Brazil’s banking system ‘strong despite slowdown’, says Larson

In a world where much of the financial sector is in crisis, Brazil's banking giants Banco Itaú and Unibanco are merging from a position of strength, according to Urban Larson, manager of the F&C Latin American Equity fund.

Last week Banco Itaú and Unibanco - the country's second and third largest private sector banks respectively - announced their first pro-forma consolidated earnings after the Brazilian authorities approved their merger.

"The combined entity recorded good will was 12.9 billion Reais (US$5.6 billion) on the merger, all of which was charged off immediately instead of remaining on the books to bolster capital, as is often the case in such circumstances" said Larson.

A further US$3.1 billion in merger-related accounting gains was used to increase provisions for non-performing loans. Despite this, the newly formed bank has a capital adequacy ratio of 16.3%, including Tier 1 Capital of 12.5%, which is far above international standards.

Additionally, the newly formed Itaú-Unibanco has 183% reserve coverage of its non-performing loan portfolio, allowing ample margin of safety should the slowing Brazilian economy lead to a further deterioration in credit quality. "Despite what in a more normal environment would be seen as an excessively conservative balance sheet, Itaú-Unibanco still managed to generate a pro-forma Return on Equity of 25% in 2008, not counting all of the merger related non-recurring items. Larson explains that Brazil is hardly insulated from the global recession, highlighting that the economy has in fact appeared to slow down dramatically during the last quarter of 2008.

"However, the banking system remains solid and profitable", he adds. "The Brazilian banks learned the hard way about of the importance of maintaining strong balance sheets during the country's bouts of hyperinflation, devaluation and other financial turbulence and could now emerge among the winners in the troubled global financial sector."

He concluded: "They may even be in a position to take advantage of their international competitors' weakness to buy attractive assets cheaply, should the likes of Citigroup or other global banks need to disinvest from Latin America".