HSBC’s Brazil exit highlights strategy mistakes, country woes

SAO PAULO (Reuters) - Brazil simply proved too tough for "the World's Local Bank." Executives at HSBC Holdings Plc's Brazilian unit put relationships with corporate clients before profitability, kept branches overstaffed and failed to protect profits from a deteriorating economy, analysts and investors say.

Strategy missteps coupled with rising competition turned the unit into a problem for London-based HSBC. Now, the moment of reckoning has come.

Chief Executive Officer Stuart Gulliver, pledging a new era of higher dividends, laid out plans on Tuesday to slash nearly one in five jobs worldwide and fix operations saddled with compliance costs and low interest rates.

As part of the plan, HSBC's units in Turkey and Brazil were officially put on the block. The process of disposing of HSBC Bank Brasil Banco Múltiplo, as the unit is formally known, is well advanced. Brazil's top three private-sector lenders have placed bids, a source with direct knowledge of the situation said on Tuesday.

The sale could fetch between $3 billion and $4 billion, said the source, who requested anonymity since the talks remain private. For Gulliver, maintaining a costly business with over 21,000 employees that provided just 1 per cent of pre-tax profit made no sense.

For shareholders, betting on Brazil was risky as lenders grapple with tax hikes, weak credit demand, rising defaults and the impact of what looks likely to be the country's worst recession in over two decades.

HSBC's exit from Brazil "comes in line with a broader trend of consolidation in the local banking industry driven by large local lenders able to gobble up rivals and ride out a tougher economic outlook," said Claudio Gallina, head of financial institutions at Fitch Ratings in São Paulo.

In a Tuesday statement, HSBC Brasil said it is "committed to continuing its business and ensuring a smooth and orderly transition to a potential buyer."

The situation highlights the impact of government intervention in the sector since 2012, when President Dilma Rousseff instructed state lenders to cut borrowing costs and step up competition.

While Brazil's top private-sector banks reacted by retreating to protect profits, HSBC Brasil might have been "caught in the middle," the source said.

Management failed to spur revenue as lending spreads narrowed and loan defaults jumped. Expense growth outpaced inflation, hampering efficiency, Tito Labarta, an analyst with Deutsche Bank Securities, said in a recent client note.

While profit before loan-loss provisions came from retail, corporate and investment banking in about equal shares, HSBC Brasil took on too many low-yielding corporate loans - which represented two-thirds of its loan book.

A number of top-flight executives departed, including former senior country officer Conrado Engel, who joined Banco Santander Brasil SA three years ago. As a result, slow asset growth prevented HSBC Brasil from gaining scale to win market share, and return on equity was a negative 4.2 per cent last year.

ROE, as the gauge is known, was 15.5 per cent at the start of 2012.

The fact that HSBC Brasil has consistently underperformed Brazilian peers explains why the bank is worth just above book value, analysts such as Banco Brasil Plural's Eduardo Nishio said. A bank with a strong local presence could absorb HSBC Brasil's operations through reducing as much as 40 per cent of the unit's workforce, improving the bank's lending mix by increasing exposure to individuals, and using capital in a smarter way, he added.

This week, Bloomberg News reported that Banco Bradesco SA placed the highest bid for HSBC Brasil, at 14 billion reais ($4.5 billion), in an all-cash deal.

Itaú Unibanco Holding SA, Bradesco and Santander Brasil - the nation's three largest non-government lenders in that order - had access to the sale's preliminary documents and made bids, the source said. Both Itaú and Santander Brasil placed offers below Bradesco's, the source added.

The most powerful source of synergies could come from job and branch reductions, analysts said. HSBC Brasil has 31 workers per branch, compared with 16 at Itaú and Bradesco and eight at Santander Brasil. Yet, growing reputational issues such as allegations that HSBC Brasil helped hundreds of Brazilians hide billions of dollars in Switzerland could depress valuations more.

Itaú, Santander Brasil and Bradesco declined to comment.

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