TEXT - S&P cuts Banco Rural rating to 'B-'
(The following statement was released by the rating agency) Overview -- Brazilian bank Banco Rural keeps struggling to stabilize its business and faces significant losses due to asset quality deterioration, new regulations, and high administrative costs. -- We are lowering our issuer credit ratings on the bank to 'B-' from 'B' on global scale and to 'brB' from 'brBB+' on national scale. -- The negative outlook reflects at least a one-in-three probability that we could lower the ratings in the next few months. Rating Action On Dec. 11, 2012, Standard & Poor's Ratings Services lowered its issuer credit rating on Banco Rural S.A. (Rural) to 'B-' from 'B' on global scale and to 'brB' from 'brBB+' on national scale. The outlook is negative. Rationale Standard & Poor's bases its ratings on Rural on its "weak" business position, "weak" capital and earnings, "moderate" risk position, "below average" funding, and "moderate" liquidity. The stand-alone credit profile (SACP) is 'b-'. Our bank criteria use our Banking Industry Country Risk Assessment (BICRA) economic risk and industry risk scores to determine a bank's anchor, the starting point in assigning an issuer credit rating. Our anchor for a commercial bank operating only in Brazil is 'bbb'. The indicative BICRA group for Brazil is '4', according to our criteria. One factor we base the BICRA group on is our evaluation of economic risk. In our opinion, economic improvements and cautious fiscal and monetary policies have added to the Brazilian economic authorities' flexibility to manage significant external shocks and potential distortions arising from the current economic expansion in Brazil. We believe these potential risks remain manageable, and the central bank's proactive stance has contained them. With regard to industry risk, sound regulation, the regulators' good track record, and a high and stable share of core deposits support the Brazilian banking industry. We also consider the banking sector's moderate risk appetite as a positive factor in our assessment. We continue to view Rural's business position as "weak" given its small market share, concentrated business lines, while it exits the payroll deductible lending segment and focuses on lending to small to medium enterprises (SMEs). Rural is the 47th-largest financial institution in the country as of September 2012, representing less than 1% of the system's total assets. The bank decided to exit the payroll deductible segment in 2011, in which it made the last loan in August of that year, following the management's that decision that this product was no longer viable and profitable for the bank. Under the new regulations, revenues from ceded loans must be accrued during the term of this loan, as opposed to the revenues recognized upfront. Also, ceded loans with co-obligation must be provisioned. Furthermore, increasing competition from the large retail banks (many actively winning payroll auctions), a shifting base of loan originators, and their increasing commissions convinced Rural to discontinue this business, which should be completed by 2014. Until then, the bank's results suffer from this loan portfolio. As of September 2012, 85% of the bank's loans were to SMEs and the remainder (including the ceded loans with co-obligation) was payroll deductible loans. In our opinion, Rural's capital and earnings is "weak" given its small capital level and historical low profitability, with significant losses in the last couple of years. The bank's capital, forecasted by our risk-adjusted capital framework, will average below 4% for the next 18 months, which we view as weak. The forecast considers a capital injection of R$100 million in 2012 and our growth expectation for the next couple of years. Recently, the Central Bank required Rural to adjust its exposures twice to comply with regulatory requirements. The first, in December 2011, required Rural to adjust its balance sheet by R$181 million, which it did so through deleveraging, recognition of losses, and a capital injection of R$65 million. The second, in mid-2012, required a capital injection of R$100 million (R$13 million in June and the remainder in September). In addition, Rural's results sharply weakened following credit portfolio deleveraging, exit of the payroll deductible segment, asset quality deterioration, and increasing loan loss provisioning. In 2011, the bank posted a R$83 million loss, while for the first six months of 2012, it was R$33 million. As a result, return on assets (measured by our core earnings methodology) was negative 2.04% and 1.24%, respectively, for both periods. Rural's risk position is "moderate" due to the asset quality deterioration, shifting risks resulting from the exit of the payroll segment, and reputational risks Rural is subject to. In 2011, the bank's nonperforming assets spiked to 2% from 0.94% in 2010, while it rose to 3.3% in June 212. The continuing asset quality deterioration required more loan loss provisioning, which weakened the bank's results further, and this trend will continue in the next few months. However, the bank doesn't have client concentration. We view Rural's funding as "below average" and liquidity as "moderate." The bank depends on time deposits to fund its activities, as is the case for most of the small Brazilian banks that don't have a branch network to capture retail deposits, especially demand and savings deposits, which are cheaper and more stable than time deposits. However, 62% of the bank's funding is comprised of time deposits, 23% of ceded loans. Among the time deposits 48% correspond to DPGE--special deposits guaranteed by the national deposit insurance agency up to R$20 million, which can't be withdrawn before their maturity date) and 39% from regular CD's. The bank has been trying to diversify its funding sources through the use of financial and agricultural bills that accounted for 10% as of September 12. The bank's reliance on corporate and institutional investors for its deposits makes up 80% of total funding base. As of June 2012, around 53% of the time deposits had liquidity condition, higher than for its peers. Rural's liquid assets covered 22.8% of total deposits as of June 2012 and 55% of the time deposits with liquidity condition. Outlook The negative outlook reflects our opinion that Rural will keep focusing on the SMEs segment, while it's exiting the payroll deductible lending segment and implements its growth strategy. We believe that its capital will remain weak, with losses hampering internal capital generation for future growth. We could revise the outlook to positive if the bank receives a capital injection and achieves a sustainable capital base that would lead our forecasted RAC ratio above 4%. On the other hand, a further capital level decrease, asset quality deterioration, or liquidity downfalls could result in a negative rating action. Ratings Score Snapshot Issuer Credit Rating B-/Negative/-- SACP b- Anchor bbb Business Position Weak (-2) Capital and Earnings Weak (-3) Risk Position Moderate (-1) Funding and Liquidity Below Average and Moderate (-1) Support 0 GRE Support 0 Group Support 0 Sovereign Support 0 Additional Factors 0 (Caryn Trokie, New York Ratings Unit)
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