April 28 (Bloomberg) -- As the U.S. Federal Reserve struggled on March 14 to prop up Bear Stearns Cos., Banco Santander SA Chairman Emilio Botin was at a news conference in Brazil with soccer legend Pele.

Botin greeted his audience in Portuguese with ``Bom dia'' and then reverted to Spanish as he joked about challenging the three- time World Cup champion on the soccer field and boasted about Santander's rise as Spain's largest bank by assets and Europe's second largest by market value.

``We've done it little by little, match by match,'' said Botin, who sported a red Santander jacket. ``That's how we've gone from being a small, local bank in Spain to become a global financial group.''

Pele, 67, who was hired to promote the bank's sponsorship of the Copa Libertadores soccer tournament, put on a matching coat and said he was happy to take on the ``God-given'' responsibility to help make Santander No. 1.

Botin, 73, patriarch of a family that has helped run the bank for 113 years, has reason to be in good humor. Financial institutions from London to New York, to Zurich are wrestling with credit losses and asset writedowns that totaled $309 billion as of April 25. Not Santander. It has prospered by minimizing investment banking, shunning newfangled financial instruments and sticking to the basics: taking deposits and making loans.

Santander, named for the northern port city where it started, earned a record 9.06 billion euros ($14.32 billion) in 2007. Per- share earnings will grow this year and next an average of 15 percent, Chief Executive Officer Alfredo Saenz said at an investors conference in London on April 2.

`A Clear Winner'

Santander may say tomorrow first-quarter profit climbed 20 percent to 2.16 billion euros ($3.38 billion) from a year ago, according to the median forecast of 18 analysts. Analysts including Javier Bernat of Caja Madrid said the bank may include a one-time net gain of 605 million euros from a real-estate sale.

``In this market environment, Santander is a clear winner,'' says Inigo Lecubarri, manager of the $250 million Abaco Financials Fund in London. ``They're a retail bank, and they don't have the toxic waste material that has done so much damage elsewhere.''

Whether Santander can continue to score will depend on its ability to manage higher funding costs and loan defaults because of slumping real estate markets and slowing economies at home and abroad.

Growth in Spain will fall this year to 1.8 percent, less than half the pace in 2007, according to the International Monetary Fund. Santander's fourth-quarter profit dropped 6 percent after a 737 million euro writedown in the value of its investment in Philadelphia- based Sovereign Bancorp, the bank said in February.

And there may be trouble on the horizon in the U.K., where home prices fell 2.5 percent in March, the biggest monthly drop since 1992, according to Edinburgh-based HBOS Plc, the country's largest mortgage lender.

Not a Happy Place

``The U.K. is not going to be a happy place to be for the next year to 18 months, and I suspect the same is true in Spain,'' says Andrew Lynch, who manages $3.5 billion at Schroder Investment Management Ltd. in London. ``These are head winds that even the best- run banks are not going to be able to ignore,'' says Lynch, who sold his Santander shares a year ago.

There also are challenges in Latin America, where Santander earned 32 percent of its 2007 profit. After last year's $15 billion purchase of Sao Paulo-based Banco ABN Amro Real SA, it must avoid alienating customers as it integrates the acquisition with its existing operations and attempts to match the profitability of Brazilian rivals such as Banco Itau Holding Financeira SA, the country's third-biggest publicly traded bank by assets.

`They've Stretched Themselves'

``Their record in Brazil hasn't been perfect,'' says Mauro Guillen, a professor at the Wharton School of the University of Pennsylvania in Philadelphia. ``Santander has been trying to hit a lot of targets at once, and at times, they've stretched themselves,'' says Guillen, who's co-author of a history of Banco Santander that was published in Spain last year and will be available in June in an updated English version called Building a Global Bank from Princeton University Press.

The absence of a clear successor to Botin is another concern for some investors. His eldest child, Ana Patricia Botin, is given the nod by many. At 47, she's chairman of Madrid-based Banco Espanol de Credito SA, or Banesto, the retail bank that's majority owned by Santander.

``The daughter has obviously been groomed,'' says John Yakas, a fund manager at HIM Capital Ltd. in London with $120 million under management. ``She is a candidate to take over whether she's a family member or not, and perhaps it should be her.''

The family controls Santander through force of personality and a power base that exceeds its 2.5 percent stake, and some investors question whether the bank can continue to operate as a family run enterprise.

`More-Dispersed Ownership'

``Over the long term, Santander will need to look at forms of governance that are more appropriate to more-dispersed ownership,'' says John Wilcox, a consultant who was formerly head of corporate governance at New York-based TIAA-CREF, the nonprofit firm that manages $435 billion for teachers and academic researchers. Neither Botin would comment for this article.

The institution the Botins built was founded in 1857 as a bank to service trade from Santander, a port on Spain's Cantabrian coast, as the region embarked on an industrial boom spurred by mining and the railroad. Rafael Botin Aguirre, brother of Emilio's great-grandfather, became the first family member with a management role at the bank when he was named a managing director in 1895.

Emilio Botin-Sanz de Sautuola y Garcia de los Rios, the third in his family to hold the Santander chairmanship, joined the bank in 1958 at age 24 and spent almost three decades under the tutelage of his father, also called Emilio.

Low-Level Manager

He started as a low-level manager in the bank's oldest branch in Santander, where he needed a superior to sign off on his approvals of customer applications for loans and new accounts. He became chairman in 1986 when his father stepped down from the post after 36 years. The elder Botin died in 1993 at age 90.

Botin helped build Santander, the country's sixth-largest bank in 1985, into its biggest lender with the purchase of Banesto in 1994. He also guided an international expansion that has cost the bank more than $60 billion. After a wave of acquisitions in Latin America in the 1990s, including Banco Osorno y La Union in Chile in 1996, Santander bought Banco do Estado de Sao Paulo SA, or Banespa, for $4.7 billion in 2001.

Santander's international expansion continued with the acquisitions of Abbey National Plc, the third-biggest U.K. mortgage lender, for $16.9 billion in 2004 and Banco Real in Brazil last year. The Brazilian purchase was part of a breakup of Amsterdam- based ABN Amro Holding NV by a group led by Royal Bank of Scotland Group Plc. When fully consolidated in the second half of this year, the acquisition will place Santander among the top three nongovernment- owned banks in Brazil by assets and add 1,100 branches, according to Brazilian central bank data.

Suburban Office Park

Santander, which operates from an office park in a Madrid suburb, has weathered the drop in financial shares better than many companies. Its stock fell 8.5 percent this year to 13.54 euros on April 25, about 5 percentage points less than the 13.7 percent plunge in the 60-stock Bloomberg Europe Banks and Financial Services Index. While Santander is Europe's 10th-biggest bank by assets, its $132.4 billion market value is second only to London-based HSBC Holdings Plc's $202.4 billion. That shows investors value Santander's focus on retail banking, says Guy de Blonay, a director at London-based New Star Asset Management Group Plc, which manages $1.2 billion in financial stocks.

The secret of Santander's success has been a single-minded focus on plain-vanilla banking.

``We've always been a commercial bank because it's the kind of business we understand,'' CEO Saenz says during an interview in a meeting room overlooking the 18-hole golf course on the bank's corporate campus in Boadilla del Monte. ``Definitely one of the businesses we don't want to be in is investment banking,'' he says.

Consumer Banking Dominates

Retail banking accounted for 80 percent of Santander's 10.9 billion euro pretax profit in 2007; investment banking contributed about 1.6 percent, according to a Santander official.

Sticking to basic banking has enabled Santander to sidestep financial land mines that have jolted competitors such as Citigroup Inc., the biggest U.S. bank by assets, and UBS AG, Switzerland's largest, that got caught up in the collapse of the U.S. subprime mortgage market.

Losses and writedowns wiped out about half the stock market value of those two banks during the past 12 months and cost the jobs of Citigroup CEO Charles ``Chuck'' Prince, 58, and UBS CEO Peter Wuffli, 50.

Former Citigroup Co-CEO John Reed, one of the architects of the 1998 merger of Citicorp and Travelers Group Inc. that created the banking giant, said in an interview with the Financial Times that the deal was a mistake, the newspaper reported on April 4. Former UBS President Luqman Arnold has called for a breakup of the Swiss bank.

Dodging Subprime Losses

Santander, whose shares rose 0.2 percent during the 12 months through April 25, suffered no impact from losses associated with the U.S. subprime collapse, Saenz says. While structured products such as collateralized debt obligations have caused losses at many banks, they may account for 1 percent of assets at Santander, he says.

``Nothing, negligible,'' he says. ``Maybe we weren't 'clever' enough to deal with that.'' CDOs are securities that repackage assets such as mortgage bonds and buyout loans.

Santander's rapid growth -- profit quadrupled from 2002 to '07 -- has been rooted in a booming Spanish economy. As a result, the bank hasn't been under the same pressure as some other European banks to accelerate earnings growth, Daragh Quinn, an analyst in London at New York-based Lehman Brothers Holdings Inc., says.

Bank of Spain's Role

It also benefited from Bank of Spain regulations that effectively prevented banks from having off-the-books structured investment vehicles. SIVs use short- and medium-term borrowings to buy high-yield securities. Competitors such as Citigroup and HSBC have agreed to finance SIVs with assets totaling about $150 billion, taking on the risk of losses on the SIVs' holdings.

``It's more a tick in the box for the regulator than for the banks,'' Quinn says. ``If they'd been allowed to do it, they would have done it more.''

Santander also may have learned a lesson in the 1990s when Ana Patricia Botin built up investment banking as she led the company's expansion into Latin America, says Peter Braendle, a fund manager who helps manage about $60 billion at Swisscanto Asset Management AG in Zurich.

By 1997, her Santander Investment had a staff of 1,980 people and accounted for 9 percent of Santander's personnel costs, according to the bank's annual report for that year. In September 1998, the unit shed 300 jobs as it was buffeted by turmoil in Asian and Russian markets.

`A Learning Experience'

``They had an emerging-markets presence in Latin America and a large research operation, and the idea was to bolt on an Asian business on the cheap,'' says Christopher Wood, a stock market strategist who worked at Santander Investment in 1998 after it bought a regional equities team from Hong Kong's Peregrine Investments Holding.

``Russia blew up that summer, the crisis gathered,'' says Wood, who's now at CLSA Asia-Pacific Markets in Hong Kong. ``It was all under the daughter. I think it was a learning experience for them, and they're better off in just retail.''

Santander revolutionized consumer banking in Spain, introducing the country's first interest-paying checking account in 1989, eliminating account fees and improving efficiency with technology.

Enrique Candelas, head of Santander's branch network in the country, says Emilio Botin took just two minutes to approve his plan to eliminate account fees for 2.4 million customers that generated annual revenue of 83 million euros. Candelas, 54, says he proposed the change during a flight on Santander's private jet between Barcelona and Madrid in July 2005.

`Riskiest Decision'

``I said something like it was going to be the riskiest decision for me in my whole professional life,'' he says in an interview in his offices in a 19th-century mansion in downtown Madrid.

The plan was partly defensive. Santander had to do something to stem an exodus of customers caused by its decision to close 1,600 branches in the wake of its $12.6 billion acquisition of Banco Central Hispano in 1999.

``We realized we'd made a mistake, that we'd closed too many branches,'' Candelas says.

The no-fee campaign was a sign that Santander had lost steam in Spain, says Diego Barron, an analyst in Madrid for Brussels-based Fortis, Belgium's biggest financial services company.

``They were very aggressive, but maybe they had to be because the business was losing momentum,'' he says.

The Strategy Worked

Whatever the motivation, the strategy worked. The number of customers under the no-fee plan has since risen to almost 4 million, helping the bank lock in 1 million new Spanish clients who have their salaries paid into Santander accounts, generating new revenue with products such as credit cards or pension plans.

No other branch-based bank except Bancaja -- a Valencia-based savings bank formally known as Caja de Ahorros de Valencia, Castellon y Alicante that has a third of Santander's and Banesto's 4,950 Spanish branches -- has followed suit, Candelas says.

Technology explains 60 percent of Santander's success in meeting profit targets through improved efficiency, Saenz says. At a Banesto branch in Madrid, manager Silvia Gomez examines a computer printout listing clients who are behind on loan payments, including seven customers who have gone into default that day. It also lists longer-term debtors, including a construction company that's been behind on a 92,000 euro payment for 17 days.

The information comes from Partenon, a computer system developed by Santander that helps branch staff monitor account use and sell additional products by identifying potential customers. The branch can lose bonus payments and privileges to award loans if it exceeds limits on customers in default, Gomez says.

``This is an important tool,'' she says.

Rising Household Debt

It may come in handy as Santander works to maintain its profitability in the face of the slowing Spanish economy. Household debt has soared, climbing to 130 percent of income at the end of 2007, almost 40 percentage points more than in 2004, according to the Bank of Spain.

That makes it hard to predict the risk of loan defaults as unemployment mounts, Gilles Moec, a London-based senior economist for Europe at Bank of America Corp., says. Defaults as a proportion of loans in Spain's banking system reached 1.04 percent in January, the highest level since 2002, according to the Bank of Spain.

``The problem when I look at the financial system in Spain is that I don't see any precedent for this level of leverage,'' Moec says.

Santander views the slowdown in Spain as an opportunity to build market share and increase profit.

`A Stupendous Moment'

``It's a stupendous moment for transferring to the customer the cost of financing,'' Candelas says.

Loan losses won't be a problem, he says. Defaults as a proportion of lending at Santander's Spanish retail bank reached 0.65 percent as of the end of 2007, up from 0.57 percent in 2006. Default rates for banks in other European countries such as Germany and Italy are about five times those in Spain, the Bank of Spain said in an April 2 report.

To really cause trouble, house prices would have to drop at least 40 percent and interest rates rise to 7 percent from 4 percent, Candelas says.

``We don't see great risks for our bank in Spain,'' he says.

Brazil will be a different kind of challenge. Operations in Latin America's largest economy eventually will generate as much as 30 percent of Santander's profit, Saenz says. That would put Brazil, which contributed 11 percent of the bank's profit in 2007, on a par with retail banking in Spain.

Improving profitability will be essential. Santander's return on equity in Brazil was less than 20 percent in 2007, says Luis Miguel Santacreu, an analyst at Austin Rating Servicos Financeiros Ltda., a Sao Paulo-based credit rating company. That compared with 29 percent for Banco Itau.

Service May Suffer

Closing the gap will require integrating information technology, and customer service may suffer initially. That's what happened at Abbey National in the U.K. as Santander rolled out new banking systems and cut 6,000 jobs.

``If you want to do that in a relatively short period of time, you are paying a price in customer service,'' Saenz says about the experience at Abbey. ``During the integration, Brazil could suffer more or less the same kind of measles.''

Among the 10 banks in Brazil with at least 1 million customers, Santander received either the highest or the second- highest number of complaints in 10 of the past 12 monthly surveys by the Brazilian central bank. Rita Berlofa, a Santander employee who represents the bank's staff as a director of the Sao Paulo Bank Workers' Union, says 150 people have been fired and 154 have quit in the first two months of this year. That compares with 91 dismissals and 75 resignations a year earlier.

``We interview people as they leave, and there is a problem at Santander,'' she says.

`Badly Timed'

Santander is still assessing its role in the U.S., where the bank spent $2.9 billion in 2005 and '06 to buy 24.9 percent of Sovereign, Saenz says. Sovereign's share price had plunged 70 percent as of April 25 from the average price of $24.83 that Santander paid.

``They did some empire building with Sovereign that was badly timed,'' Lehman's Quinn says. ``It's still not clear the Spanish model works there,'' he says. While Saenz says Santander's model can work in the U.S., he says it's too early to say whether it will buy Sovereign outright.

Whatever is eventually decided, Emilio Botin gets high marks for his willingness to expand the bank's geographical horizons. Profit has increased almost 70-fold during his 22-year chairmanship, while the customer base has surged to 69 million from 750,000.

``I consider him to be a great banker,'' says Pedro Luis Uriarte, 65, a former competitor who served as CEO of Banco Bilbao Vizcaya Argentaria SA, Spain's second-biggest bank, from 1994 to 2001. ``His clear vision for Santander and pragmatism set him apart.''

Board Member at 28

Family precedent suggests Ana Patricia Botin is the front-runner to succeed her father when he eventually steps aside, Wharton's Guillen says. After earning an economics degree at Bryn Mawr College in Pennsylvania in 1981, she worked for New York-based J.P. Morgan & Co. -- a predecessor of JPMorgan Chase & Co. -- rising to vice president in the Latin American division.

She moved to Santander in 1988 and became head of international capital markets and a board member a year later, at age 28. She was named head of investment banking in 1991 and chairman of Banesto in 2002.

Saenz, born in the Basque Country, is another candidate. He joined the board in 1994 after being appointed to run Banesto when it was taken over by the Bank of Spain and sold to Santander and became Santander's CEO in 2002.

Juan Rodriguez Inciarte, the bank's strategic planner, is also a possibility, Guillen says. Inciarte is an economics graduate from Madrid's Autonomous University and a 23-year veteran of the bank. An equestrian and golf fan, his mobile phone has a bagpipe ring tone, the legacy of his stint as a board member of Royal Bank of Scotland.

Whoever gets the job will probably have to wait. Botin shows no sign of slowing down. His own father didn't retire until he was 83 -- 10 years older than his son is now.

To contact the reporter on this story: Charles Penty in Madrid at cpenty@bloomberg.net

Last Updated: April 27, 2008 19:01 EDT