Two Brazilian Bank Stocks to Watch

NEW YORK (TheStreet) -- Brazilian banks are among the most profitable banks in the world, with an average return on equity of 15%-25%. The country's banking sector and economy are benefiting from the burgeoning middle class. Statistics show that Brazil's middle class is expanding, with 50% of the population (200 million) categorized as middle class. Credit card purchases in the country have been rising at 22% per year, since a decade now.

Banks are the second-best performing sector in Brazil, with the MSCI indicator of financial stocks increasing 34%, as of date from June 30, against the 35% rise in the industrial index, and 14% for the benchmark Bovespa.

We have listed two Brazilian banks -- Itau Unibanco Holding ( ITUB) and Banco Bradesco ( BBD), with potential upsides in the future, supported by the country's strong banking sector.

JPMorgan Chase and Credit Suisse foresee Brazilian banking stocks benefiting from interest rate hikes. As per the median estimate of a central bank survey of 100 economists, it is likely that policymakers will raise the benchmark interest rate to 12.25% in 2011 from the current 10.75%, in order to combat spiraling inflation, which is currently hitting 28-month highs.

Credit Suisse has raised banks' ratings to overweight, as higher lending rates will boost earnings.

Marcelo Gil de Souza, global head of Accenture's Corporate Strategy, says the rate of home mortgage loans is growing rapidly, although from a small base. Home mortgages are expected to experience the best movement in Brazil over the next few years. Currently, real estate credit accounts for only 3% of GDP, while total credit to GDP is at 45%. Accenture believes that the growth in the mortgage market will narrow the existing gap. By year-end, overall bank credit is estimated to reach 48% of GDP, a 22% jump from 2009 levels.

During October, outstanding loans were up 1.9% month on month and 20.3% year over year, as per Brazil's central bank data. Lending to the private sector rose 2% on a monthly basis, while housing loans to individuals and housing cooperatives grew 3%. The average interest rate on consumer credit stood at 40.4% in October, compared to 39.4% in September, increasing for the first time in three months.

Credit operations of financial institutions are on a positive trend, coupled with favorable developments in income and employment levels, as per the central bank. This has led to demand growth in investment and working capital of not only enterprises, but also household consumption of durable goods, the bank added.

Itau Unibanco Holding, Brazil's largest private-sector bank, engages in commercial and investment banking, consumer credit to non-account holders, corporate, and treasury activities.

The bank recently said that the merger between Banco Itau Holding Financeira and Uniao de Bancos Brasileiros will improve operational efficiency during 2011, further boosting the share price. Itau Unibanco was formed when Itau acquired Unibanco in 2008, with total assets of $261.4 billion. In comparison to rival banks, Itau did not generate attractive returns for investors, due to increased spending for the integration of branches and technology between the two banks. However, Itau believes that 2011 will throw up a pleasant surprise for investors.

For the third quarter ending September 30, net profit was up 19%, compared to the year-ago period. Loan portfolio expanded 16.6% year over year. The bank offers an attractive 23.84% return on equity with a past record of 30% sales growth and earnings rising around 20% annually during the past three years. The bank has a strong pipeline of potential acquisitions and regards Mexico, Peru and Colombia as the hunting ground for acquisitions. Moreover, Itau is keen on broadening its current business in Chile.

During November 2010, the bank sold $289.4 million in five-year real-denominated global bonds with a yield of 10.5%. Fitch Ratings has assigned a BBB rating to the bonds and believes that the proceeds will be used for general corporate purposes.

Of the eight analysts covering the stock, seven recommend buying, with a 21% upside from current levels. Itau has one hold rating. The stock has accumulated 0.9% during the past five days, as compared to 0.2% by the Bovespa Index.

Banco Bradesco, Brazil's second-biggest bank by market value, is a private-sector commercial bank offering a suite of banking and financial products and services within and outside of Brazil. The bank is the first national sponsor of the Rio 2016 Olympic Games, exclusively in the finance and insurance services categories. This sponsorship will benefit Bradesco in the longer term, as private and public-sector spending is seen accelerating in Brazil beginning in 2011.

For the three months ended September 30, adjusted profit jumped 40%, compared to a year ago, while the loan portfolio expanded 19%. For 2011, the bank expects its credit portfolio to increase in the range of 15%-20%. The bank's return on equity for the third quarter stands at an impressive 21.69%. Revenue from outside Brazil accounted for almost 37% during third-quarter 2010.

Fidelity National Information Services ( FIS), an electronic payment processor, has signed a deal with Banco Bradesco, also a Brazilian card processing bank. Under the contract, Fidelity will provide card processing, call center, collection, and back-office services for Bradesco's private label and bank cards, including its Visa and MasterCard portfolios.

Bradesco is planning to raise $872 million through a rights offering to shareholders, Dow Jones reports. The bank plans to roll out 62.34 million new shares priced at BRL 24.06 per share, with half the amount issued as preferred shares and the remaining as common. The plan of operations for the offering will be discussed at a shareholder meeting scheduled for December 17.

Meanwhile, the bank plans to open brokerage offices in Hong Kong and Tokyo during March-April 2011, with new service offerings, including private banking and asset management services. In London and New York, Bradesco is moving offices and is looking to hire more people in the U.S. Total income for the third quarter included a 29% contribution from fee-based income.

The growing demand for emerging market equities and debt instruments has been increasing the bank's corporate debt sales, with new issues in Brazil amounting to $88 billion so far in 2010.

Of the 10 analysts covering the stock, six recommend buying, with a 13% upside from current levels. Bradesco has four hold ratings. In the past five days, the stock has accumulated 1.3% as compared to 0.2% by the Bovespa Index.


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This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

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