Brazil's Credit Boom Could End in Tears

The Nov. 9 rescue of Brazil's 21st-largest bank, Banco PanAmericano, has exposed cracks in what many had regarded as one of the most solid financial systems among emerging-market countries. Brazil's economy grew at a 8.4 percent clip in the first nine months of 2010—its fastest pace in more than 15 years—powered in part by a sharp increase in government-subsidized loans and a rapid expansion in consumer credit. That can be a lethal cocktail. The data in Brazil are troubling: Late payments on credit cards and other consumer loans jumped 23 percent in November from a year earlier, prompting government leaders to begin scaling back their easy-credit policies. "It's time to be a little bit careful about the B in BRIC," says Jim O'Neill, chairman of Goldman Sachs Asset Management (GS) and the man who coined the BRIC acronym for Brazil, Russia, India, and China.

Former President Luiz Inácio Lula da Silva, a founder of Brazil's Workers' Party, impressed Wall Street with his commitment to free-market policies. Yet even he was unable to resist the temptation of indulging in an age-old Brazilian tradition: the election-year splurge. The national development bank, known as BNDES, made $101.1 billion in loans in the 12 months to October, a 33 percent increase from the same period a year earlier. Lula's protégée and successor, Dilma Rousseff, pledged to rein in spending as she assumed power on Jan. 1.

Bankers in New York, London, and as far away as Shanghai have a lot riding on how well Rousseff steers Latin America's biggest economy. With interest rates at all-time lows in much of the developed world, the 12 percent return on benchmark 10-year Brazilian government bonds has attracted money from all over. Foreign investors poured $15.9 billion into Brazil's stock market in the past two years. "The quest for yield and higher investment returns has flooded Brazil and other emerging markets with capital from around the world," says Russell Certo, a managing director at New York-based investment bank Gleacher & Co.

The capital inflows have buoyed Brazil's currency, the real, causing it to rise 34 percent against the dollar since late 2008. Finance Minister Guido Mantega, a holdover from the previous administration, has said he would consider a number of measures, including the imposition of new capital controls to fight the currency's appreciation, which puts Brazilian exporters at a disadvantage.

At the same time, Brazil's central bank is moving to curb the growth in consumer loans. The country has witnessed a fivefold expansion in consumer credit over the past eight years, with the total value of outstanding loans reaching $440 billion in October, according to central bank figures. This explosion was triggered in part by a 2001 regulatory change that allowed lenders to package auto, payroll, and other consumer loans into securities called FIDCs. The market for such notes has grown from nearly $290 million in 2003 to more than $35 billion last year.

Big Brazilian banks have stopped buying the credit portfolios since a November government probe into PanAmericano revealed losses stemming from improper accounting of sales of its loans. "PanAmericano was the wake-up call," says Denise Debiasi, the São Paulo -based managing director for Latin America at FTI Consulting (FCN), a Baltimore firm that advises on compliance, risk, and finance. "There's risks people may be overlooking—like credit quality—as the market booms." PanAmericano won't comment on the ongoing investigations, according to a spokesman at the bank's public relations firm.

To head off a subprime-style crisis, Brazilian authorities in December upped reserve requirements on time deposits held by banks to 20 percent from 15 percent. Banks must put aside more capital to back consumer loans whose terms exceed 24 months.

The government is also looking to regulate Brazil's credit-card industry. There are now 153.4 million credit cards in circulation in the country, triple the number from 2003. The average debt load of Brazilian consumers amounts to 18 percent of total disposable income, compared with 13 percent in the U.S., says Morgan Stanley (MS). In a Nov. 30 interview, Henrique Meirelles, who at the time was Brazil's central bank chief, indicated that a special task force would be convened to study the industry. "Some supervision could be proper," he said. "The case of PanAmericano showed how important this is."

The bottom line: The bailout of a Brazilian lender has exposed the need for greater supervision of the local consumer credit industry, which is growing rapidly.

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