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BRAZIL - Tale of Two Bankers

One caters to Brazil’s working class, the other to blue chips and the affluent. Both represent the bold future of Brazilian banking.

Roberto Setúbal and Márcio Cypriano come from very different worlds. Cypriano, the hardworking son of a police captain, has spent a 40-year career climbing his way to the top of Banco Bradesco, the country’s mass-market champion and largest lender by market capitalization. The patrician Setúbal is a scion of Brazil’s preeminent banking family and a member of the third generation to run Banco Itaú Holding Financiera, the country’s No. 2 player. But notwithstanding the sharp contrast in their personalities and backgrounds, each represents the future of Brazilian banking.

Taking a page from the playbooks of the likes of Citigroup and Deutsche Bank, Setúbal is seeking to build Itaú into Latin America’s universal banking champion. The bank is pushing an increasingly sophisticated menu of banking and investment products to Brazil’s middle and upper classes, offering loans and investment banking services to the country’s fast-growing ranks of globally minded companies and looking to extend its presence into neighboring markets. “We believe we can expand as a retail bank in Latin America and become the leading regional bank,” the CEO tells Institutional Investor.

By contrast, Cypriano is sticking close to Bradesco’s blue-collar, small-business roots. The bank boasts the largest retail network in the country, with some 20,500 outlets, ranging from full-service branches to banking windows at post offices. It is leveraging that network to drive the growth of everything from bill-paying services and small-consumer and business loans to insurance — Bradesco is Brazil’s leading insurance provider, with a 25 percent market share. “Clearly, they are very different banks with different philosophies that have been equally successful,” says Antônio Delfim Netto, the former Finance minister who presided over the economic boom of the late 1960s and early ’70s under a military dictatorship.

Although the strategies are vastly different, the results at both institutions have been remarkably similar. Last year Itaú boosted its net income, excluding extraordinary items, by 15.9 percent, to 7.18 billion reais ($4 billion); consumer lending led the way with a 34.8 percent increase, paced by strong growth in credit cards and auto loans. Bradesco, meanwhile, posted a 13.3 percent rise in earnings, to R$7.21 billion.

In terms of market capitalization, Bradesco ranks 17th among the world’s banks, and Itaú is 20th. At a time when the share prices of global banks have been hammered by concerns about the worsening credit crisis, the Brazilians have benefited from strong performance at home and a continued appetite from international investors. Bradesco’s share price climbed 6.77 percent over the past 12 months, to R$44.13 on March 26, giving the bank a market value of R$101.8 billion, or $58.4 billion; Itaú’s shares rose 9.48 percent over the same period, to R$41, giving it a value of R$98.6 billion, or $56.6 billion. By contrast, Citigroup’s market cap has plummeted from $260 billion to $118 billion.

Thus far, says Mario Pierry, a New York–based banking analyst for Deutsche Bank, “the Brazilian banks have come out of the global financial crisis unscathed.” Unlike U.S. and European financial institutions, says Setúbal, “Brazilian banks haven’t been affected at all by the subprime crisis — we have no assets in that business.” Moreover, Brazilian banks enjoy high liquidity, a good funding profile (with less than 10 percent of revenues and profits coming from abroad) and continued prospects of high lending growth. This rosy scenario could change if global prices for Brazilian minerals and agricultural commodities — key factors in the country’s recent GDP growth — fall because of a worldwide recession. But for now Brazil’s banks are strong on all fronts. Itaú and Bradesco have BBB– ratings from Standard & Poor’s — higher than the BB+ rating it gives to Brazil.

With profits rising and new opportunities opening up at home and abroad, Itaú and Bradesco are reacting very much in character. At the more inward-looking Bradesco, the global crisis means there is less reason to worry that foreign competitors are looming on the Brazilian banking horizon and more reason to focus on lucrative domestic markets. The strong performance explains why Setúbal and Cypriano are relaxed about the biggest acquisition in Brazil’s history: the purchase of Banco Real by Spain’s Grupo Santander as part of the record-breaking €71.4 billion ($105 billion) buyout of ABN Amro last year. The combination of Real with Santander’s small existing Brazilian operation will create the country’s third-largest private sector lender by branches and loan volume and a powerful rival to Brazil’s financial heavyweights — state-owned Banco do Brasil, Itaú and Bradesco.

“This is the most important event in the Brazilian financial market in the past decade,” acknowledges Setúbal. “But it will be two years or so before it becomes a fully integrated, operational bank.” Cypriano contends that Santander-Real will have its hands full trying to maintain the combined market share of its two franchises against inroads by Bradesco, Itaú and other players. “We have plenty of time to take the measures necessary to continue growing,” says the Bradesco CEO. He is keeping his focus squarely on the domestic market, which he believes offers the best opportunities for continued expansion, and will consider opportunities beyond Brazil’s borders only where they support its key market. Bradesco’s foreign presence is largely confined to wholesale banking and includes ten offices that help finance trade for large Brazilian corporate clients. ‘‘We will not become involved in retail business abroad,” says Cypriano.

Many analysts agree that the two domestic banking leaders are more than ready to meet the competitive challenge posed by Santander. “There is no reason for Bradesco or Itaú to be nervous about the Santander acquisition or to change their strategies because of it,” says Tamara Berenholc, a São Paulo–based credit analyst for S&P.

Setúbal and Cypriano are at the forefront of a transformation that has turned Brazil’s banking sector from a poorly capitalized, crisis-prone backwater into one of the most dynamic and profitable financial sectors among the world’s emerging-markets economies. The banks spent much of the 1980s and ’90s struggling to cope with hyperinflation and emerged stronger for the challenge. Today fiscal and monetary policies have slashed inflation to the single digits, and record commodities prices are fueling a surge in growth. Brazil’s banks are taking advantage of the new prosperity by expanding their networks and feeding the burgeoning demand for credit.

Bradesco and Itaú were historically protected from foreign competition. A constitutional amendment in 1988 allowed foreigners to purchase Brazilian banks, but the market didn’t truly open until the repeal of other protectionist measures in 1995. However, that didn’t lead to a victory lap by global banks. “Foreign banks always overestimated themselves and believed they were technically superior to us lowly natives,” says former Finance minister Delfim Netto.

The “natives” became adept bankers. Bradesco, Itaú and Unibanco, another major private sector bank, built nationwide branch networks and increasingly effective retail banking strategies. They were not intimidated by global giants that scored notable successes elsewhere in Latin America. For example, Citicorp’s $12.5 billion purchase of Grupo Financiero Banamex in 2001 instantly made it the second-largest bank in Mexico. But in Brazil, where it first opened a branch in 1915, Citibank ranks only tenth in total assets. Spanish-owned Santander is taking a more active role. In 2000 it bought Banespa, a major state-owned bank focused on the São Paulo region, for R$7.05 billion, and in October 2007 acquired Banco Real.

The new entity should flourish in the current golden age of growth under the center-left government of President Luiz Inácio Lula da Silva, which has continued the conservative macroeconomic policies of its center-right predecessor and seen the economy’s expansion accelerate to 5.4 percent last year from 3.8 percent in 2006.

Banking penetration — as measured by total loans to GDP — reached 35 percent in 2007, up from 29 percent only three years earlier. Brazil remains far behind Chile (75 percent) but well ahead of Mexico (20 percent). Over the past three years, loan portfolios expanded more than 20 percent annually as banks, led by Bradesco, descended the socioeconomic ladder in search of new clients.

Although Itaú and Bradesco have prospered in equal measure, their divergent strategies stem from very different heritages. “Bradesco was really born like a religious cult that preached hard work and savings,” says Delfim Netto. “Itaú was built by intellectuals with strong ties to urban industry and motivated by profit.”

Roberto Setúbal is the son of Itaú chairman Olavo Setúbal, whose family has always controlled the bank. At 53 the lanky Roberto, with slicked-back hair and a smartly tailored suit, is the very image of a progressive, sophisticated Brazilian banker. He can wax equally poetic about derivatives and U2 (whose concerts in Brazil he never fails to attend) and presides from a bright-green-tinted glass tower that overlooks the main runway of São Paulo’s Congonhas International Airport. His penthouse office is at the end of a corridor lined with a remarkable collection of Latin American paintings and sculptures, including works by Oscar Niemeyer and Roberto Burle Marx, Brazilians best known for their architecture and landscape design, respectively.

Like his father, Setúbal earned an engineering degree from the prestigious Escola Politécnica of the University of São Paulo. He went on to receive a master’s degree in engineering from Stanford University. Except for a yearlong stint in 1983 at Citicorp in New York, where he worked directly under soon-to-be-CEO John Reed in the consumer banking area, Setúbal has spent his career at Itaú, holding positions in the financial controls, products and sales areas, and then heading the bank’s commercial operations from 1984 to 1994. That year, at age 39, he was appointed president and CEO, taking over from two successive nonfamily chief executives who served after his father stepped aside as CEO in 1985.

Banco Itaú was founded in São Paulo in 1945 by Alfredo Egydio, Roberto’s grand-uncle, as the Banco Central de Crédito. Olavo’s father, Paulo Setúbal, was a well-known writer and intellectual, but his son preferred business and banking, and went to work for his uncle Alfredo. When Alfredo died in 1959, Olavo took over and began a string of acquisitions that by the mid-1970s made Itaú the second-largest private sector bank after Bradesco. By then Olavo had launched himself into politics, serving as São Paulo’s mayor from 1975 to 1979 and as Brazil’s foreign minister from 1985 to 1986. “Olavo Setúbal was a brilliant banker,” recalls Delfim Netto, the former Finance minister. “And Roberto is pretty good himself.”

Under Roberto, Itaú’s expansion continued, focused first on developing its domestic retail and corporate base, and then on establishing a presence abroad. In 1995 it purchased Crédit Lyonnais’s Brazilian unit, Banco Francês e Brasileiro, for R$500 million; two years later it bought state-owned Banerj in Rio de Janeiro for R$311 million. Abroad, Itaú acquired Bamerindus Luxembourg (now Banco Itaú Europa Luxembourg) in 1997 for R$10 million and Banco del Buen Ayre, a medium-size Argentinean retail bank now known as Banco Itaú Buen Ayre, in 1998 for $213.5 million.

Even more important acquisitions have followed at home and abroad that rocketed Itaú far ahead of Bradesco in investment banking and international operations. In December 2002, Itaú paid $930 million for Banco BBA Creditanstalt, at the time widely considered Brazil’s best corporate bank. Instantly the largest wholesale bank in the country, Banco Itaú BBA in 2005 made its most important move into investment banking by snatching a team of seasoned young executives from the Brazilian operation of Swiss bank UBS. “Before then we were strong in fixed income but not in equities,” says Candido Bracher, president and CEO of Itaú BBA. “With them aboard we have made the big leap forward.”

In 2006, in a stock swap worth $2.76 billion, Itaú purchased the Chilean, Uruguayan and Brazilian operations of Bank of America Corp.’s BankBoston, whose reputation rests on private banking. The deal gave BofA a 7.5 percent stake in Itaú and widened the Brazilian bank’s presence in the region. The operations in Argentina, Chile and Uruguay “are giving us experience and confidence,” says Setúbal. International operations account for less than 10 percent of total revenues and income, “but the trend is upward,” he adds, while declining to expand on any pending acquisitions abroad.

The best way to understand the image that Itaú wants to convey to retail clients is to visit its Personnalité Paulista branch in the posh Jardins neighborhood near downtown São Paulo. The Personnalité brand — the French word is meant to evoke a sense of chic — is reserved for upscale branches that operate somewhere between conventional retail and private banking. Drawing on the format of the Crédit Lyonnais subsidiary acquired by Itaú in 1995, Personnalité has more than 200 branches in the city, and Paulista is the largest.

Andressa Boé de Figuereido, the young deputy manager of the branch, sports a tan exposed by a sleeveless dress. On her desk is Personnalité’s new lifestyle magazine, with glossy stories on film stars, hot vacation spots and speedy cars. “Most of my clients are men,” says Figuereido, adding that the branch’s typical investor is a young professional. To open an account they must have a minimum monthly income of R$4,000; to use the branch’s brokerage services, they must invest at least R$1,000.

To get a client started with an investment, Figuereido seats him in front of a computer screen that mirrors her own and displays a speedometer on which financial products are rated in kilometers per hour. At lower speeds, between 5 and 10 kph, are fixed-interest, short-term CDs; at the other extreme, between 110 and 120 kph, are high-return, high-risk derivatives. The client uses a joystick to reach the desired velocity and investment. On the right side of the speedometer, the screen flashes with the expected return on each product and its risk. “I try to keep a client driving at about 60 kph,” says Figuereido. That corresponds to a portfolio with a roughly 50-50 mix of equities and corporate and government bonds.

Personnalité branches exude a private club atmosphere. There are no tellers behind counters. Clients and Itaú executives carry out transactions — brokerage, insurance, pensions, foreign currency exchange — in cubicles decorated in soothing tan and blue fabrics. Aside from a discreet row of ATMs at the entrance, there is nothing to indicate that this is a bank.

Itaú is the market leader in credit cards, automobile financing, corporate lending and investment banking — just the sort of high-growth, big-profit segments that have long endeared Setúbal to institutional investors. “Also, historically, Itaú was seen as much more geared toward delivering shareholder value and communicating that to analysts and investors,” says Victor Galliano, New York–based banking analyst for HSBC Securities.

Itaú is also the domestic leader in investment banking. For the past three years, Itaú BBA has been the third-largest equity underwriter in Brazil, behind UBS Pactual and Credit Suisse. In 2007, Itaú BBA was the book runner on 19 IPOs and follow-ons worth $11.5 billion — far ahead of the five deals worth $4.6 billion done by Bradesco BBI, the investment bank Bradesco started in 2006. Itaú BBA had a 2007 net income of R$1.14 billion, down from R$1.34 billion the year before.

The Brazilian equity underwriting market has grown explosively, from 36 deals that raised $6.9 billion in 2005 to 126 deals worth $38 billion last year. Itaú BBA was a joint book runner in two of the three largest IPOs in Brazil last year — the $3.3 billion offering for the Brazilian Mercantile & Futures Exchange (BM&F) and the $2.5 billion offering for credit card issuer Redecard, in which Itaú owns a 23.2 percent stake. But the deal that Itaú BBA executives consider their most noteworthy was the $1.1 billion IPO in December for MPX Energia, an energy company majority-owned by billionaire entrepreneur Eike Batista that plans to build thermoelectric plants. “We raised the capital even though the project won’t generate any cash flows for the next three years,” says Fábio Ferraz, Itaú BBA’s managing director of investment banking.

Itaú BBA has also made rapid inroads in Brazilian mergers and acquisitions, an activity still dominated by global banks. In 2005 it advised on seven deals worth $284 million, but by 2007 activity was up sharply, to 18 deals worth $7.5 billion. That year Itaú BBA ranked fifth compared with the global banks by overall value of total deals, trailing Credit Suisse, Citigroup, ABN Amro and UBS Pactual. It advised on the $1.58 billion sale of a minority stake in an iron ore mine owned by MMX to Anglo American and the $1.78 billion sale of a 65 percent stake in Serasa, the leading Brazilian credit bureau, to the U.K.’s Experian in June 2007.

At the other end of the spectrum, Bradesco is most comfortable courting blue-collar clients and small and medium-size enterprises. “Cidade de Deus” — City of God — is the name Bradesco has given its sprawling headquarters in Osasco, a barely middle-class suburb ten miles west of São Paulo. Etched above the employees’ entrance to the main, four-story, yellow-brick building is a huge slogan: “Only work can create wealth.” The boss, Cypriano, is the tall, square-jawed son of a career cop. He spends weekends at his small cattle spread a couple of hours’ drive inland from São Paulo.

Bradesco’s founder, Amador Aguiar, was a mixture of entrepreneur and evangelist. He preached his banking gospel to the humblest coffee plantation workers in his native state of São Paulo. A former traveling salesman, he launched Bradesco — calling it Banco Brasileiro de Descontos (Brazilian Discount Bank) — in 1943 in Marília, then a small agricultural town 275 miles northwest of the city of São Paulo. Within a year Aguiar opened six branches on the outskirts of plantations, targeting shopkeepers, public employees, small landowners and illiterate laborers who had never before had savings accounts or even dared walk into a bank.

Bradesco’s growth was explosive. By 1951 it had become the largest private sector bank in Brazil. It expanded organically and through 43 acquisitions — the latest, in October, was São Paulo–based Banco BMC, a specialist in payroll-deductible loans, purchased for R$800 million. Bradesco’s strength continues to be its small-town and rural presence through a nationwide network of 3,160 full-service branches; 11,539 Bradesco Expresso outlets, offering basic services such as bill and tax payments; and 5,821 Banco Postal units, operating out of post offices and offering savings and checking accounts, as well as small loans.

Many, if not most, Bradesco executives are small-town natives, or just a generation removed from the Brazilian hinterlands. CEO Cypriano, 64, though born in the city of São Paulo, grew up in northern São Paulo state. After graduating with a law degree from Universidade Presbiteriana Mackenzie — not one of the more illustrious Brazilian universities — he began his career in 1967 as an employee at the Banco da Bahia in northeastern Brazil. When that bank was acquired by Bradesco in 1973, Cypriano was named branch manager. He was so eager to impress his new employers that on weekends he and his wife personally cleaned the office and scrubbed the sidewalk to prepare for clients on Mondays.

Rising steadily through the ranks, Cypriano became chief executive in 1999 and will retire by November 2009, before he turns 66. There is no mystery about possible successors. Bradesco prides itself in offering lifetime employment and staffing its top positions with careerists. “We have eight vice presidents, and any one of them could take charge,” says Cypriano, who looks forward to spending more time at his ranch with his wife and two teenage children.

The prototypical Bradesco operation is on view at its biggest retail branch, in Lapa, a blue-collar, lower-middle-class neighborhood west of downtown São Paulo. Most buildings here are a squat two or three stories. The narrow streets are constricted by ambulant vendors of cheap consumer electronics, jeans, overstuffed sandwiches, herbal remedies and supernatural potions. In the cavernous Mercado da Lapa — a metal-roofed food emporium that covers a square block — housewives mill around counters laden with cheese, olives, chicken and more-exotic meats from the Amazon, such as capybara, a pigsize rodent, and caiman, a variety of crocodile.

Just across the street, on premises that are almost as large, is Bradesco’s Lapa branch. Its main floor extends a full block, with a multitude of ATM machines at either entrance and a long corridor in between with counters to handle commercial transactions, personal loans, insurance and pensions. According to the manager, Volnei Francisco Rama, his branch opens an average of 500 new accounts a day. No business or retail client is too small. Personal loans start at R$2,000 for 30 to 60 days, with 4 to 6 percent monthly interest.

Given its long history with lower-middle-class Brazilians, Bradesco continues to approach these markets with more confidence than Itaú. “These clients represent our greatest growth potential,” says CFO Milton Vargas. Bradesco goes after them through Finasa, its consumer finance arm, which has 375 branches and point-of-sale operations at 36,970 stores and car dealerships. Another vehicle is Bradesco Expresso, which has contracts with 11,539 retail shops.

Even more ambitious has been Banco Postal. Under an arrangement with the government since 2002, Bradesco operates 5,821 branches in post offices, offering checking and savings accounts and loans as low as R$500 to 6.9 million clients, many of them in poor communities where banks don’t exist. “This is the fastest channel to reach low-income customers — and to move them over to Bradesco branches when their incomes grow,” says Vargas. “For now the major challenge is identifying the clients most at risk.” When Banco Postal got started six years ago, its nonperforming loan rate was 27 percent; by the end of 2007, it had fallen to 12 percent. That compares with Bradesco’s overall NPL rate last year of 4 percent. Payroll-deductible loans are a relatively secure means for Bradesco to lend to blue-collar and lower-middle-class clients. For the third quarter of 2007, issuance of such loans reached R$5.6 billion, up 41.7 percent over the same period the year before.

Bradesco also dominates Brazilian insurance with a 25 percent market share in total premiums, versus Itaú’s 11.2 percent. Bradesco bought Grupo Atlântica Boavista, one of the largest Brazilian insurance companies, in 1983, and merged it with its own insurance operation. Today known as Grupo Bradesco de Seguros e Previdência, it generated 31 percent — or R$2.48 billion — of Bradesco’s total 2007 net income. “We are already the largest insurance company in Latin America,” says GBSP chief executive Luiz Carlos Trabuco Cappi.

Bradesco ranks first in life, pension and health insurance and second in car insurance. Insurance penetration in Brazil is still a minuscule 2.5 percent of GDP — compared with 11 percent of GDP in the U.S. “The potential is enormous,” says Cappi.

Despite their different images and market strengths, both Itaú and Bradesco stand to make gains in several consumer areas over the next three years. “Last year Brazil overtook France in automobile production because so many Brazilians could afford the financing to buy cars,” says Itaú’s Setúbal. More than 80 percent of automobiles are bought with bank financing, with monthly payments starting as low as R$250. And the two biggest private sector banks are strong rivals in auto financing, with a 25.1 percent share for Itaú and 18.0 percent for Bradesco. In credit cards Itaú claims a 22.3 percent market share, ahead of Bradesco’s 16.9 percent.

Both are poised to make large inroads in a mortgage market that is just awakening. Until last year the mortgage-to-GDP ratio in Brazil stood at a puny 2 percent — compared with 10 percent in Mexico, 53 percent in the U.S. and 112 percent in the Netherlands. With inflation abating and the passage of a 2006 law making it easier for banks to foreclose, Bradesco forecasts that the mortgage-to-GDP ratio in Brazil will climb to 6 percent by the end of 2011. At Bradesco mortgage issuance totaled only R$901.6 million in 2007, a 3 percent rise over 2006, but the bank predicts 40 to 50 percent mortgage growth this year. At Itaú, where a more aggressive strategy, especially aimed at upper-middle-class clients, is under way, mortgage issuance reached R$2.68 billion last year, up 10.9 percent over 2006, and is expected to double in 2008.

The rival banks are also increasingly looking to penetrate each other’s core markets. In 2003, Itaú analyzed the entire Brazilian market and decided that although it had achieved high penetration of the top income brackets, a substantial part of the bank’s future growth would have to come from poorer, underbanked Brazilians.

A major part of this new strategy is a green-field consumer finance business, called Taií, started in 2004. Designed as a point-of-sales operation outside Itaú’s branch network, Taií now includes 261 units in high-density shopping zones; joint venture consumer finance operations in 251 outlets of Lojas Americanas, a countrywide department store chain; and a similar joint venture with 534 stores in the Pão de Açucar supermarket chain. But Taií failed to reach the targeted break-even point last year. “Taií isn’t delivering as promised,” says Deutsche Bank analyst Pierry, recalling the fanfare with which it was launched four years ago. The biggest problems have been payment delinquencies by lower-income clients and the expense involved in opening new outlets.

Bradesco is in equally unfamiliar territory when it comes to investment banking. “Our investment banking operations have just gotten started, so income isn’t yet significant,” acknowledges José Luiz Acar Pedro, the vice president in charge of international operations and investment bank Bradesco BBI.

One needed boost will come from the R$830 million acquisition in March of Agora Corretora, Brazil’s largest independent brokerage, which will become a wholly owned subsidiary of BBI. The deal will give Bradesco about 10 percent of Brazil’s brokerage market — which reached a stock trading volume of R$239 billion in 2007 — and make it the market leader, ahead of UBS Pactual and Morgan Stanley.

To expand its retail business, Bradesco has adopted the more segmented approach to clients that Itaú pioneered two decades ago. Two years ago Bradesco started to separate retail clients by income and corporate clients by their annual turnover. A few larger retail branches in upscale neighborhoods offer private banking.

So which strategy is likely to prevail? Bradesco’s strong focus on lower- and middle-income consumers, small and medium enterprises and insurance? Or Itaú’s concentration on high-end, big-city consumers and the capital needs of Brazil’s globally minded corporate elite? Brazil’s status as an emerging-markets superstar alongside Russia, India and China in terms of GDP growth and rising personal incomes may offer both bank strategies ample opportunity to succeed. “The traditional image is that Itaú is more dynamic, while Bradesco is the supertanker,” says HSBC analyst Galliano. “But they are both well managed and very profitable.” And each of their strengths is in market segments that continue to grow. “They don’t have to become what each other is,” says Pierry. “The market can accommodate both as they are.”