After a substantial increase in provisions for credit losses in 2020 due to the pandemic economic fallout, large Brazilian banks reported a 30% net income increase as of December 2021 compared with the same date one year earlier. Moreover, lending growth was 16.5% year over year, fueled by residential mortgages, credit cards, payroll deductible loans, and loans to small- to mid-size enterprises. Relaxation of social-distancing measures and the advance of vaccinations in Brazil helped prop up economic activity after the severe recession in 2020. We believe these factors enabled banks to keep their asset quality metrics under control during 2021. In addition, regulatory changes allowed banks to restructure loans to mitigate potential losses stemming from the pandemic-induced economic shock. Brazil's central bank introduced a comprehensive set of measures to limit the impact of COVID-19 on the sector, including liquidity support, and capital and provisioning relief, which helped banks continue lending while maintaining a sound operating performance.

Moreover, large banks have continued to generate stable revenue thanks to a diversified business mix and strong net interest margins (NIMs) despite heavy competition. We expect sound NIMs and fee revenue to continue serving as a buffer against credit losses. Despite rising policy interest rates in Brazil, we believe banks' margins are still robust, given ability to quickly reprice their portfolios. We forecast provisioning needs for Brazilian banks to remain high in 2022, while the economy struggles to rebound and individuals' debt payment capacity deteriorates. But provisioning will remain lower than the 2020 peak. Our base-case scenario assumes credit cost ratios and asset quality metrics to remain under control in 2022. However, we believe that geopolitical and Brazil's political uncertainty will continue to pose risks to the country's economy, weighing on banks' asset quality. 

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We Scaled Back Our Forecast On Nonperforming Loans

Despite persistent inflationary pressures, which has prompted the central bank to accelerate the rise in interest rates, we believe the asset quality risk is lower than what we forecasted during the pandemic. Our current base-case scenario assumes that the vaccine rollout can continue to provide significant protection against severe illness, reducing the need for new lockdown measures. We project asset quality metrics to remain stronger than expected but should return to pre-pandemic levels due to Brazil's likely flagging economic growth, still sluggish labor market, and modest credit growth in 2022. But asset quality should remain manageable thanks to banks' focus on lower-risk lending segments during the pandemic. In addition, the share of loans under moratoriums has continued declining, while the performance of deferred loans was more resilient than expected.

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Credit Growth Momentum Likely To Ease In 2022

Lending growth in Brazil was strong during 2020, mainly because of the higher credit demand among corporations to boost their liquidity amid the pandemic-related uncertainties. However, in 2021, consumer loans propelled overall credit growth slightly higher than one year earlier to 16.5%. Credit cards benefited the most from the economic recovery with a 37% growth, while personal loans and payroll lending rose 24% and 17%, respectively. Residential mortgages maintained a similar trend in 2021 with a 14% growth, despite the rise in interest rates that impacted this lending segment the most. Finally, auto loan volume rose nearly 10%, pointing to a strong recovery from 2020, during which this was hit hard by the lockdowns. However, we expect the origination pace to cool in the first quarter and for the rest of 2022, given the spike in Brazil's interest rates.

We believe private banks will continue to drive credit growth, while we expect government-owned banks to remain focused on their core business. We expect lending growth to ease to 10% in 2022, given the absence of the borrower relief programs and due to the lower appetite among banks to take on additional risk given the uncertainties stemming from upcoming presidential election and global geopolitical tensions. We also expect retail loans to grow at a higher pace, thanks to the higher demand in this sector, than for corporate loans due to still limited growth prospects for companies.

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What's On The Horizon For Brazilian Banks Credit Losses?

We expect credit losses to represent a higher share of large banks' pre-provision earnings in 2022 than in 2021, but still sharply lower than the pandemic-driven peak in 2020, during which the average ratio among the top five banks reached 54%. Households' high debt burden, combined with high interest rates and inflation, should strain asset quality in the retail lending sector, prompting credit losses to widen in 2022.

On the other hand, we expect efficiency gains to bolster banks' profitability, stemming from strong revenues and tight cost controls. Banks continue to focus on cutting administrative expenses, while shrinking their branch networks and expanding digital platforms. In our view, the high share of fees and commissions from non-lending activities as a percentage of total revenue should continue to mitigate the impact of Brazil's economic malaise that could dent credit and asset quality, and require banks to increase credit provisions.

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