Itaú: Muscling In, Branching Out

With broad smiles and a clasp of hands, Roberto Setúbal and Pedro Moreira Salles – captains of Brazilian finance – christened the largest commercial bank in Latin America and set sail on a business adventure that is already exploring expansion possibilities across the region.

Yes, the economic waters are choppy. And true, there’s a more than fair chance they’ll have to deal with some financial storms. But the men at the helm also expect to discover opportunities in a world that’s looking for well-capitalized answers.

The announcement of the union of Itaú, the Setúbal financial group, and Unibanco, long the property of the Moreira family, caught financial markets by surprise, even though the merger talks had been underway for almost a year. The move came at the height of an international sell-off of stocks in the wake of last fall’s vaporization of Lehman Brothers, the venerable Wall Street institution whose demise has been followed by the consolidation of ailing U.S. financial institutions.

After the merger, which was given the green light by Brazilian banking regulators in February, the new Itaú Unibanco Banco Múltiplo has some US$266 billion in net assets, making it one of the world’s 20 largest banking groups.

Setúbal, who holds the title of chief executive at the new group, and Moreira, who took on the role of chairman, shook hands as equal partners during the Nov. 3 news conference at the Modern Art Museum in Sao Paulo, where they launched the deal. But the all-stock financed transaction was not entirely a marriage between equals, as market analysts agreed that Itaú acquired its smaller rival to create Latin America’s biggest non-government controlled bank.

The government hailed the event, with Finance Minister Guido Mantega telling reporters that the new and larger bank “would strengthen the local financial system.”

Still, this financial marriage is taking place in troubling times.

Both bankers hastened to quash speculation that Itaú bought Unibanco because the smaller rival was buckling under heavy debts or that some Brazilian corporations had ensnared the larger bank in derivative losses stemming from a series of wrong bets that the U.S. dollar was going to weaken.

The Itaú heir dismissed direct problems with derivatives.

“Any poorly done derivatives sales in Brazil were absolutely an exception to the rule,” Setúbal said in December.

“A lot of our clients announced derivatives losses that they did not hold with us,” Setúbal said, although he conceded that a company in trouble with derivatives held by other institutions could face difficulties paying off separate credit lines with Itaú Unibanco.

Despite the global financial turbulence, the general consensus in Brazil is that the country’s banks are sound, having weathered a crisis in the prior decade that sparked a round of consolidation. Brazilian banks also kept strong by being conservative.

FORMIDABLE BRAND FOR REGIONAL EXPANSION

The merger has created a Brazilian bank that has the financial muscle to undertake international acquisitions, the kind of cross-border deals carried out by U.S. and European banks snatching up profitable institutions throughout the region. The bank’s strong cash position gives Itaú Unibanco the strength to expand, but how fast the high-flying Brazilian banking families intend to proceed is still in question.

“We have a plan for overseas expansion and we will give careful consideration to opportunities as they arise,” Setúbal said. “If an important banking institution in Mexico becomes available for sale, we will give that opportunity very careful study.”

Analysts have said that Itaú Unibanco would be a good fit for Mexico’s Banamex, the banking powerhouse owned by struggling Citigroup, even though the New York bank has denied intentions to sell its Mexican holdings. Setúbal is not interested in all of Citigroup’s discards, for example Citigroup’s stake in the credit card company, Redecard, where the U.S. bank and Itaú Unibanco are the controlling shareholders.

The Brazilian banks have their hands full right at home, although banks in South America’s largest country are not as freewheeling and leveraged as their U.S. counterparts, said Giles Conway, asset manager of Cogo Wolf, a San Francisco hedge fund.

“Itaú has a lot of growth to deal with locally and that will be enough to keep them busy,” Conway said. “They don’t need to expand in other markets.”

Brazil’s newest banking heavyweight faces a climate of severe economic slowdown, with both consumers and companies wary about taking on new loans.

As world financial markets shudder, not a month passes without the Brazilian Central Bank’s weekly survey of local bank economists lowering the forecast for 2009 economic expansion. After the economy expanded at a rate of 5.5 percent in 2008, the economic performance is now estimated to go no higher than 1.5 percent in 2009.

The first financial report confirmed the dour climate for the bank.

Itaú Unibanco reported in February that higher provisions for bad debts had caused profits to fall by some 8 percent, declining from US$3.5 billion in 2007 to US$3.2 billion in 2008. The bank also conceded that 2009 would be a tough year and that credit expansion would fall from 30 percent to less than 15 percent this year.

MERGER JOINS TWO TITANS OF BRAZILIAN FINANCE

The corporate marriage brings together two of Brazil’s most established financial groups, forged by financiers who moved seamlessly between business and government circles as Brazil was developing into the region’s largest economy.

Itaú traces its roots to an insurance company founded by Roberto Setúbal’s great-uncle in the 1920s. Setúbal’s father Olavo Setúbal, who died in 2008 at the age of 85, helped build Itaú into one of the country’s largest banks and at one time was tapped to serve as Brazil’s foreign minister.

Moreira’s grandfather, João Moreira Salles, founded his own banking house in the state of Minas Gerais in 1926. His father, Walter Moreira Salles, made the bank into one of the country’s top three banks and served as the country’s finance minister and ambassador to Washington before retiring in 1991, a decade before his death at age 88.

The similarities between the two powerful bankers continue. Long-time friends in the cozy world of Brazilian banking, both studied at California universities and both of them took the helm of the family banking business. Still, the slender Setúbal, 53, who received his masters in science engineering from Stanford, marks a physical contrast to the boyish-faced Moreira, 49, who studied history and economics as an undergraduate at the University of California, Los Angeles.

When the Itaú and Unibanco merger talks began in early 2008, an investment grade rating was right around the corner for Brazil and the Bovespa stock market was heading toward 70,000 points. The ratings agencies bestowed the investment grade in April 2008, but a year later, the stock exchange was around 44,000.

The timing of the deal is key. Moreira has explained the urgency behind the merger came once Spanish bank Santander took over Banco Real Brasil as part of the acquisition and dismemberment of ABN Amro by a consortium of European banks. Santander combined its existing Banco Santander Brasil with Banco Real Brasil to make a new bank with a total of US$150 billion in assets and announced plans to invest US$1 billion in the South American country. For the first time, Brazil had a major international player expanding on its turf.

The banks should finish their integration within two to three years.

By then, rival government powerhouse Banco do Brasil could retake the lead in terms of its credit position. In mid-February, the state-run Banco do Brasil said it was in talks with Banestes, a government-owned bank in Espirito Santo state with around R$9.2 billion in assets. Banco do Brasil has been on its own shopping spree, recently acquiring Nossa Caixa, the government-run institution in the state of São Paulo, and a 49.9 percent stake in the private bank, Banco Votorantim in January.

These banks are small when compared to the Unibanco acquisition, but Banco do Brasil’s credit portfolio is seen expanding more vigorously than its private rivals, according to market estimates.

“Our credit portfolios are growing because we have a strong presence in export credit markets and also cash flow lending services,” said Antônio Francisco de Lima Neto, chief executive of Banco do Brasil. “This strategy worked, especially for companies that needed short-term financing and found markets closed or too costly.”

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