Liquidity crises usually hit the banking segment front and center. At the peak of the current turbulence, the Brazilian Central Bank (BC) took up several measures to ensure the Brazilian financial system's health. One of them in particular shed light on the situation of the so-called medium-sized banks. They are important financers of working capital for companies and for credit targeted at retail customers, and they pay more to obtain capital in the market. They raise such capital from large banks by, among other means, selling their credit portfolios. Hence, they would be the greatest beneficiaries of the exemption from part of the compulsory time deposit, granted by the BC in October, for banks to buy credit portfolios from other institutions. The exemption aimed to promote the return of liquidity to interbank operations, after the confidence crisis set off by the international shake-up.

The result, however, was not as expected. Larger banks preferred to use the compulsory deposit money to invest in public bonds, rather than buy credit portfolios from medium-sized banks. In late October, the BC took up another, better-advised measure: they allowed these institutions to use assets acquired from other banks (such as portfolios of credit granted to individuals) to reduce their compulsory deposit by up to 70%. It worked. From the date of the measure through November 24, smaller banks sold R$ 22 billion in portfolios to large institutions.

There are now nine exchange-listed medium-sized banks. Most presented solid balance sheets for the third quarter. "These statements say little about the crisis", says Nicholas Barbarisi, of Hera Investimentos. After all, the July to September period encompassed little of the most critical part of the crisis. BicBanco's credit portfolio advanced 6.3% during the quarter due to good conditions found in the first two months. Net profit, however, retreated by 1%.

The words contained in the performance comments are drenched in caution. "A return to pre-crisis portfolio levels is unlikely in the short term." This sentence is from Milto Bardini, Investor Relations (IR) director at BicBanco, and appears right at the start of the ITR disclosed in mid-November, together with the statement that operation volume should fall, accompanying the falling demand for credit. The credit portfolio's R$ 9.7 billion are in line with the R$ 10 billion raised, but maturity dates are misaligned. While 80% of the credits will mature in the short term - less than one year -, only half of time deposits (which represent 56% of funds raised) will mature within that period.

This mismatch, the name used by the market to define such a situation, is a risk especially at moments of low liquidity. Pairing funding maturity with loan maturity avoids cash gaps and disparities in operation costs. The second case applies to Bic, which recently tapped the market repeatedly for long-term capital, as in a four-year Credit Rights Investment Fund (FIDC), launched in August. Longer-term capital has higher costs, making loans less lucrative, in theory. Therefore, the numbers suggest that Bardini's bank was raising funds at higher prices than would be necessary to maintain its portfolio, even before the hard blow of the crisis.

Nevertheless, Bic looks good compared to its competitors in the sector. The opposite situation would be worse, if capital raised had shorter maturities than the bank’s loan portfolio. The middle market leader, Bic is a working capital financer - typically a short-term operation and less affected than consumer credit. "But not all medium-sized banks are in the same boat", warns Aloisio Lemos, analyst at broker Ágora Corretora. Some focus on consigned credit and automobile financing - longer-term, more expensive and, therefore, riskier operations.

Such is the case of PanAmericano. Focusing on consumer financing for lower and middle class individuals, the bank, which is controlled by Brazilian communications mogul Sílvio Santos, has a credit portfolio with an average maturity of five quarters. The average maturity for raised funds, however, is 14 months. A one-month mismatch, says the third quarter ITR, "is covered by the institution's net equity" – this is not at all a comfortable situation for a bank, especially if one considers that such equity amounts to R$ 1.4 billion and that the unsecured amount for the period reaches R$ 900 million.

INDIVIDUALS, A CRUEL NICHE — PanAmericano presented 43.5% higher net profits for the quarter, compared with the same period in 2007 - but it would be wise to remember that the stock offering carried out in November 2007 increased the bank's capital by R$ 700 million during the period. In a more significant comparison with 2Q 2008, the institution's net profit dropped 25%. Add to this the credit portfolio/capital profile mismatch problem and we get an idea of what the upcoming months will be like for PanAmericano.

The credit portfolio’s 9.4% third-quarter growth (in relation to the previous quarter) came from financing the purchase of automobiles, where demand has been showing signs of cooling down. And that’s not all. “Nonpayment in operations with individuals is more sensitive to crises than the corporate portfolio”, warns the analysis team at broker Banif. One indication of this is that AA to C rated credits, on a scale where H is the riskiest, reduced their participation in PanAmericano’s credit portfolio by 1% in the past year. But this operation is the specialty of Sílvio Santos’s bank, and a crisis is not the ideal moment to start diversifying.

The Indusval bank knows this well. They operated in financing until 2004, when they sold their portfolio to HSBC. In 2007, they resumed financing of used cars. The project prescribed a maturity period of a few years, but Indusval soon gave up. In October, they dismissed their team of 57 employees. “The scenario deteriorated and we preferred to focus on the middle market”, explains Luis Masagão, chairman of the bank’s board of directors, which had a profit of R$ 19 million during the quarter on a portfolio of R$ 2 billion.

Banco Pine was another bank that drew back from offering credit to individuals. In 2006, this type of client accounted for 43% of its portfolio, a share that dropped to the current 28% of its R$ 4.8 billion operation. Loans to companies accounted for 72% of the portfolio, which has a short-term profile. In its ITR, Pine warned that “market and regulation” changes to consigned credit forced the bank to revise their operations targeted at individual consumers.

The change in the market is explained by Banif. “When the consignment fever started a few years ago, spreads were up to 40%. Competition obviously increased and profits fell”, says one of Banif’s analysts. More subtly, the regulatory changes also put an end to interest in this operation. Amid the package put out to reduce consumption in the already far-away start of 2008, when the threat of inflation frightened all, the government reduced the payroll-discountable margin for government employees. And that was not all. A little earlier, when interest rates were falling, the government stipulated a maximum spread that could be charged by banks on payroll-discounted loans. “But when interest rates started to rise again, there was no rectification”, says Lemos.

THE SHOT BACKFIRED — The changes to consignment rules also displeased Cruzeiro do Sul, another bank specializing in this type of loan. With a R$ 4 billion portfolio, 85% of which in payroll-discounted credits, over the quarter the bank dismissed 173 employees working the middle market area. The bank’s net quarterly profit dropped 57% in relation to 2007, falling to R$ 27.6 million.

Among the reasons for the drop, the ill-fated share buyback program put into practice this year comes to mind. Several medium-sized banks created similar projects (Pine, for example, did three), but none went through such difficulties as those faced by Cruzeiro do Sul. Forced by regulations to restrict the buyback to 10% of free float capital, the bank was not able to hold up its share prices and generate value for shareholders, because one of them insisted on getting rid of a considerable stake. This investor, say market sources, was Opportunity, which held a higher than 5% stake in the bank up to June 4, 2008, when their position fell to 4.8% and no longer had to be publicly disclosed.

Having overstepped its quota, Cruzeiro do Sul signed a swap agreement with UBS, in which the investment bank would buy the shares and Cruzeiro do Sul would receive their financial variation, in exchange for the ID rate plus a spread. As share prices did nothing but fall, Cruzeiro do Sul incurred losses of R$ 17.8 million with the operation. Nevertheless, the bank announced another buyback program. The move aimed to generate value for shareholders, but it backfired. The bank’s shares, quoted at R$ 15.5 on June 26, 2007, were worth R$ 4.4 on November 21, 2008. All nine listed medium-sized banks are suffering from share prices below their issuance date price.

To Lemos, the low price scenario does not necessarily imply a stimulus to consolidation in the segment. “Buyback programs are proof that the controlling shareholder believes that his equity is undervalued”, he says. Therefore, a low price would not be accepted as a reference value by these entrepreneurs. Barbarisi thinks differently. He sees the Itaú/Unibanco merger as the start of a process of mergers and fusions among financial institutions that will involve medium-sized banks. “The greats became smaller after the negotiation between Unibanco and Itaú. Acquiring medium-sized banks will be the trend in the years to come.”

Using the same example, Marco Aurélio Barbosa, chief analyst at Coinvalores, is more cautious. For him, the major banks’ appetite for acquisitions will manifest itself first through consolidations of retail institutions. “That checkerboard still holds more attractive pieces than smaller institutions do. After all, how many medium-sized banks would you need to make an Unibanco?”, he asks. Answering this question is an ill-fated task, especially if we consider the scenario for 2009. Slower consumption will probably weaken medium-sized banks’ portfolios--and also the appetite of large banks.