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It’s not too late to get out of Brazilian banks

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Brazilian banks like Banco Bradesco ( BBD , quote ), which dropped 5.8% on Monday and extended losses on Tuesday after it reported second quarter earnings, are getting hammered. Earnings were basically flat as increases in loans and financial services revenue were offset by a higher expense in loss provisions.

Default rates on loans have increased five consecutive quarters and the money set aside for loan losses has increased by 39.8% over the last year. Non-performing loans increased to 4.2%, well above 3.7% in the same period last year.

Despite higher default rates and lower interest rates squeezing margins, the bank said it expects 18% growth in its credit portfolio this year.

Shares are down almost 20% over the last twelve months compared to losses of 18% in the broader iShares MSCI Brazil ETF ( EWZ , quote ).

Itaú Unibanco ( ITUB , quote ), the largest of the private Brazilian banks, lost 3.7% on Bradesco's report but gained most of it back on Tuesday on its own earnings report. The bank said it would be limiting growth in auto loans and other high risk loans. The bank expects total loan growth to exceed 10% this year, less than the 15% growth across the industry estimated by the central bank.

Shares of Itaú are down 16.4% over last year, outperforming peers and the general index. While the bank may outperform competitors it could still see losses. Shares rallied on news that management cut its outlook on loan loss provisions by about 8% for the third quarter even as these provisions have increased 53% over the last six quarters. Loss provisions for the fourth quarter are still expected to rise 13% to about 5.95 billion real ($3 billion USD) over the third quarter.

Telling is the fact that estimates for fourth quarter provisions are about equal to loss provisions for the second quarter reported on Tuesday at 5.99 billon real. Either management is underestimating loan loss growth or they will need to find a way to stem the pace in credit defaults as their total loan portfolio grows.

Default rates for Brazilian banks will increase over the rest of the year and they will continue to be pressured by the government to lower rates and increase credit lending. This will squeeze return on equity and continue to drive up loan loss provisions. Barring a resolution to the credit crisis in Europe or a strong rebound in global growth, the lending environment for Brazilian banks will keep them from performing.

As with any industry facing uncertainty and steep losses year-to-date, there is the potential for a rebound in asset values in Brazilian banks, but most investors would do well to look for higher risk-adjusted returns in the financials of other countries.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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