A Best Buy in Brazilian Banking

Erik Kobayashi-Solomon: Hi, I'm Erik Kobayashi-Solomon , one of the co-editors of the Morningstar's OptionInvestor. Today it's my great pleasure to welcome Maclovio Pina, who is senior analyst in charge of foreign and regional banks here at Morningstar.

Mac, thanks for coming.

Maclovio Pina: Thank you very much for inviting me.

Kobayashi-Solomon: So, just recently, I wrote an article for OptionInvestor that dealt with Banco Santander Brasil, one of the companies you cover, and when I wrote this article, European sovereign debt was melting down. It seemed crazy that I would be recommending a bullish play in a bank that has some relationship to the European banking.

Now Banco Santander Brasil, it's parent bank is a Spanish bank. How worried are you about the European credit problems and how much effect do you think they would actually have on Banco Santander Brasil.

Pina: Well, I mean I definitely think that there is an issue with Europe sovereign debt crisis. That said, I'm not too worried about its impacts on as a liquidity crisis with Banco Santander Brasil. So 80% of it is owned by Banco Santander in Spain, the financial company. And so they essentially have voting control about anything that goes on in Santander Brasil.

However, Santander Brasil is a distinct company. They have like their own capital allocations. They are concentrated in Brazil and its run as a standalone company. So I'm not too worried about Santander doing something outrageous. If anything and the company, the Spanish company, needs some capital, what it will do it will just sell part of its stake, not necessarily a dilutive issuance, but just sell part of the 80% it has in the open market and perhaps that will help it raise its capital.

Kobayashi-Solomon: And I think Santander has also has stakes in banks, other banks throughout the world, right. And so it's not like Banco Santander [Brasil] is Santander's piggybank and they are just going to break that piggybank for….

Pina: As you say, they do have operations elsewhere in the Western Hemisphere mostly. They have operations in U.K. and another may be--not as spectacular growth economies like Germany right now, but they do have a subsidiary in Chile, they do have a subsidiary in Mexico and elsewhere in Latin America. So, they do have like a vast diverse network from where to sell a part of those (places).

Kobayashi-Solomon: So, the European sovereign problems might be something, but you're not so concerned about that. That's the point that I made in the article as well. So to me, the real crux of Banco Santander Brasil is a bet on the Brazilian economy, can you just go through and explain a little bit about the tailwinds that are behind the Brazilian economy right now.

Pina: It is a still growing economy. It's GDP is expected to grow, not as spectacular as before, but still at around 3.5% to 4% this year by some estimates and then staying at somewhere around 4.5% in the next couple of years. Then it has some – and just to capture that growth banks do a fantastic job of doing that because they are the ones that the economy goes to for a capital.

Kobayashi-Solomon: If the economy prospers, the banks is going to prosper.

Pina: The banks do. And also you have like two very important events happening in the short amount of time. You have the Summer Olympics in 2016 and the World Cup in 2014. So these are two…

Kobayashi-Solomon: The World Cup is soccer right, for our American viewers.

Pina: It's soccer. So these are two events that require very vast amount of capital injection and then that will definitely I think filter through the economy and in turn benefit the banks.

Kobayashi-Solomon: These are some of the tailwinds to Brazil and two BSBR. What are some of the headwinds that are facing it? Are you worried about let's say the low reserve levels that Banco Santander Brasil has? What do you think are kind of main weak points?

Pina: In contrast, with its larger peers, Itau and Bradesco, the other big Brazilian banks that are not government controlled. As you say, Banco Santander Brasil's reserves are lower than them, but they're still adequate. I mean, it's not something that we foresee that they will have to make huge provisions and thus go into red numbers for several quarters.

I don't think that will be the case, but it's just the fact that relatively they are lower. So once recently we saw that credit quality falter a little bit across the whole Brazilian economy, so that would be one of the headwinds facing not just Santander Brasil, but all the system.

Kobayashi-Solomon: But even though they don't have as large a reserve as another bank, they do have plenty of capital right? I mean, they are hugely overcapitalized.

Pina: Right. So even in the event that they would have to a tremendous amount of reserves, they have about twice as much capital than their peers measured by equity to assets or by Tier 1 capital ratios. They are very, very, very well capitalized. So, even in any event, in any crisis event, they would still be in, if anything, ahead of its peers because of this.

Kobayashi-Solomon: So just to summarize, they've got the tailwinds of the Brazilian economy, which seems to be growing at a very nice clip and the headwind doesn't seem to be that serious. In other words, they are very well capitalized. They may have a bit of let's say reserves that they need to take, but…

Pina: That is correct. The only thing I would add about the headwinds and as I was saying this affects all the system is there are inflation threats in Brazil, and eventually what that does to interest rates and economic growth or real economic growth, but as I say it is a threat to the whole system.

So, overall, as an individual company, I think Santander Brasil is well positioned.

Kobayashi-Solomon: It sure sounds like an interesting story to me. Thanks for coming in, Mac.

Pina: Thank you.

Kobayashi-Solomon: And thank you for joining us. Please stop by the OptionInvestor website where you will see many more great ideas based on Morningstar's fundamental research.