The top Brazilian lenders have nearly doubled provisions in the first quarter to deal with likely defaults in the months ahead, as an unprecedented level of uncertainty stemming from the coronavirus pandemic has confounded banks as to how hard their portfolios will be hit.

Only one thing is certain: credit losses will be big. But beyond this consensus, banks' specific strategies around COVID-19 have varied considerably.

Itaú Unibanco Holding SA, the largest lender in Latin America, has run through as many as 32 GDP growth scenarios, which hinge on the lockdown's extension. It is illustrative of the level of ambiguity bankers are dealing with when calibrating provisioning levels as the pandemic continues to spread.

Given this lack of visibility, banks have stepped up to bolster their balance sheets. The four largest institutions, which account for roughly 80% of credit in Brazil, have put aside 27.71 billion reais in provisions in the first quarter of 2020, up from 17.61 billion reais in the year-ago period.

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Banco Bradesco SA was the first Brazilian major to report extraordinary COVID-19 related provisions, adding 2.70 billion reais for a total stock of 7.33 billion reais. State-controlled Banco do Brasil SA took a similar approach, setting aside an extra 2.04 billion reais.

Itaú went further and decided to beef up its reserves, now being referred to as its "Fort Knox." Aside from its 10.19 billion reais set aside for cost credit, the bank later padded its complementary allowance for loan losses by nearly 45% to more than 14.52 billion reais given concerning economic readings in late March.

"This has been much harder to do this time [but] we felt it was the right number," Itaú's Head of Investor Relations Renato Lulia said in an interview. He explained the bank had frontloaded a big portion of expected losses and hopes to make marginal adjustments ahead.

"There is basically no parameter, nothing like it since the Spanish flu," Leandro Miranda, head of investor relations with Banco Bradesco, told S&P Global Market Intelligence. The bank leaned on the previous 2008 and 2016 crises to come up with the figure, as it braces for the biggest impact to come on its small and medium enterprises portfolio.

Banks are building up reserves despite the fact that the nonperforming loans to support those decisions have not hit banks yet. Central bank relief measures have flattened the so-called NPL curve, as defaults are only expected to materialize later in the year, once the nonpayment exceeds 90 days.

"You are only going to see the real NPLs once clients start paying again from September on," Lulia said. Brazilian banks have already postponed 22.2 billion reais in loan installments during the pandemic.

With no extraordinary provisions allocated, Banco Santander (Brasil) SA has been the exception to the rule. The decision had a positive impact on its earnings, which rose 10.5% to 3.77 billion reais. In contrast, Itaú and Bradesco saw their profits shrink by more than 40% to 3.40 billion reais and 3.38 billion reais, respectively.

"We will see big differences come up, [but] it does not necessarily mean that a given bank will be better prepared than another," said Cynthia Cohen Freue, bank analyst with S&P Global Ratings. In the long run, provisioning will even out among banks, she said. "Santander will eventually provision [since] it's got the profitability to do so," she added.

Banking specialists who preferred to remain anonymous said that Santander's reluctance to provide complimentary provisions for the pandemic were founded on the holding group's strategy to lessen the quarterly impact on profits. Santander Brasil declined a request to comment.

A prolonged quarantine could result in more provisions

With roughly half a million cases, Brazil has quickly escalated as the second most affected country in the world and the regional epicenter of the disease.

Bankers fear a deterioration in sanitary conditions could result in longer lockdowns to contain the outbreak. An all-out health crisis could add pressure on Brazilian banks as a prolonged quarantine further jeopardizes the health of their portfolios.

"If the economy does not come back in the sense that the quarantine is not suspended by mid June, then we will have to create more provisions," Bradesco's Miranda said.

According to Felipe Guimarães, head of Credit at Banco do Brasil, credit risk stemming from job security concerns is lower for the state-controlled institution given public sector employees make up for most of its individual loan stock. "Compared to the private sector, (they) present a reduced risk of an increase in the default of our credits," he said. Yet banks are actively monitoring payroll loans where defaults could materialize if the isolation measures are extended. Banco do Brasil expects losses of around 1 billion reais in the individual segment, according to official figures.

Data is getting more reliable

Uncertainty regarding the length of lockdowns is one of the key unknowns undermining credit models, as the undefined extension of sanitary measures affects job security expectations and the capacity of companies to endure the crisis.

In an earnings call, Itaú's CEO Candido Bracher referred to modeling as "more of an art than a science." With 32 possible GDP growth outcomes to calibrate, the "art part of modeling becomes more relevant now," Lulia said. "It is a health topic rather than an economic one (so) the biggest challenge is not being able to predict when things will go back to normal," he added.

On top of variations on GDP forecasts, assessing how customers will behave during and after the pandemic is yet another challenge. After March and April showed dramatic contraction in consumption data, Brazilian consumers are now resuming their shopping habits, even if they are mostly confined to online sales.

Bankers are expecting their models to benefit from this fresh data to recalibrate with greater accuracy. "I tell you one thing, we got it wrong for sure." Itau's Lulia said. "What are the odds of getting it exactly right on the first go?"

"What you try to do is to make your best guess based on a lot of information and a solid process. And then you repeat that process," he added.

With more consolidated data streams flowing in, bankers are eager to reload their provisions models.

As of June 4, US$1 was equivalent to 5.12 Brazilian reais.