Consumers cheated by banks

THE lawlessness that pervades the international banking industry and especially the large Western banks must raise serious questions as to what perpetuates such barbarous behaviour among the custodians of people's money.

A big part of it is that the banking industry operates on greed rewarding its key employees via commissions for businesses brought in, deals made, and products sold even if they were dubious in the first place.

This encourages among the industry a bunch of highly dishonest salesman who shield themselves behind a veil of professionalism to dupe and seduce customers into believing their products are good and their processes are strong, secure and fair.

And they are aided by ineffectual regulators who parrot the trite phrase that free markets should not be overly regulated but turn a blind eye when the biggest financial institutions amass massive positions to fix markets and deceive customers, making a mockery of market freedom.

The integrity of free markets was compromised because big players could affect the direction of markets, making the markets way less than perfect. Free markets basically became unfettered freedom to make money even at the expense of the market and the potential collapse of the world's financial system.

They did it yet again or to be more accurate they did it earlier but their misdeeds surfaced once more recently. UK's Barclay's bank made a US$453mil settlement with regulatory authorities in the United Kingdom and the United States for fixing the London interbank offered rate (Libor).

Now, it turns out that Barclay's may not be the only one. According to a Reuter's report, other major banks are likely to be involved and may try and go for a group settlement with regulators, the US' Commodities Futures Trading Commission and the UK's Financial Services Authority.

The banks being investigated include top names such as Citigroup, HSBC, Deutsche Bank and JPMorgan Chase. They all declined to comment to Reuters.

And one of these banks, Europe's biggest HSBC, has been found laundering billion of dollars for drug cartels, terrorists and so-called pariah states, in a scandal which almost overshadows the Barclays' one. That leads to the question of whether other banks were involved as well.

If they jointly fixed the Libor, the world's most used reference rate for borrowings and derivatives with an estimated US$550 trillion, yes trillion, of assets and derivatives tied to the rate, it will be a scandal of epic proportions and may result in settlements of an estimated US$20bil-US$40bil.

That settlement will only scratch the surface. Just 0.1% of US$550 trillion is US$550bil. That implies that if banks had been able to fraudulently fix Libor so that it was just 0.1 percentage points higher, customers throughout the world would have had to pay US$550bil more in interest charges in a year.

In March this year, five US banks, including Bank of America, Citigroup and JP Morgan Chase, made a landmark US$25bil settlement with the US government for foreclosure abuses.

Even so, only a small fraction of affected house buyers are expected to benefit from this. Many other banks, however, are relatively unaffected and have not been fully called to account for their role in the US subprime crisis, which could have caused a collapse of the world's financial system.

Banks which bundled together risky housing loans into credit derivative products and passed them off as those with higher credit rating than their individual ratings, aided by ratings agencies, got off scot free. No one was called to account.

That the financial system is still vulnerable and that all gaps have still not been closed is JP Morgan's recent loss of up to US$4bil from rogue trading by a London trader going by the name of The Whale.

There needs to be a new set of rules, regulations and behaviour one based on ethics, honesty, competency and checks and balances. Custodians of public money should be required to be above all else honest first and foremost.

They should be consummate professionals whose first duty should be to protect the deposits of customers and the bank's capital. They should not do anything which puts the bank at undue risk.

The insidious habit of rewarding those who bring in revenue with hefty commissions have to be stopped so that bankers do not take risks which put their banks at undue risk which will eventually require trillion of dollars in rescue from governments.

Regulators should again make clear demarcations between those financial institutions who are custodians of public money and those who are not and hold the former to much higher standards of accountability and integrity.

Shareholders of financial institutions who are custodians of public money should be led to expect a lower rate of return on their investments but they should also be led to expect a lower corresponding rate of risk befitting that of major institutions which are so vital for the proper functioning of the economy.

Enforcers should focus on bringing individuals responsible for these losses to book and throwing criminal charges at them which will put them behind bars for long periods of time, befitting their severity. Society at large tends to treat white-collar criminals with kid gloves.

When derivatives trading and deception brought major Wall Street firms such as Enron and WorldCom to their knees and eventual collapse in the early 2000s, enforcers brought to book key executives who are spending time behind bars.

But despite the near collapse of the world's financial system, despite fraudulent behaviour, despite misrepresentation and deception, despite selling structured products of dubious value and then promptly taking positions against them, despite fixing of reference interest rates, despite money laundering and despite many other crimes still to be unearthed, no one has been brought to account.

Fining institutions leaves those individuals responsible free. In fact, settlements made come with the agreement that there will be no prosecution of individual bank staff and gives major incentive for others to do the same.

They are safe in the belief that the institution will pay the price and they will go free in the event things turn wrong. Otherwise, they will end up millionaires and even billionaires. How convenient an arrangement!

There is anarchy in the financial markets and a state of lawlessness which encourages heists of unimaginable proportions without risk of punishment. If we don't watch it, the losses will do the world economy, and all of us, in.

Brazil's high powered economy

Key Points:
External headwinds most culpable in 2011 for poor equity returns, 2012 (thus far) has seen returns of 18.8%
Positive policy support should see the Brazilian economy stage a strong comeback in 2012
Growing consumer strength poised to benefit 2 key sectors - Consumer Sectors, Financials Sector
Demographic and Structural changes present investors with opportunities to benefit from Brazil's continuing transformation
Brazil currently offers potential upside of 27%, maintain 4.5 Star "Very Attractive" rating
After a horrid year in 2011 where it lost -24.7% as a combination of rate hikes to combat inflation and a weak global economic outlook took hold, the Brazilian stock market has come roaring back in 2012 with returns of 18.4%.

EXTERNAL HEADWINDS MOST CULPABLE IN 2011
Ever since the re-ignition of the European debt crisis in the middle of 2011, Brazil’s economy has faced significant headwinds.
The uncertainty took its toll on the local economy with economic activity deteriorating as both capacity utilisation and industrial production began to fall, leaving 3Q 2011 GDP coming in slightly negative at - 0.1% on a quarter-on-quarter basis.
Internally, Brazil had been fighting its nemesis that is inflation in 1H 2011, hiking its key Selic interest rate to 12.50% as it sought to cool an overheating economy which also suffered from rising commodity prices. In addition, lending curbs were introduced in an effort to reduce credit available and reduce Brazil’s demand-pull inflation.
As for the Bovespa, the materials, industrials and utilities sectors were amongst the hardest hit as a result of the above while the Financials benefitted from the initial rate hikes before succumbing to pressure emanating from troubled Europe as well as rate cuts in 2H 2011.

With the closure of 2011, 2012 has spelt much better news for the Latin American nation.

Currently, the Brazilian government has undertaken several measures ranging from the slashing of its key Selic rate to cutting taxes on various goods in an attempt to boost growth since 2H 2011. With the government prioritising growth over inflation control, we take a closer look at 2 key sectors which are poised to deliver.

CONSUMER SECTOR - FROM STRENGTH TO STRENGTH
Brazil’s domestic consumption story, based on demographic and positive structural changes is something that’s not new to investors. However, what investors might not know is that the story has continued gaining in strength. Retail sales in Brazil have been climbing higher and higher, growing by close to 7% for the second consecutive month on a year-on-year basis in November and December, on the back of rising real wages and historically low unemployment (thanks to job creation), with retail sales growing by 7% for the second consecutive month on a year-on-year basis as seen in Charts 1 and 2 below.

CHART 1: RISING RETAIL SALES & REAL INCOME















CHART 2: MORE JOBS, LESS UNEMPLOYMENT


The strengthening of incomes and the creation of more jobs has also seen family expenditure become more resilient as compared to the past.
During the financial crisis of 2008-2009, although family expenditure did not contract, this key component of Brazil’s’ economy saw its growth rate fall significantly from 7.7% to 2.7% on a year-on-year basis from September 2008 to December 2008 in spite of the seasonal effect normally seen in December (holiday sales).
In the most recent episode of the European debt crisis, family consumption held up significantly better and demonstrated its new-found resiliency with a less painful fall from a 5.6% growth rate in June 2011 to a 2.8% rate in September 2011 (Chart 3).

CHART 3: CONSUMPTION'S INCREASING RESILIENCE


Taking a closer look at the retail space, the decision by the government to cut taxes for household goods has seen the purchases of furniture and appliances continue to hold its pace of growth steady with data showing a healthy year-on-year gain of 15.3% in December 2011. Supermarket retail sales have like-wise kept up its pace of growth, registering a growth rate of 4.6% in the same period. However, retail sales for apparel & footwear have slowed as a result of a minor slip in consumer confidence as the weak external environment saw consumers reduce their discretionary spending.

Given the increased stature of the Brazilian consumer, both the Consumer Discretionary and Consumer Staples are expected to benefit from the resilience of Brazil’s consumption story and its growing strength.

FINANCIAL SECTOR - LONG TERM BENEFICIARY
The financial sector in Brazil has long been on the up and up. Credit loan growth in the country has been growing steadily over the course of the decade as a conflux of factors allowed such phenomenal growth.

The very same demographic and structural changes in Brazil that has seen the consumer sector do well have also positively impacted the Financials sector.
With increasing affluence, credit cards and loans to service mortgages (which in part is also due to urbanisation, a structural change), the Brazilian financials have a benefitted from the consumer boom.
Consumer credit has almost doubled over the past since December 2007, while default rates still remain in an acceptable range of 7-7.5%, a far cry from the 8.5% seen during the peak of the financial crisis in 1H 2009 (Chart 4).

CHART 4: CONSUMER CREDIT BOOM


Looking at the larger picture of total private sector loans outstanding, currently, the total amount of these loans only reach approximately USD 1.2 trillion, with a booming economy in the backdrop and as the Middle Class in Brazil grows, incomes increase and urbanisation takes place rapidly, the financials are a sector which is poised for further rapid expansion.

The decision by the Brazilian central bank to cut interest rates is a double-edged sword for financials as although it will cut the rate with which they lend at, the rate at which they borrow to fund their operations will be reduced as well. Historically, the average banking spread for Brazil has averaged 27% with the latest figure as of end December 2011 registering a reading of 26.9%, almost spot on with the long-term average (Chart 5).

CHART 5: AVERAGE BANKING SPREAD


While margins are important for banks, we believe that an increase in the growth of demand for credit in Brazil as a result of lower borrowing rates will more than sufficiently make up for any shortfall in profits as a result of a potential narrower lending spread.

CONCLUSION

Any country moving from an “Emerging Market” status to “Developed Market” status provides investors with several opportunities to capitalise on demographic and other structural changes; in Brazil’s case, the ever-growing consumer spending power and the need for financial services will see the Consumer Staples, Discretionary and the Financial Services sectors prosper.

At current levels, the Bovespa is trading at a price-to-earnings ratio of 9.0X based on 2013’s earnings, representing a potential upside of 27% (as of 7 March 2012) by then when compared to its fair value of 11.5X. We have a 4.5 Star “Very Attractive” rating on Brazil, and a 5 Star rating on the larger Global Emerging Markets.