THE BANKER: Uruguay’s banks being crippled by caution

As governments in the Western world attempt to implement more conservative regulation within their financial markets, banks in Uruguay are stagnating because of the country's overcautious economic approach over the past decade.
Pint-sized Uruguay has successfully cleansed its banking system of Argentinian deposits and loans since the disastrous crash of 2002 and its banks are well cushioned and reserved. Yet, in spite of a rash of takeovers by large foreign banks, the sector remains curiously undynamic. Levels of lending are trifling, particularly to corporates, capital markets are moribund and the development of long-term lending is painfully slow.
During the second term in government of the left-leaning Frente Amplio party, which retained power in March, the government will be legislating to nudge banks to serve more of the population and lend more to meet long-term infrastructure needs and social objectives. However, it needs to tread carefully not to deter foreign banks altogether, for whom tiny Uruguay is not a major priority.
Macro background
The good news is that Uruguay's economy is performing well. Gross domestic product (GDP) growth is expected to be about 8% this year, well ahead of earlier official projections, says Fernando Calloia, president of Uruguay's largest bank, the state-owned Banco de la Republic Oriental de Uruguay (BROU). He adds that GDP is expected to maintain a healthy growth of 4.5% in the following few years. Ricardo Marino, vice-president of foreign banking at Brazilian bank Itaú Unibanco, which has business interests in Uruguay, is somewhat more cautious, but even he predicts 6.5% economic growth this year and 4% in the following few years.
The super-commodities cycle that has bumped up neighbours Brazil and Argentina has also given Uruguay's agricultural sector a shot in the arm. The stability of its regulations and openness of the economy continue to attract foreign investment.
"The government has pursued the right policy for economic growth over the past five years," says Mr Calloia. Growth has been high, inflation has stayed at about 6%, low compared to previous periods, and the fiscal deficit has been reduced, he adds.
The government is also pushing to diversify its economy. "We are the most open country in South America and have been growing in services, software, logistics and outsourcing. One-third of our exports today are [in] services and the growth rate is higher than other sectors," says Fernando Lorenzo, minister of economy and finance. "We are in a good position to enjoy many benefits from the new international situation."
Even so, the economy is still too dependent on agriculture and competitiveness needs to be sharpened. "We need to implement transformations in infrastructure, qualification of the workforce, education and many aspects that lie at the core of competitiveness. We could do better in many fields related to competition, innovation and infrastructure," says Mr Lorenzo.
Continuity, not change
The strong economic growth enjoyed during the term of the previous administration, and Frente Amplio's re-election for a second five-year term, means the buzzword in Montevideo's political scene is 'continuity'. Indeed, although there have been musical chairs for key economic positions, the main political players have not changed.
The continuity message is important because president José Mujica, who took office in March, was not supported during campaigning by his popular predecessor Tabaré Vázquez. Mr Mujica was a guerrilla fighter against Uruguay's right-wing government during the 1960s and 1970s, making some nervous about his policies. In a region where political change is often extreme and legislation regularly overhauled, Uruguay has been a model of stability and that has always been its most precious commodity.
"In our first term, we were a socially oriented administration. That is not to say that we are populist or imprudent. We've proved to be a very responsible administration," says Mario Bergara, president of Uruguay's central bank.
Already, 70% of the government's total spending is channelled towards social programmes and the focus on cutting poverty will continue, says Mr Bergara, who adds that poverty was almost halved under the old administration to 20%.
Nevertheless, there are new emphases in economic policy, particularly on security, housing and infrastructure, and with regards to the latter, banks will be key in supplying the long-term financing.
Too much caution?
Uruguay was long at the mercy of Argentina's mercurial economy, and since the 2002 economic crisis in Argentina impacted greatly on Uruguay, prudence has been the watchword.
In December 2001, just before the crisis that led to Argentina's devaluation and debt default, more than 40% of deposits in Uruguay were held by Argentine residents. Today, that figure is 17% and other non-residents make up just another 3% of deposits. Much stronger supervision and restrictions on lending have led to a more prudent banking system, and capital ratios today are a very conservative 17%.
The growth of the country's economy has slashed non-performing loans (NPLs) and many companies have been able to pay down debt in the past few years. Those that had US loans have been helped by the stronger peso as well.
NPLs represent about 1% to 1.5% of Uruguay's banking system and counter-cyclical provisioning, similar to the system in Spain, means banks need to hold reserves worth 7% of loans, says Mr Bergara.
Supervision was restructured in 2008 with the end of self-regulation, which had caused problems, and the creation of a superintendency of financial services, says Mr Bergara. The new, centralised supervisor is responsible for all of Uruguay's financial markets: banks, insurers and pension funds, he adds.
So far, so good. Yet, although fundamentally stronger, Uruguay's banking sector has been stagnant or even in decline in terms of new business and profits, says Ana Pereyra, director at AMP Financial Advisory Services in Montevideo.
"We expected to see a little more activity in recent years but it has actually fallen," says Ms Pereyra. "The imposition of a personal income tax of 25% in 2007 is applied across the board, even a maid pays it. With average salaries of between $500 and $1000 a month there are fewer savings," she adds. The sector has never been particularly profitable, especially as Uruguayans can invest inside or outside the country, adds Ms Pereyra. Higher real peso salaries have remorselessly driven up costs for banks, especially as most have income from US dollar streams, in which most lending and deposits are carried out.
Weak demand for corporate credit means such lending is not extensive or profitable, and low profits mean banks offer depositors few incentives, making savings accounts unattractive. Lack of demand for bank services has kept spreads very tight and the corporate sector unprofitable for them. Strict supervision and high provisioning levels add to the general torpor in the sector.
Deposits are more than twice the amount of credit, says Mr Calloia. Structurally, there is an insufficiency of demand, he adds. Also, most companies are family-owned and used to self-financing and reinvesting profits, says Mr Bergara.
That has banks looking to consumer credit, also an under-developed area. Credit to GDP is rock-bottom at 25% and this area will be the driver for growth in the Uruguayan banking sector, says Mr Bergara. There is still a long way to go to meet consumer demand for credit, agrees Ms Pereyra, adding that as this is the only decent source for profits, all the banks are following the same strategy and rates are coming down just as competition heats up.
Decades of consolidation
The 2002 crisis and lack of profitability have led to huge consolidation. The number of banks has fallen from 25 at the time of the crisis to just 14 banks today, of which only seven or eight are particularly active, according to Ms Pereyra. Moreover, BROU accounts for some 45% of the market and Santander a further 25%, making the sector too concentrated. If there were a problem with any of the country's top three banks, it would infect the whole system, she adds.
"Our banking system is very simple," says Mr Bergara. Yet he is not concerned the system is too consolidated. "The public bank sector is not at the peak of market share historically and Uruguay is a very small market making five or six banks with significant market share reasonable." Stronger foreign banks with deep pockets and know-how may actually bring more competition to the system, he adds.
The largest acquisitions in Uruguay were made by Spain's Santander and BBVA. The former bought the operations of ABN Amro in 2008 as part of a Latin America package, but Brazil was the chief draw for the bank, not Uruguay. Spreads in Uruguay are thin whereas Brazil has some of the highest spreads in the world. This year, BBVA took over the operations of Crédit Agricole, which has 36 branches in the country.
These mergers are still being digested, says Mr Pereyra, who finds that service has generally got worse at all the merged banks as they get to grips with different business models and systems.
A final problem remains the prevalence of dollar-based lending and deposits in the country. The dollar may have fallen over the past seven years, making peso deposits a better bet, but Uruguayans have remained firmly wedded to the greenback. A deep-rooted fear of inflation that has destroyed monetary value in the past has prevented evolution of deposits and lending in the peso market, says Mr Calloia. About 80% of corporate lending is transacted in US dollars, he adds.
New proposals
As banks in Uruguay struggle to integrate acquisitions and make profits on the slim pickings available, the government is figuring out how to extend banking services.
"We need to improve financial inclusion, extend bancarisation and bring services to the public and firms. Banks needs to be more active in terms of deposits and credit. There is a lot of space and opportunities to expand and improve our banking activities," says Mr Lorenzo.
To that end, the government is introducing new regulations and a legal framework to encourage the use of banks as a financial intermediary, such as making the payment of wages and tax obligations electronic.
Itaú Unibanco is one bank making an effort in this direction. The bank will expand its branch network from 18 to 25 by the first few months of 2011.
The government has put together a task-force that brings together the banks, the Ministry of Finance and Economy, financial institutions and workers to prepare a set of suggestions for legal changes to the system in areas such as tax and regulation, says Mr Bergara.
More risk please
As the rest of the world reins in on lending, Uruguay's ossified banking system is looking to be a little less cautious. When asked if banks are too conservative, Mr Bergara laughs and says: "Yes, absolutely. In the crisis of 2002, everyone - regulators, bankers, managers, companies and families - became more conservative." This was the first crisis in Uruguayan history where depositors lost money, he adds.
The moment is ripe for the supervisor to allow more flexibility with reserves at a staggering 70% of capital, says Mr Bergara. "Having seven out of every 10 dollars in their pocket means that banks are not fulfilling their role," he adds.
He cautions that banks should not expect a blanket break, but carefully thought-out regulations that tie the loosening of supervisions or better tax treatment with real results, such as expanding Uruguay's very low number of points of sale for debit cards or extending internet and mobile banking, he says. "If we make regulations looser, we need to balance bancarisation with security," he adds.
The question is, with so many other areas of growth in the region and frugal levels of capital for investment, will foreign banks really be interested in investing in low-profit Uruguay, particularly in bancarisation?
Long-term planning
If Uruguay's government is successful in persuading banks to offer more services, it would help with another cherished aim. A serious issue is the banks' long-term lending. With a rip-roaring economy and government plans to boost infrastructure to keep up with growth, the re-emergence of peso-denominated capital markets is becoming essential.
The government is getting a new law on public-private partnerships passed to attract in private and foreign investments. Private equity firms could be one rich source and are already present, and capital markets would help enormously.
The good news is that the government is no longer crowding out such investment. There has been a significant drop in public debt as well as the development of a peso-denominated market.
Today, gross debt is some 40% of GDP, compared to close to 110% at the time of the crisis. At that time, all the debt was dollar-denominated and today nearly 40% is in pesos or in inflation-indexed units, says Mr Bergara. The government will keep pushing the development of the peso market issuing in local currency, he adds.
Uruguay's debt profile is comfortable and over the next 10 years, just 1% of GDP will be spent on amortising debt, says Mr Bergara. That has driven down yields and even though Uruguay remains speculative grade, "we are comfortable that the market has given us an investment grade, looking at our country risk", he adds.
That opens space for long-term infrastructure financing with institutional investors and banks expected to play their part. The government and BROU have set up a guarantee fund to get the market off the ground, says Mr Calloia.
Pension funds too should play an important role. Today, they represent 18% of GDP and each year assets are growing by 2%. Traditionally, they have invested heavily in government paper, but as the debt profile improves and assets grow, they should turn to riskier assets, such as infrastructure, says Mr Lorenzo. The airport that has recently opened in Montevideo was built with private public monies, he notes.
But Mr Bergara accepts that the challenge is to financially engineer such projects to make them attractive and understandable to institutional investors.
Optimism when it comes to Uruguay's prospects is well placed as the country enjoys a boost from its agricultural sector and takes advantage of its enticing investment laws and stability in a region that is booming. To maximise the potential from this golden era, the government needs to make sure it sets out clear priorities and persuades banks that they can make decent profits at the same time as they reach out to under-banked parts of the country.
LATIN FINANCE: BOUTIQUE BANKS PROLIFERATE IN BRAZIL
November 5

The crop of boutiques that sprang up from the bulge bracket wreckage faces fresh competition. They will need relationships, international connections and a proper structure to survive.
Boutique banks popped up in post-crisis Brazil like mushrooms after the rain. G5 Advisors, BR Partners and Orienta Partners have joined the ranks of an older generation that include Rothschild, Vergent Partners, Singular Partners, and Estáter Gestão e Finanças.

The brains behind the new pretenders are generally veteran investment bankers with large client lists, says Jorge Maluf, partner at recruiter Korn Ferry in São Paulo. "International banks put the brakes on too hard during the recession and senior executives became frustrated by the conservative attitudes and lack of attention from headquarters," he notes, pointing out this is similar to what drove the previous wave of openings, many following the 2002 Brazil market crisis.
Newcomers are already carving a niche out in Brazil’s explosive M&A scene. They generally seek to focus on the middle market, which they say larger investment banks either disdain or serve poorly and where fees remain generous.
The largest blue chips were able to reduce commissions for advisory work paid to global investment banks significantly during crisis, says a boutique investment banker. That has seen fees fall to 0.5%-0.7% from 1.0% on deals of 1.0 billion reais or more, he says. Meanwhile, fees on mid-sized deals of between 400-600 million reais have not proved so elastic, with charges of 2%-3% still typical, the banker says.
Mid-Market Opportunity
Companies in the mid-market sector felt they were not well served by the large investment banks in previous booms, notes Maluf. Often, large banks appoint a director rather than a partner to oversee mid-market clients and that can grate on the sensibilities of company management, he notes.
Celso de Barros, partner at boutique Vergent Partners in São Paulo, sees firms such as his filling an exposed niche in the mid-market corporate universe that New York-centric investment banks tend to ignore. In its 10 years of business, Vergent’s business has grown every year, including during the crisis, thanks to this focus, he says.
How long that remains the case is in doubt. The mid-market fees are likely to attract greater attention from investment banks, who are seeing compression as large-cap M&A gets more competitive. Maluf thinks it unlikely that the large, international banks such as Credit Suisse, Goldman and JPMorgan will pursue small deals.
However, new entrants and Brazilian banks will probably focus on such deals either as a differentiated strategy, leveraging the private bank or commercial bank relationships, or as an opportunistic way to generate revenues to maintain the team.
"My concern is whether the growth in boutiques is really sustainable," says Maluf. "The market will stabilize at some point and at the same time large banks are aiming to compete on smaller deals as they push more deeply into Brazil. This process will take one or two years, but it will show up a small number of winners and lots of losers in the boutiques," he adds. Losers are likely to be those lacking strong relationships with a key account, international connections and a proper structure, he predicts.
For boutiques to get a running start, client relationships are essential. Some bankers have been successful in bringing over very large clients from previous employers, which has catapulted them up the league tables. Maluf points to a close relationship between Estáter’s Pércio de Souza and Abílio Diniz, chairman of the board at Grupo Pão de Açucar. That has enabled the new firm to support the expansive supermarket in its acquisitions, most notably the take over of electronics firm Casas Bahia through a deal worth over 4.0 billion reais.
Meanwhile, BR Partners’ approach cements relationships even more tightly by inviting heavyweight Brazilian companies to become shareholders. "It’s more like a corporate, shareholder structure than a partnership," notes Maluf. Owners of firms like Hypermarcas, Suzano, BMC, Rodobens and Ripasa are all shareholders in the would-be bank.
Lumpy Streams
The newcomers are pursuing different models with varying levels of specialization. Some are looking for synergies and cross-selling opportunities between advisory and wealth businesses while BR Partners is seeking a full investment banking franchise. André Esteves’ BTG Pactual, the Brazil-based boutique that is swiftly morphing into a global player, has already blazed the trail.

Corrado Varoli, partner at G5 in São Paulo, explains why the firm is built on the pillars of advisory and wealth management. "M&A is attractive but it yields a very lumpy revenue stream. You can work on 10 deals at the same time and can then close a bunch or none at all. That fits in well at very large banks where it represents a small portion of revenues or at very lean boutiques, such as Estáter," he says.
For larger shops like G5, it is an advantage to have private wealth management, which is predictable in revenues and not capital intensive, making it an ideal partner for M&A. Putting M&A and private wealth together is uncommon in Brazil, but established in the US, Varoli says. "Our M&A and wealth managers communicate daily and are based in the same offices. Large investment banks claim that they can translate M&A business into private wealth management and vice versa but my experience suggests it does not work," he says.
Unbiased selection of asset managers is key and G5 is set up to avoid conflicts of interest, he adds. G5 has close to $1 billion in high net worth assets and some 50 professionals in São Paulo and Rio. The private wealth business could grow 3-4 times by assets in the next five years, predicts partner Marcelo Lajchter.
Conflicts of Interest
G5 is also developing a nascent asset management group, which has garnered 100 million reais to date, according to Lajchter. Assets are up from 30 million reais one year ago and he predicts they will hit 300-400 million reais in a year and could grow 8-9 times over five years, if performance is maintained.
Some warn that bringing asset managers inside the firm risks repeating the conflicts of interest seen at bigger firms. De Barros is establishing an outsourced private wealth management firm as he too believes that there are significant synergies between that business and advisory work. But he notes that an internal asset management team that is trading stocks could become privy to privileged information from the M&A side. The same criticism is often leveled at BTG Pactual.
At BR Partners, chief operating officer Andrea Pinheiro does not view the firm as a boutique but a fledgling full-service investment bank. It has applied for a banking license which it hopes to get as early as the end of next year, she notes. A comparison with BTG may be premature, but is not denied. "We are in the same market and are competing with them. But we are at a very different stage," she says.
A central advantage for BR Partners is the number of senior relationship bankers, she believes, which has translated into immediate mandates. M&A has only been up and running for six months but already clients include Carlyle Group, which the firm advised in its acquisition of Scalina. In addition, it worked on Grupo Localfrio’s purchase of assets of Complexo Industrial de Saupe, and São Luiz in its takeover of a controlling stake in Rede D’Or.
BR Partners is firing on all cylinders. It is also soliciting Brazilian high net worth clients for a proposed 200 million reais private equity fund that will seek to take stakes in companies looking to consolidate their sector. The fund is slated to start operations early next year, says Pinheiro. The company is also structuring an investment management business that may use purely independent outside managers or some internal oversight, she adds.
Global Reach
The business plan is not the only major difference between these firms. Boutiques also have varying degrees of international reach.
G5 is convinced a global presence is necessary, says Varoli. Brazilian managers are ever more keyed into international trends. Even though M&A has been mostly domestic in the last two years, this is not indicative of future trends.
"Cross-border flows represented 50% of all business historically, but have dropped to 10% because of the crisis. But in the next five years, you will see many more companies carrying out international transactions especially with Japan and China," says Varoli.
Putting its money where its mouth is, G5 sold a 50% participation to its US partner, investment bank Evercore, in September. G5 has also signed agreements with Japan’s Mizuho, Mexico’s Protego, Citic Securities of China, and Quantum Finanzas of Argentina. The Japanese connection has already yielded four advisory mandates, Varoli notes.
One boutique global advisor, which already has a successful franchise in Brazil, is equally convinced of the merits of global presence. "You can see trends in industries in other countries and provide industry intelligence to local clients. We have relationships with global industry players and can give information on their competitors in Europe and the US," says the partner.
Meanwhile, Vergent Partners is a member of the Global M&A network that gathers 40 boutiques and investment banks across the world, says de Barros. There is typically one firm per country although in Brazil Vergent and Porto Alegre-based Amati Negócios Internacionais are both members.
BR Partners, however, does not see the need for such cross-border partnerships, at least at this stage. Nonetheless, it has still lured foreign business, notes Renato Naigeborin, CFO, investment products. "We want to cater to Brazilians or clients investing in Brazil through M&A, private equity and direct investment and don’t see the need for a global tie-up," he says.
The business models may be different but the marketing pitch is often similar. The core selling points are typically the lack of conflicts of interest at a boutique level and the long-term views that come from a partnership.
Boutique managers claim conflicts are rife within large investment banks. "Do investment banks do a good job at separating out business lines?" asks one established boutique manager in São Paulo with an M&A focus. "Do they have conflicts of interest between clients? Just look at the number of mid-sized bank IPOs coming to market in 2007," he says.
Longer-term client commitments bolstered by a partnership structure that provides equity rather than annual bonuses is the other selling point. It should lock in talent and allow companies to plan for the long-term, believes Pinheiro.
The new boutiques are confident that they will be able to compete with investment banks even when the client’s financing needs include borrowing, traditionally an Achilles’ heel for small operations.
BR Partners has 120 million reais in equity and cannot compete for credit mandates, notes Pinheiro. However, she believes this poses less of a problem than the past because domestic banks are more willing to lend and international and domestic capital markets are opening. It can even be an advantage to be a boutique today and to be able to shop around the offers between different banks, says Pinheiro.
Building the Bank
Boutiques generally claim to give juniors a piece of the pie and offer more transparency. Yet the start-up phase is trying as revenues are low and spending needs high.
BR Partners pays most of its professional staff, excluding areas such as risk management and compliance, just 5,000 reais per month. Despite this, when the market was tight for new staff, BR Partners hired more than 20 people for the investment bank and 10 for the investment team, says Pinheiro.
Senior staff is content to wait for rewards down the line as the business is built, Pinheiro adds. At G5, 80% of employees have shares, although these can be as little as 0.01% and up to 5%-6%, says Lajchter.
The question remains whether boutiques can compete in a limited talent pool with thrusting new and well-established full service investment banks looking to add in Brazil. This year, a full seven investment banks have been looking for a new head either as a replacement or to start a new business, says Maluf. Many are also looking for more junior bankers.
In his recruitment work, Maluf has spoken to senior staff at the boutiques and generally finds they are happy. Moreover, boutiques are generating comfortable deal flow today, and most of the senior bankers like not having a boss along with all the politics and bureaucracy that entails, he says.
However, leading institutions pay more than a boutique in a start-up phase of 2-3 years, and for junior staff the immediate attractions are less obvious. If investment banks start to eat away at boutiques’ mid-market business or the M&A gravy train slows, the boutiques may prove as short-lived as a fungus.

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