OREANDA-NEWS. Good loan portfolio diversification and limited loan growth have been key to the credit profiles of Brazilian midsized banks amid the country's soft macroeconomic conditions, says Fitch Ratings. As a group, Brazil's midsized banks reported fiscal 2014 results that were supportive of current rating levels.

Disciplined underwriting has thus far held off credit pressures within loan portfolios. In spite of sluggishness amid Brazil's challenging macro environment, asset quality continued to trend positively during 2014, as the weakest-performing loan categories (D-H rated loans) dropped to 4.5% of total loans, down from 6.0% and 6.4% in 2013 and 2012, respectively. A focus on less risky loans to the small and the medium enterprise (SME) sectors has contributed to the improvement in our view.

Looking ahead in 2015, however, Fitch expects higher loan-loss provisions for midsized banks, due to fewer loan concessions and macro pressures on SME borrowers and smaller corporate customers. While midsized banks' direct exposures to companies involved in the Petrobras scandal are not an issue, many SMEs are among the chain of suppliers and service providers to Petrobras.

Capitalization remains a strength of Brazil's midsized banks, as Fitch Core Capital for the group increased to 13.5% in 2014, up from 11.9% in 2013. These banks have generally kept loan growth in check in anticipation of a reversal in asset quality trends. High liquidity, adequate asset-liability management and solid funding profiles should also continue to be supportive of credit strength.

However, profit growth was soft across the Brazilian banking sector in 2014, particularly in second-half 2014. For Brazil's midtier banks, return on average assets was around 1.5% in 2014, down slightly from 1.6% in 2013. Historically, challenging macro conditions affect smaller and less established businesses to a higher degree, which is also the target market of many of Brazil's midtier banks.

Brazil's Fitch-rated midsized banks included in this analysis are Banco Safra, Banco Daycoval, Banco ABC Brasil, Banco Pine, Banco Pan, Parana Banco, Banco Sofisa and Banco Indusval. Each bank's ratings are driven by intrinsic financial strength, with the exception of Banco Pan, which has its Issuer Default Ratings driven by the support from one of its shareholders, Banco BTG Pactual.

Fitch believes that solid diversification and credit risk management will be key to performance among this group of banks in the current environment. Loan diversification continued to be supportive of solid results for Daycoval, Safra and to a lesser extent, ABC Brasil. Diversification has been key to Daycoval, especially because of the bank's focus on the lower end of the SME segment which is more sensitive to the negative economic environment.

Banks with less diversified loan portfolios include Pine and Indusval, which despite their focus on larger, higher credit-quality SMEs, have faced pressures on their profitability.

For Pan, its recent capital base improvements should be supportive of less reliance on credit sales to Caixa. For Indusval, its turnaround is more dependent on an unlikely improvement in the operating environment that could allow a higher credit appetite for the bank.

The challenging economic environment that drove some banks to revise their strategies, implement turnaround plans, lower cost structures and make important shifts in their business models should continue. Over the last 18 months, some banks were able to carry out M&A transactions and reorganizations involving agreements and joint ventures with larger and smaller players and to redefine their strategies. We expect foreign institutions to continue to acquire smaller Brazilian lenders.