Nov. 23 (Bloomberg) -- Brazil’s largest banks are too expensive after an “absurd” rally this year spurred by prospects they will accelerate lending to meet rising consumer demand, according to Mercatto Gestao de Recursos.

“Banks are expensive whatever multiple you’re looking at,” said Regis Abreu, executive director at Rio de Janeiro- based Mercatto, which oversees about $1.2 billion and manages the R2 FI de Acoes fund, Brazil’s best performer this year.

State-controlled Banco do Brasil SA more than doubled in 2009, while Itau Unibanco Holding SA and Banco Bradesco SA, the biggest non-government lenders, rose 60 percent and 59 percent, respectively. The advance helped push the MSCI Brazil Financials Index to 17.6 times reported profit as of Nov. 20, the highest level since 2007 and above the five-year average of 14.4.

All three banks probably will increase lending by 25 percent next year as growth accelerates in Latin America’s biggest economy, said Mario Pierry, an analyst with Deutsche Bank AG in New York. That’s about double the credit expansion Itau and Bradesco estimate for this year and compares with an increase of at least 17 percent forecast by Banco do Brasil.

Abreu, 39, said Mercatto has been selling shares of Banco do Brasil, which had been the firm’s biggest holding. The Brasilia-based bank, which increased its loan portfolio by 41 percent in the third quarter from a year earlier, trades for 8.8 times profit, almost double its level at the beginning of 2009.

‘Not Cheap’

“Banks have risen an absurd amount this year,” Abreu said. “Banco do Brasil has had good results, they’re well managed and an interesting investment, but it’s not cheap anymore.”

Banco do Brasil rose 0.8 percent to 30.88 reais in Sao Paulo trading today. Itau climbed 2.2 percent to 37.89 reais, while Bradesco increased 1.6 percent to 35.85 reais.

Banco do Brasil expanded faster than rivals after the acquisitions of Sao Paulo-based Banco Votorantim SA in January and Banco Nossa Caixa SA in November 2008. Non-government banks’ lending growth rate was below Brazil’s average since October of last year, according to data compiled by Bloomberg. The central bank is scheduled to release its report for October lending on Nov. 25.

Loan Growth

Itau and Bradesco will become more aggressive next year in expanding loans, said Pierry, 37.

Sao Paulo-based Itau forecasts its loan portfolio can grow as much as 25 percent next year. Bradesco, based in Osasco, Brazil, estimates an increase of at least 20 percent. Banco do Brasil hasn’t released a forecast for lending growth in 2010.

“A lot of these positive outlooks for 2010 have already been reflected in the performance of the share price this year,” Pierry said. “Valuations are not cheap by any means.”

Brazilian lenders are trading at 2.7 times stock price to book value for 2009, compared with 1.5 times for global peers, Pierry said, citing Deutsche Bank data. Israeli banks trade at 1 times stock price to book while lenders in Russia fetch 1.3 times, he said.

Pierry rates Banco do Brasil and Itau “hold” and Bradesco “buy,” saying the company’s market value doesn’t reflect the size of its business.

Competition

Brazilian banks may be less profitable next year as Itau and Bradesco expand, according to Laura Lyra Schuch, an analyst at Ativa Corretora in Rio de Janeiro.

“Increased competition, with the resurgence of private banks, will lead to narrower margins,” Schuch said. “To compensate for that banks will need to increase volume, so you have another incentive for banks to lend even more.”

Economists forecast Brazil’s gross domestic product will expand 0.21 percent in 2009 and 5 percent next year, according to the median forecast in a weekly central bank survey released today. President Luiz Inacio Lula da Silva, 64, said Nov. 17 Brazil is expanding at a “Chinese pace” of about 9 percent, an estimate based on annualized quarter-on-quarter growth.

“We see a positive scenario that we’ve never seen in Brazil before,” Itau Chief Financial Officer Silvio de Carvalho said on a Nov. 3 conference call.

Marco Geovanne Tobias da Silva, Banco do Brasil’s investor relations manager, said the bank is trading near the levels it has been at “historically” and that it’s cheaper than Itau and Bradesco. He said international banks became “too cheap” during the financial crisis, making Brazilian lenders look expensive. Banco do Brasil fell 52 percent last year.

Recovering Value

The Banco do Brasil “share increase this year can’t be considered excessive,” Tobias da Silva said in a telephone interview Nov. 21 from Brasilia. “Our stock fell too much during the crisis. Now it is recovering that lost value as investors are more confident in our policies.”

Spokesmen from Itau and Bradesco didn’t return phone calls from Bloomberg News seeking comment.

“The economy is growing, income is expanding, consumption is strong, all that ends up boosting credit,” said Kelly Trentin, the head of research at Sao Paulo-based brokerage SLW Corretora, who has a “buy” rating on Banco do Brasil, Itau and Bradesco. “There is still a repressed demand that banks can explore.”

Mercatto’s Abreu recommended Brazil’s smaller banks as the best investments in the industry as the economy expands. He didn’t name which ones he favors. Sao Paulo-based Banco Indusval SA has the biggest weighting in the firm’s R2 FI de Acoes fund, which has returned 264 percent this year, the most among more than 8,000 Brazilian funds tracked by Bloomberg. Indusval, with a market value of 322 million reais ($186.5 million) has gained 90 percent in 2009.

“Investors should stop looking at big banks that are well- known and well-liked and start looking at smaller lenders,” said Abreu. “There you have options of interesting banks that are well managed and with huge discounts.”

Markets Last Week

The benchmark Bovespa index rose 1.5 percent last week, led by Gol Linhas Aereas Inteligentes SA, which advanced 8.9 percent. Banco do Brasil fell the most, losing 4.2 percent.

The yield on the government’s zero-coupon bonds due January 2011 fell 12 basis points, or 0.12 percentage point, to 10.18 percent, according to Bloomberg data. Brazil’s real slipped 0.5 percent to 1.7314 per U.S. dollar from 1.7225 on Nov. 13.

The following is a list of events in Brazil this week:

Event                                             Date
Current Account (Oct.)                            Nov. 24
Foreign Investment (Oct.)                         Nov. 24
FIPE CPI (Weekly)                                 Nov. 25
FGV Consumer Confidence (Nov.)                    Nov. 25
Total Outstanding Loans (Oct.)                    Nov. 25
Private Banks Lending (Oct.)                      Nov. 25
Central Gov. Budget (Oct.)                        Nov. 25
Unemployment Rate (Oct.)                          Nov. 26
IBGE IPCA-15 (Oct.)                               Nov. 26
Nominal Budget Balance (Oct.)                     Nov. 26
Primary Budget Balance (Oct.)                     Nov. 26
Net Debt % GDP (Oct.)                             Nov. 26
FGV Inflation IGP-M (Nov.)                        Nov. 27

To contact the reporters on this story: Paulo Winterstein in Sao Paulo at pwinterstein@bloomberg.net; Helder Marinho in Sao Paulo at hmarinho@bloomberg.net

Last Updated: November 23, 2009 15:57 EST