Banks Taking Steps To Boost Brazil ETF

The iShares MSCI Brazil Index (ETF) EWZ is one of this year's best-performing non-leveraged exchange-traded funds. Up nearly 66 percent year-to-date, the largest Brazil ETF is outpacing the MSCI Emerging Markets Index by an almost 4-to-1 margin.

Brazil ETF

Predictably, rebounding commodities prices are widely cited as one of the drivers of the Brazilian equity market resurgence this year. EWZ is levered to that theme as energy and materials stocks combine for 21.6 percent of the ETF's weight. What has been truly impressive, however, is the strength of Brazilian banks, an important factor for EWZ because financial services names are the ETF's largest sector allocation at 35.3 percent.

Challenges for Brazilian banks stem from what is 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.

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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.

To the credit of Brazilian banks, they are taking steps to endure a tough operating environment and still lethargic local economy.

“Banks cut back on new lending in both 2015 (minus 3.2 percent) and 1H16 (minus 6.8 percent) as they adopted a conservative approach in the face of recession, slumping consumer spending, weaker confidence and falling investment. We expect banks to continue this cautious approach to credit demand until they see clear signs that economic growth can be sustained. We expect GDP to contract by 3.3 percent in 2016 but we have slightly increased our growth forecasts to 1.2 percent in 2017 and 2.2 percent in 2018, respectively from 0.7 percent and 2 percent,” said Fitch Ratings in a recent note.

What Does Brazil Add?

Brazil is home to some of the world's highest borrowing costs at 14.25 percent. In fact, there is growing momentum for Brazil's central bank to start lowering rates, perhaps as soon as this month, but that might not hamper Brazilian banks the way lower interest rates in the United States and Europe have banks in those regions.

“Lower rates would help the flow of credit to the corporate sector as even Brazil's prime companies are struggling to take on more debt at current rates. But even if the cost of lending falls, we are not convinced that banks will relax their underwriting standards, which were considerably tightened at the outset of the recession,” added Fitch.

Full ratings data available on Benzinga Pro.