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Banks Are Still An Issue For Brazil ETFs

April 27, 2017 9:32 am
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The iShares MSCI Brazil Capped ETF (NYSE:EWZ), the largest exchange traded fund tracking stocks in Latin America's largest economy, is up a solid 11.6 percent year-to-date, though that lags the MSCI Emerging Markets Index by 320 basis points.

Amid ongoing political volatility in Brazil, something investors have become accustomed in recent years with this big emerging market, another issuers lingers and it's one that's particularly relevant to EWZ. Shares of Brazilian banks have been surging for over a year, but there some analysts have concerns about that rally. The $5.59 billion EWZ allocates over 38 percent of its weight to financial services stocks, more than double the ETF's second-largest sector weight, which is consumer staples.

Non-performing loans (NPLs) and recovery of those loans are expected to be tricky issues for Brazilian banks to navigate amid the country's fragile economic recovery.

“Loan recoveries will likely remain challenging for Brazilian banks alongside a continued tough macroeconomic environment in 2017,” Fitch Ratings said. “Asset quality should also remain a key issue. Corporate NPLs are likely to improve only marginally while increasing unemployment should continue to weigh on retail NPLs and household indebtedness.”

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Challenges for Brazilian stem from what's becoming a familiar issue from Illinois to Greece: public pensions. Cash-strapped Brazilian states are now delaying doling out benefits to pensioners, potentially crimping banks that previously rushed to lend to this segment of the Brazilian population.

Add to that, banking issues are starting to creep up again. As Benzinga reported late last year, a problem for EWZ is weakness in Brazilian bank stocks, which is particularly problematic when considering the sector's issues against the backdrop of some of the developing world's highest interest rates. Fortunately, Brazil's central bank is in the midst of an easing cycle that's resulting in significant reductions of the benchmark Celic rate.

“Asset quality and provisioning trends in 2017 are unlikely to be as negative as in 2016, especially considering the high concentration of problematic cases in the corporate sector last year,” Fitch said. “However, asset quality trends will still be challenging for banks until there is greater evidence of recovery in certain key sectors and more solid growth trends in the economy. Fitch forecasts economic growth in Brazil to rise to just 0.7% this year following deep contractions in 2015-2016 and maintains a negative sector outlook on Brazilian banks.”

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