Santander Brazil IPO Raises Question: Are Banks Invested In Emerging Markets For Long Haul?

In Rio De Janeiro, the vibrant carnival for which the city is best known comes once every January. So far in October, however, there has been a samba dance of a financial sort, as the city secured its place as host for the 2016 Olympic games, and a multi-billion dollar market debut there rocked the IPO world.

While the first event made for popular headlines, the second is a significant sign that globalization is really setting in the banking industry. But it’s still unclear what strategic purpose developed country banks have in mind for emerging market ones.

Banco Santander Brazil’s (BSBR) $8.1 billion initial public offering (IPO), which made the Spanish parent a capital gain of €1.43 billion ($2.1 billion), marks the largest IPO in the world in 2009, and Brazil’s largest ever.

What makes BSBR’s debut in Brazil so unusual is that, unlike big financial services listings in emerging markets in the past, this was a foreign bank. Madrid-based Banco Santander intends to use its capital gains on the share sale to bolster its traditional Spanish (and European) operations, which have been hit hard by the country’s massive unemployment and spiraling real estate prices.

In other words, Santander is realizing income from its emerging market operations to fund its developed country ones. The process is similar to the one where a spate of U.S. banks sold their stakes in Chinese financial institution IPOs earlier this year in order to pay off the gigantic losses they accrued in the credit crisis (see story here).

For all the talk about growth in emerging markets, before 2009 that was more commonly an equation you saw working the other way round, where banks from developed countries kept channeling funding outwards but rarely realized profits.

As the world’s largest economies have suffered, the process has flipped a bit, and Santander is the latest in line to mark the new trend. That raises an interesting question: are big country banks investing in emerging markets for operational reasons (and hence hoping to derive long-term income), or mostly just for the purpose of making a big one-or-two-time capital gain? For while it makes most sense for them to do so for the long haul, continued stress on domestic operations might force them into divesting the majority of their emerging market stakes before they become cash cows in their own right.

For example, while Brazil is booming, BSBR is hardly in fantastic shape. TheStreet.com’s Michael Baron wrote:

As fervent as demand appears to be — and the pricing due overnight will really be the true indicator — there are still enough questions about the company to make the case for taking a wait-and-see approach.

“They are a bit more at risk since the percentage of their loans that are non-performing is higher than their competitors while their reserves are lower,” Morningstar’s Pina told TheStreet.

Pina estimates Banco Santander Brazil’s allowance for bad loans currently covers about 80% of its non-performing loans, compared to coverage of 140% and 120% respectively at its main private competitors, Itau Unibanco and Bradesco.

Earlier this year, when China raised its qualified foreign institutional investor (QFII) quota limits for global banks, I pointed out that in effect, there was no real significance since only one bank (UBS) was fully invested anyway (see story here). You would think if international banks were serious about long-term ownership in the region they would be fully invested.

Now consider that Santander’s BSBR IPO wasn’t really an IPO in the strictest sense, but an additional share sale, with the firm merely realizing an additional 16 percent of its holdings for fast cash:

Brazil’s capital market characterized the sale as an IPO, although strictly speaking it was not. Prior to the offer, 1.98% of the unit’s shares were held by the market. Following the present offer, nearly 18% will be held by the market.

This is similar to a lot of emerging market deals recently, where banks invested not to maintain long-term ownership but instead to get windfall gains. While BSBR will open new branches and solicit more customers in Brazil, in light of the recent trend, it remains unclear whether the Spanish parent Santander will end up staying for the long haul, or whether it will eventually have to sell out most of its ownership.