge from private banks. Since 1988 private sector institutions’ share of the financial system has expanded from 49 percent to 67 percent, though most of that gain can attributed to the 2001 privatization of Banespa, the big state bank of São Paulo province. In head-to-head competition with private banks, BB has mostly made gains. Still, it too must endure a tougher operating climate that is reflected in a sharp fall in average interest rate spreads, from as high as 135 percent in 1995 to about 40 percent today.

Nonetheless, the banks’ steep interest rates -- 50 percent for a short-term working-capital loan despite single-digit inflation -- have drawn fire from businesspeople, who contend they are choking off economic growth. Political pressure to ease rates continues to mount, posing complications for all banks but especially for a relatively inefficient institution like BB. Its efficiency index -- operating expenses divided by net income -- is 73.6; Bradesco’s is 58.4.

“The big challenge for BB going forward is to prepare for the day when we have implanted a civilized interest rate policy: BB would have to learn to live with reasonable spreads,” says Augusto Carvalho, a socialist member of the Brasília district legislature who once worked for the bank and is the former president of the Brasília bank workers’ union, Sindicato dos Bancários.

Maranhão counters that the bank’s strategy is based on quality service and products in its niches of project and trade finance and the capital markets. “We have no type of dependence on interest rates,” he says. “If interest rates reached international levels, we would have greater growth because the client base would broaden and we would have greater scale in our operations.”

Public banks in Brazil -- BB included -- in fact put downward pressure on lending rates because they offer some credit at subsidized rates, as their private sector rivals like to point out. For instance, the bank provides loans that can be as cheap as 4 percent a year for family farms and average only 8.75 percent a year for agribusinesses. Naturally, Lula has encouraged such quasidevelopment financing.

“The strategy of the government is well thought out,” says Austin Rating’s Rodrigues. But as he also points out, lending at such favorable rates can hamper BB’s profitability, creating a built-in incentive for the bank to expand its client base and promote cross-selling, as it is barred by law from doing acquisitions.

Banco do Brasil finances the loan subsidies by tapping public worker insurance funds and development bank loans at low, long-term rates; it also relies on its own deposits and, critically, a so-called equalization subsidy paid directly out of Brazil’s Treasury. In 2004 this compensation amounted to $151.5 million. Under the country’s fiscal responsibility law, the Treasury payments must be made public; the government is legally bound to fund the allocations out of the federal budget to ensure transparency and to avoid adding to Brasília’s debt.

BB’s presence in agricultural lending is overpowering: It accounts for 60 percent of all farm credit, largely because of its subsidized lending. The bulk go to large producers. But 4 million family farms are eligible for loans at that 4 percent rate as part of a program begun in 1995 under Cardoso and expanded by Lula to strengthen family agriculture. During last year’s harvest the bank extended loans totaling $1.2 billion to 1 million farmers. “The program has acquired a lot more muscle in this government,” says Ricardo Conceição, BB’s vice president of agribusiness.

Some big farmers, however, gripe that the bank does not treat them as well as it does small farmers. The complaints are loudest from those who participated in the government’s restructuring of BB’s and other banks’ bad-loan portfolios in 2001. They cannot get new loans from BB and have no recourse but to obtain costlier credits from private sector banks or multinational corporations, says Feliciano Dias, whose highly mechanized 2,125-acre farm in Mato Grosso do Sul produces soybeans. Dias, who is no longer eligible to borrow from the bank, says that because his cost of planting a single hectare (2.5 acres) is $375, BB’s farm loan ceiling of about $75,000 wouldn’t begin to meet his costs or those of other big producers.

“The BB attitude of giving little credit may be good for the bank,” he says, “but it hurts the country” because it forces producers to sell to multinational companies at a lower price, “ultimately reducing the amount of hard currency that flows to Brazil.”

BB’s similarly subsidized lending to small and medium-size businesses is booming, shooting from $2.75 billion in 2003 to a projected $8.6 billion this year. “We are in an aggressive position with interest rates, we have the distribution network installed, we have everything in hand to be a big player,” contends Edson Machado, who recently retired as the bank’s vice president for retail. BB is able to lend at 18 to 28 percent a year, compared with 24 to 54 percent for competitors. The bank’s retail arm brought in $2.25 billion last year in fee income alone, boasts Machado.

“You can no longer say that official banks have functions very different from other banks’,” observes Gustavo Franco, Brazil’s central bank governor from 1995 to 1999. “I don’t think there has been any significant change in the modus operandi of BB during the Lula government.”

Except, perhaps, that it behaves even more like an aggressive private sector commercial bank.

Banking the unbanked: A developing story

Early on a Saturday afternoon on the outskirts of São Paulo, Fernanda Jesús de Freitas does her banking. The 22-year-old shoe saleswoman enters a corner store and wends her way past the floor-to-ceiling displays of jeans and tennis shoes to a counter at the back, where there is a PC. A store clerk stands by. There she makes a modest deposit to her savings account.

“It’s quick -- I don’t have to wait in a line,” she says.

Jesús de Freitas’s financial institution is Banco Popular, the two-year-old Banco do Brasil subsidiary whose mission is to make financial services available to Brazil’s low-income workers in neighborhoods like hers in São Paulo’s sprawling eastern suburbs. The minibranch inside Carlos Ferreira’s store, Loja de Calças (“pants shop”), is one of more than 7,900 such units set up by the bank throughout Brazil in the past year.

Although not the only populist bank in Brazil, Banco Popular is the showcase for Lula’s drive to achieve so-called social inclusion within the country’s financial sector. The president proclaims that his aim is to “bank the unbanked": Fully 40 percent of adult Brazilians lack accounts.

“We have the expectation that borrowers can create for themselves regular, permanent work” and go on to become steady clients of the bank, says Robson Rocha, 46, the newly appointed interim director of Banco Popular and a Banco do Brasil employee since 1980.

He cites the example of a $100 loan the bank made to a man who prepared fruit salads that he sold on the street for 30 cents apiece. The loan enabled him to buy a hand-pulled cart and greater quantities of fruit, boosting his sales so much that he’s now earning $340 a month.

Beneath its blue-and-yellow banner, the Banco Popular outlet in Ferreira’s shop manages loan disbursements and repayments and receives deposits and payments for water, electricity and other bills. The convenient location saves local residents precious time and transportation expenses.

Personal loans start at as little as $17 but can quickly mount to $110 for individuals and $370 for businesses, and then go up from there as borrowers build up credit histories. The interest rate of 2 percent per month is heavily subsidized; a market rate would be more than twice that. To qualify, borrowers need not produce proof of income, only their national identify card and tax ID.

For supermarket owners and shopkeepers, the incentive to participate in the scheme is the chance to lure more customers into their establishments and to receive a small commission on transactions. As banking correspondents, they pass deposits and payments on to Banco Popular or their own banks for processing.

Ferreira confides that he has seen scant increase in sales at his shop and that the Banco Popular commissions are minimal. But he notes other important benefits: “You add an image of service to your store, and there’s the social aspect -- you are getting money out to a lot of poor people.”

At the end of 2004, Banco Popular had 2.8 million clients and a presence in 1,560 towns. The bank contracts with management companies to set up its retail network, negotiating and then supervising alliances with shops, bakeries, grocery stores, drugstores and gas stations. As a result of all this outsourcing, it has a staff of just 80.

Accommodating customers who are unfamiliar with banking requires simplified procedures. Services are basic: checking and savings accounts, microcredits for purchasing consumer goods and, more recently, small-business loans. Customers must not write more than $160 of checks a month. Businesses without a credit history may borrow no more than that $370 at the outset, but their limit rises as long as they maintain good credit.

BB’s Banco Popular is not the only Brazilian bank pursuing low-net-worth individuals. Outposts of another public bank -- Caixa Econômico Federal -- and two private ones, Bradesco’s Banco Postal and Lemon Bank (owned by Argentinean Internet entrepeneur Wenceslao Casares), are sprouting up in poor urban neighborhoods and rural towns across Brazil’s vast territory. In all, the four have 31,000 minibranches; together they have opened 8 million accounts in the past two years.

The impetus for the creation of these deliberately down-market banks came from Lula. In 2003 he decreed that all banks in Brazil, private or public, must dedicate 2 percent of their deposits to microlending -- extending small loans mostly to the poor.

Until recently, Banco Popular and the three other specialized lenders have concentrated on financing the purchase of consumer goods. But lately, the Lula government has shifted the banks’ emphasis to providing microcredits for small businesses. This activity has been coupled with training in rudimentary entrepreneurship by civic and religious organizations and agencies of local government.

Banco Popular’s business plan calls for losses in the initial stage but profits eventually. “We are not a social-action secretariat,” emphasizes director Rocha. “We’re not going to distribute money for free; we’re going to lend.” -- L.C.

BB DTVM’s asset growth: ‘Nearly infinite

Pity Nelson Rocha Augusto. “It is hard to set a goal for growth,” laments the head of Banco do Brasil’s asset management arm. “We have exceeded all our objectives.”

Indeed, since Luiz Inácio Lula da Silva became Brazil’s president in January 2003, Distribuidora de Títulos e Valores Mobiliários do Banco do Brasil has more than tripled its assets, to $63.7 billion. BB DTVM is widening its lead over rivals. It has a 21 percent market share and oversees $21 billion more than its closest competitor, Banco Bradesco.

“If the second-largest asset manager [in Brazil] buys the fourth largest, they still don’t reach us,” boasts Rocha Augusto, who was named president and CEO of BB DTVM in January 2003.

Rocha Augusto does not see any reason why BB DTVM and other Brazilian asset managers cannot amass even bigger hoards. “It is possible to have at least 20 million people in funds, given an educational process and the improved security of funds,” he contends. “The goal is nearly infinite.” BB DTVM has 1.2 million investors in its funds now.

The money manager is well positioned to collect a goodly proportion of any future windfall. Start with its CEO. An economist who trained at two top universities in São Paulo, the 42-year-old Rocha Augusto is the first private sector executive to lead the asset manager. He founded private bank Banco Ribeirão Preto in 1995.

In 2001'02, Rocha Augusto served as de facto CFO for Lula’s powerful Finance minister, Antonio Palocci, then mayor of Ribeirão Preto; the pair privatized select municipal services, including the sewage system. Although Palocci has lately been accused of taking kickbacks from trash haulers while he was mayor -- he vehemently denies it -- Rocha Augusto has not been implicated in the charges.

BB DTVM’s edge in asset management also comes from the vast distribution network of Banco do Brasil, which has 3,800 branches in Brazil and offices in 21 countries. An investor wishing to put money in one of BB DTVM’s mutual funds must maintain an account with the bank. Once Banco do Brasil savings account holders are ready to move up to funds, BB DTVM makes it convenient to make the leap, says Daniel Araújo, a financial institutions analyst with Standard & Poor’s in São Paulo. And although Brazil’s state pension funds can invest wherever they like, BB DTVM has managed to attract $10 billion of their money.

Contrary to a widespread impression, BB DVTM does not manage mainly captive government money, emphasizes Rocha Augusto. Fully 85 percent of its managed funds emanate from private sources. Foreign investors entrust almost $3.4 billion to it. And the 15 percent that comes from municipal and state governments, he adds, is fought over in the marketplace like any other assets.

Under Rocha Augusto, BB DTVM has upgraded its technology and refined its risk management and research.

BB DTVM’s investment peformance is mixed. In June, Standard & Poor’s gave its highest rating, five stars, to two of its funds; four stars to one; three stars to 16; two stars to 11; and one star to a single fund.

There is one trend that the money manager has not embraced: “Classic hedge funds in Brazil are small and have a high level of volatility and liquidity problems,” says Rocha Augusto. “There is no demand from our clients for this.” -- L.C.