Why Brazilian Bank Stocks Are Plunging Today

What's happening

Shares of Banco Santander Brasil SA (NYSE: BSBR), Itau Unibanco Holding SA (NYSE: ITUB), and Banco Bradesco SA (NYSE: BBD) are down by 17% to 20% as of 12:10 p.m. EDT, as part of a broad meltdown in Brazilian share prices.

So what

Reports suggest that heads of JBS SA, Brazil's largest meatpacking company, secretly recorded Brazilian President Michel Temer authorizing bribes to Eduardo Cunha to buy his silence. Last October, Cunha was arrested in Brazil on accusations that he had more than $40 million worth of bribery money stashed away in secret bank accounts, among other charges.

Temer came to power after his predecessor, Dilma Rousseff, was impeached for illegally manipulating government accounts to make the country appear to be in better fiscal shape than it actually was. Now Temer could face his own impeachment proceedings for authorizing the payment of bribes. Temer could be the third president to be impeached in a span of only 25 years.

Image source: Getty Images.

A popular Brazilian stock ETF that trades on U.S. exchanges is down by about 16% on the news. A local index, which is denominated in Brazilian real, is down about 9%. The difference is largely due to the Brazilian currency's one-day decline against the U.S. dollar.

U.S.-listed shares of Banco Santander Brasil SA, Itau Unibanco Holding SA, and Banco Bradesco SA are denominated in dollars, and are thus bearing the full brunt of local stock declines and currency fluctuations.

Now what

Brazilian banks were already under pressure from rising non-performing loans (NPLs). Across the local banking industry, NPLs grew to 3.8% of gross loans in 2016, reaching the highest level since 2009, when NPLs reached 4.2%, according to World Bank data. Banco Santander Brasil SA reported that 15 to 90 day delinquencies rose to 5.5% in the first quarter of 2017, up from 4.8% a year earlier.

A lengthy recession has weighed on the banking industry's profits. Brazil's economy shrank by 3.8% in 2015, and 3.6% in 2016. The IMF recently slashed its estimate for Brazilian economic growth to 0.2% in 2017, suggesting that even before the recent scandals and political uncertainty, Latin America's largest economy was still on weak economic footing.

Weak economies typically provoke central bank action, particularly rate cuts.Brazil's central bank slashed its benchmark rate from 14.25% in October to 11.25% at the most recent meeting in April, weighing on the banking industry's prospects for writing loans at attractive yields. Given a weak economic recovery and renewed uncertainty, larger rate cuts could be in the cards, further weighing on the industry's share prices.

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