EM LATAM CREDIT: Banco do Brasil: U.S. Moraes Sanctions - Neutral

(BANBRA; Ba1/BB/BB)

Major Brazil bank stocks fell yesterday due to fears of escalation in the conflict between the Brazil courts and the U.S. government over how to handle the sanction of Brasil Supreme Court justice Alexandre Moraes.

Banco do Brasil has said they will comply as always with all regulations where it is doing business and we believe that. We see broader sanctions applied in countries like Russia that invaded another country and Venezuela that has been accused of being narco traffickers and not holding democratic fair elections but Brazil is not in that same boat so talk of broader sanctions and blocking use of the SWIFT transaction system seem overblown.

Only one individual has been sanctioned but the concern is that more sanctions could be imposed on individuals and financial institutions so making it difficult for Brazil banks to conduct business in the U.S. Increasing the exposure for Banco do Brasil is that it is a government-controlled entity so any violation would be that much more severe.

We don't think this issue has legs but is more of a casualty from the ongoing political conflict between Brazil and the U.S. with President Trump showing support for beleagured ex-President Bolsonaro who is charged with engineering an attempted coup January 2023 shortly after Lula was elected President.

The U.S. government slapped Brazil imports with a 50% tariff and has so far declined efforts to negotiate despite the fact that the U.S. has a trade surplus with Brazil so the tariff has been deemed to be at least politically motivated.

We don't see much impact on senior debt of the major banks, including BANBRA. BANBRA 8.748% perps are showing some weakness, down about 1/2 point yesterday, better offered according to a market source, and down another 1/4 point today. Part of that is from the fallout from disappointing 2Q earnings resulting from persistent weakness in the agricultural loan book.

There are some questions about whether the perps will be called in October with the company saying on the 2Q earnings conference call that a decision hasn't been made yet. The bank could save on interest expense by replacing that debt with more senior debt but could they replace it with a similar junior subordinated type instrument and save anything?

With the pressure of maintaining proper capitalization given their loan book problems we think they need to keep that Tier 1 capital on their balance sheet and couldn't replace the issue at a lower coupon in the market right now, though maybe by September that could change. Also keep in mind that they need regulator approval to call the perps with 30 days notice so we will know more next month.

Its a government controlled bank with problems in its loan book that are not expected to improve going into next quarter so less likely regulators would approve calling the issue unless they could replace it with something equivalent.