The timing could not have been worse.
By Don Quijones, Spain & Mexico, editor at WOLF STREET.
In July last year, an analyst working for Banco Santander Brasil did something he shouldn’t have. He warned the firm’s private banking clients about the economic risks posed by the reelection of Brazil’s scandal-tarnished president, Dilma Rousseff. Those risks included a sharply devalued Brazilian real, rising interest rates, runaway inflation and tumbling shares.
When the analyst’s report went public, it provoked outrage from Rousseff’s party, which saw it as a direct intervention in the country’s general election. Santander’s now-deceased CEO Emilio Botin was given a choice: either he castigated the analyst and rejected his findings, or his bank’s extremely cozy ties with the government of its most profitable market could be in danger.
It was not a difficult decision. Within days the analyst was fired for “making a mistake.” Now, a year and two months later, it’s obvious that the analyst’s warnings were spot-on. Rather than firing him, Santander should have listened to him.
Instead of reducing its exposure to Brazil’s fragile economy over the last year, as HSBC has done (read: Does HSBC Know Something Others Don’t), Santander has doubled down on its bet, forking out €4.7 billion on the acquisition of the remaining 25% of its Brazilian unit.
A Slap in the Face
The timing could not have been worse. Yesterday, Brazil’s already troubled economy was given another long-expected slap in the face when Standard & Poor downgraded the country’s debt from investment-grade to junk status.
The impact was immediate. Brazil’s currency plunged from 3.78 Real to the dollar to 3.9. It’s currently hovering at 3.88. Just a year ago, when news of the government’s Petrobras scandal began hitting and the economy’s biggest threats – a weakening China, the abrupt end of the commodity super cycle, a strengthening dollar, and floundering internal demand – were beginning to surface, the currency was clocking in at 2.35 Real to the dollar.
In other words, it has lost about 40% of its value against the dollar in the last 12 months. S&P’s latest downgrade could be very bad news for Banco Santander and all of the other Spanish banks and corporations that have effectively gone all-in on Brazil. For a long time, Grupo Santander’s Brazilian division served as the bank’s biggest global profit center, but that came to an abrupt end early this year when the group’s UK banking arm breezily overtook it.
Shares at Santander’s Brazilian unit have slipped 15% in Sao Paulo since the end of June. Meanwhile the banking group’s shares on Spain’s benchmark exchange, the IBEX 35, have plunged 23% over the last year. As Bloomberg reports, since early August, the shares of both Santander and Spain’s second largest bank, BBVA, which is particularly exposed to Mexico’s weakening economy, have tumbled more than an index of European bank stocks:
While a focus on emerging markets helped the banks weather the [DQ: domestic] financial crises of recent years, it now leaves them exposed as those economies weaken. A blow to earnings would make it harder to build up capital without tapping investors. Santander, which already turned to shareholders for funds earlier this year, still has a lower capital buffer than many large European peers.
Barely Concealed Fear
The problem is not just that Brazil’s decade-long era of economic development has ended; it is that an extended, deep recession in Brazil is almost certain to drag down much of Latin America with it, a region in which Santander has a vast portfolio of operations, from Mexico in the north to Argentina and Chile in the south.
Brazil’s economy represents a staggering 56% of South America’s combined GDP. And at this rate it is heading towards its longest recession since the 1930s. To draw a parallel, that’s the approximate equivalent of the economies of France, Germany and the UK plunging deep into recession together. Just imagine the effect that would have on all the other economies in Europe?
As for Santander and all the other Spanish corporations that have bet their futures on the Latin American economy, they’re having difficulty enough just concealing their own fears.
A couple of days ago, Grupo Santander’s CEO Ana Botín, who was anointed Chair of Santander’s board after the death of her father last year, announced a shake-up of the bank’s leadership in Brazil. Sergio Rial, hired by Botin in March, will succeed Jesus Zabalza, who has run Banco Santander Brasil since April 2013.
All of which smacks just a little of desperation. So, too, does the petit comité hastily arranged this week between the CEOs of Santander, the Spanish telecoms giant Telefónica, the energy behemoth Iberdrola, and Brazil’s finance minister, Joaquim Levy. As El Confidencial reports, the companies fear that a downward revision of the country’s credit rating, as has just happened, would wreak untold “collateral damage” on both Brazil’s markets and their subsidiaries operating there.
Damage control was clearly the order of the day. According to José María Álvarez-Pallete, the CEO of Telefónica, whatever happens, the telecoms giant will continue investing in the country, where it expects to spend €6.2 billion on its fibre-optic network between 2015 and 2017.
“Although GDP fell 1.9% in the first quarter, the situation is nothing like what happened in 2002,” said Iberdrola’s Ignacio Sánchez Galán. “In the intervening years, 50 million people have been lifted out of poverty and a huge stabilizing force, the middle class, has been created.”
What Galán and Álvarez failed to mention is that Brazil’s current crisis is unfolding against a backdrop of rising global financial instability. The three most important factors underlying Latin America’s economic travails – the abrupt end of the commodities super-cycle, a strengthening U.S. dollar, and the gathering exodus of hot money – are completely beyond the control of the region’s governments or central banks.
No amount of positive thinking will mitigate the effects of these forces on the real economy. As Galán himself acknowledged, his company’s clients were already beginning to struggle to pay their invoices. Meanwhile José Antonio Álvarez, CEO of Santander, admitted that defaults and bad debt are on the rise in Brazil. And that is precisely how financial crises spread.B y Don Quijones, Raging Bull-Shit.
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