Santander Banks on Brazil

As the largest bank in the 16-member euro zone, Spain's Banco Santander (STD) has fared pretty well during the recession. Tough domestic regulation forced the Madrid-based giant to steer clear of toxic financial assets, and the bank mostly avoided excess lending to Spain's suffering real estate sector. Now, just when rivals in the U.S. and Europe are curtailing spending, Santander has reinforced its expansion plans.

Central to the strategy is Brazil. Once the sleeping giant of Latin America, Brazil, under the guidance of charismatic President Luiz Inácio Lula da Silva, has become an economic powerhouse. According to official statistics, the country's gross domestic product grew 1.9% in the second quarter of the year, even as many other economies around the world were shrinking. Citigroup (C) figures Brazil's GDP will rise roughly 5% next year.

Santander is preparing to take full advantage. Already the No. 3 non-state-owned bank in Brazil behind Itau Unibanco (ITUB) and Banco Bradesco (BBD), the Spanish company raised an eye-popping $7 billion to fund expansion there by selling a minority stake in its Brazilian business. Additional shares set to be sold this month will take the total raised to $8.1 billion—the largest public offering in the world so far this year.

Commercial Banking PushThe money will be put to good use. Santander aims to reinforce its own capital reserves, expand its local branch network in Brazil by one-third by 2013, and jump-start lending in the country's growing but still underserved commercial-banking sector. "Santander's move into Brazil has been smart and well-thought-out," says Robert Tornabel, a banking professor and former dean of ESADE business school in Barcelona. "It's a fast-growing economy that's becoming an important part of the bank's profitability."

Indeed, Brazil accounted for more than one-fifth of Santander's €4.5 billion ($6.8 billion) in "attributable profit," or net minus capital gains, in the first half of this year. (Attributable profit is the only earnings measure for which the bank provides a breakdown by country.) That's up from just 11% for the same period in 2008. Analysts say the change is due primarily to the consolidation of Brazil's Banco Real, which Santander bought for $16 billion in 2007 as part of the ill-fated takeover and carve-up of Dutch financial giant ABN Amro by Santander, Royal Bank of Scotland (RBS), and Fortis (FOR.AS).

While RBS and Fortis have struggled ever since, Santander's gamble paid off handsomely. Its expanded footprint in Brazil helped offset the bank's slowing operations in other regions—particularly Spain and Britain—during the worst of the downturn. Lending in Brazil, for instance, jumped 16% during the first half of 2009, compared with just 1% in Spain over the same period. Attributable profits from Brazil in the first half reached €961 million ($1.4 billion), up 12% from a year earlier.

Untapped MarketAnalysts say even greater upside is still to come. According to Citigroup figures, the ratio of loans to GDP in Brazil—a key indicator of banking-sector maturity—now stands at just 40%, about half that of regional rival Chile. And Brazil's ratio of retail deposits to GDP is comparable to that of Colombia, which is both smaller and poorer. Santander Chairman Emilio Botín thus clearly has a big opportunity to bring more of Brazil's 190 million citizens into the banking sector.

"Brazil remains a pretty untapped retail market, and that's where Santander has strengths," says Xavier Vives, a professor of economics at IESE Business School in Barcelona.

The bank's strategy is already taking hold. Since rising to prominence in its home market during the 1980s, Santander has combined aggressive cost-cutting—especially through the use of proprietary back-office software—with proactive cross-selling of financial products to customers. The bank is following a similar path in Brazil: Operating expenses over the first half of the year, for instance, fell more than 3% compared with the same period last year even as revenues grew. And the efficiency ratio of its Brazilian branches, based on expenses vs. total revenues, improved by seven percentage points year over year, falling to 37.9%, one of the lowest ratios for any bank in Brazil.

The opening of 600 new branches over the next four years also will help sell more products, such as mortgages and credit cards, to Brazil's increasing affluent middle class. Tellingly, Santander has focused its expansion in the South American country's southeast region, particularly around São Paulo, where per capita GDP is almost double that of the country's north.

Tough CompetitionStill, Santander's Brazilian ambitious plan isn't a sure thing. Both domestic and international banks are falling over themselves to tap the country's booming economy. That's particularly true for state-owned Banco do Brasil, which remains the country's largest bank and is aggressively diversifying its financial products, particularly into insurance.

And while Brazil and, to a lesser extent, Santander's recent foray into the U.S. represent the bank's main growth prospects, a rising number of nonperforming loans in Spain still could hit the bank's profitability. Santander says it has sufficient capital to weather further financial problems.

To succeed in Brazil, the Spaniards will draw on their previous experience of expanding successfully into other South American countries and across Europe during the past 15 years. And by tapping investors for $8.1 billion, Botín & Co. will find themselves in a strong position in one of the world's fastest-growing financial markets. It's no wonder, then, that Santander is widely viewed as among the biggest winners to emerge from the Great Recession.

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