Brazil bank carnage defies better profit forecast as stock rout worsens

Sao Paulo

BRAZIL'S biggest banks are trading at the cheapest levels in three years compared with the Ibovespa stock index, even as analysts boost their earnings estimates.

Itau Unibanco Holding SA and Banco Bradesco SA posted the worst weekly declines since May as the stock gauge slumped. Their valuation discount to the equity index is now wider than 40 per cent. Meanwhile, analysts covering the lenders have lifted their earnings estimates by at least 9 per cent this year.

While earnings for financial institutions surged by an average 23 per cent in the first quarter, the stocks have been tumbling since President Dilma Rousseff boosted taxes on the industry's profits in May. The rout has accelerated on concern that borrowing costs will climb should Brazil lose its investment- grade status amid government hurdles in shoring up the budget as the nation is set for the worst recession in 25 years.

"The scenario is becoming more challenging for banks," Rafael Ohmachi, an analyst at brokerage Guide Investimentos, said in a phone interview from Sao Paulo. "Lenders were among those which benefited the most after Brazil got its investment grade as they were able to raise cash at lower rates. So they could really suffer if the opposite happens."

The Ibovespa fell 1.1 per cent last Friday to 49,245.85 at the close of trading in Sao Paulo, as Itau capped the longest slide in almost two years. The stock gauge dropped for a sixth day, extending its biggest weekly decline this year. The real sank 2.1 per cent to 3.3551 per dollar, the lowest since 2003.

The Ibovespa also fell after Morgan Stanley cut its recommendation for Brazilian equities to the equivalent of sell, citing last week's cut in the target for the budget surplus before interest payments. The "poor fiscal performance should limit the pace of economic growth", analysts led by Guilherme Paiva wrote in a report to clients.

Brazil's stocks had entered a bull market in April, after rallying more than 20 per cent from this year's low, amid speculation that government measures would help Brazil stave off another downgrade after Standard & Poor's cut the country's rating to the cusp of junk in March 2014. Since then, the shares have dropped 13 per cent on concern that Congress opposition to President Rousseff's belt-tightening agenda would make the administration's goals harder to achieve.

Moody's Investors Service, which met with officials in Brazil two weeks ago, has a negative outlook on the country's Baa2 rating, the second-lowest level of investment grade.

Itau, Latin America's largest bank by assets, extended a six-day plunge to 8 per cent last Friday. Bradesco slid 7 per cent.

Vale SA, the biggest iron-ore miner, declined to the lowest in a decade after Citigroup Inc said the best trade at present is to wager on further losses in the steelmaking ingredient. The shares also dropped after a gauge of manufacturing in Brazil's top trading partner unexpectedly fell.

Petroleo Brasileiro SA, the state-controlled oil producer at the centre of Brazil's worst corruption scandal, slid as a drop in crude dimmed the outlook for the company. BLOOMBERG