Growth opportunities are becoming rarer in the financial sector, so Banco Bilbao Vizcaya Argentaria (BBVA), the second largest bank in Spain, did not want to let one get away when it showed up in Mexico. The strength of the euro provided an opportunity for launching a takeover offer for the 40.6% of Bancomer that BBVA did not already own. That will allow BBVA to control Bancomer, the largest bank in Mexico, the country that has the highest GDP in Latin America. The deal is one of several in a wave sweeping across the financial sector. According to experts, it demonstrates that international investors have regained confidence in Latin America’s more prosperous countries.


On February 2, when BBVA announced its latest earnings, the figures were accompanied by news that was both unexpected and remarkable. The bank revealed that it was launching a takeover bid for the 40.6% of Bancomer’s shares that BBVA did not already own. Bancomer has a market share of 25% in Mexico.


The deal will cost BBVA 3.3 billion euros, and BBVA will have to do some work to bring it about. However, as Francisco González, BBVA’s president, said when he announced the deal: “These days, it isn’t easy to find an opportunity that is so obvious and involves hardly any risk of execution. That’s because Bancomer has been integrated into the BBVA group ever since June 2000.”


Experts agree, and they praise the deal. So do those international investors who have profited from it already. Within four hours, the market capitalization of BBVA rose by two billion euros, increasing the value of BBVA by 60% of the acquisition cost for Bancomer.


Investors’ interest in the deal reflects confidence that the outcome will be positive from a strategic point of view, according to Altina Sebastián, professor at the Complutense University of Madrid. “The economic outlook is more positive now for Latin America and very positive for Mexico in particular. This deal will permit BBVA to narrow the distance that separates it from Santander (SCH). Mexico is the country where BBVA is going to take a lead over its rival.” In Mexico, the SCH group is run by Emilio Botín, and it controls 98% of Banca Serfin, the third-largest bank in that country. Serfin is not listed on the stock exchange.


Gonzalo Garland, economics professor at the Instituto de Empresa, finds it interesting that BBVA has chosen this particular moment to raise its stake in Mexico. “All the forecasts for Mexico are positive, both short and medium term. The country underwent a recession during the last three quarters of 2001, and began a very smooth recovery in 2002 and 2003. Its economy is very closely tied to the U.S. economy. Mexico sends nearly 90% of its exports to the U.S. That will allow Mexico to benefit from higher growth in the U.S.


Moreover, Mexico’s financial situation is among the most stable in the region. “Its debt represents only about 27% of the country’s GDP – compared with 44% in Brazil. Mexico is the only country in the region, along with Chile, that has such a high level of foreign investment,” says Garland. This is anything but “speculative investment;” these are funds that cannot be invested where risks are high, he adds. “The dark side for Mexico is the emerging competitiveness of China, but this does not directly affect its financial sector. It only affects certain companies.”


In Garland’s view, Mexico is an “interesting” market for BBVA because “the [market] penetration of banks in Mexico is much lower than in Europe, so there is a greater potential for growth. Moreover, interest rates are higher in Mexico – that is to say, 4% – and rates are more stable than elsewhere.”


Interest rates are an important consideration. In Europe, interest rates are only 2%, and this has put enormous pressure on the traditional business of banks, measured by their margins of financial intermediation. That margin is the difference between interest rates banks receive from the loans they provide, and the rates they pay to depositors. Last year, margins for financial intermediation in Spain and Portugal remained stagnant, growing by only 1%. However, in Latin America, where interest rates are higher, those margins grew by more than 10%, measured in local currencies. The numbers don’t take into account any currency depreciation.


Volume Growth

According to Sebastián, “a non-organic growth recovery is taking place because low interest rates impose pressure on bank margins. How can you compensate for very narrow margins? Only with a growth in volume.” In Sebastián’s view, this is the reason why the financial sector has showed so much interest in mergers and acquisitions since last fall.


In January, the second American bank merger in barely two months was announced, with the purchase of Bank One by JP Morgan Chase. Last November, Bank of America took over FleetBoston. Moreover, there have been rumors in Europe that American banks intend to buy European banks. Supposedly, Bank of America will buy Barclays, and Citigroup will take over Deutsche Bank. There are also rumors about cross-border deals in both Germany and Italy. According to Sebastián, “banks are always looking for growth opportunities, but they are very rare. This is a very mature market. You can’t win new customers, but you can take them away from your competitors.”


Sebastián believes that BBVA’s move to acquire Bancomer also has a symbolic significance. “With this deal, BBVA wanted to send a signal to the market that, in the current wave of mergers and acquisitions, BBVA is moving along with the larger players in the market. Ever since González became president, there has been less public talk about the bank’s intention to grow than in earlier days. But now they are showing that they are much more dynamic.” González himself boasted about this hunger for growth shortly after announcing the Bancomer deal. “I am happy about the Bancomer offer, but I am not satisfied. This group [BBVA] wants to grow, and we will be looking around for new opportunities.”


As a result of such talk, analysts foresee continued rumors that BBVA will make a purchase in the United States. Moreover, although BBVA has denied rumors, talk continues that BBVA will raise its stakes – now 14.9% – in BNL, an Italian bank. As González announced, “We are not going to make any comments about the future. We will comment only about ongoing operations.”


One factor that has helped BBVA in this deal is the strength of the euro. In 2003, the Mexican peso dropped 21% relative to the European currency. The major Spanish banks have been blaming Europe’s sole currency for most of their ills, because the strong euro means the depreciation of Latin American currencies. That translates into lower revenues when earnings from the region are repatriated to Spain. But BBVA’s purchase of Bancomer demonstrates that a strong euro can also have enormous advantages. On the one hand, shares of Bancomer have risen 111% in peso terms since BBVA injected capital into the Mexico bank in June 2000. On the other hand, when translated into euros, the Spanish bank is now paying only 78 centimos for each share of Bancomer, compared with 74 centimos in 2000.


When BBVA moved into Bancomer in 2000, it bought a 30% stake. BBVA later increased its ownership to the current level of 59.6%. Last year, Bancomer contributed profits of 406 million euros to BBVA. This amounts to 56% of the 715 million euros that Latin America generated for the banking group in 2003. If the Spanish bank finally acquires total ownership of Bancomer, its contribution could amount to between 700 and 800 million euros – or one-third of the 2.227 billion euros that BBVA earned [worldwide] in 2003. That means increased earnings of almost 30% over 2002, when earnings dropped by 27% because of accounting provisions related to the crisis in Argentina.


According to Goldman Sachs, BBVA’s latest move is “strategically positive” for the Spanish bank. However, it warns that “it will raise the volatility of BBVA’s earnings” because the Latin American bank will have a greater impact on BBVA’s overall results. That region is less stable than Europe. For Sebastián, it’s a price BBVA has to pay. “Clearly, with this deal, BBVA is going to increase the volatility of its earnings as well as its risk, but you have to increase your risk if you are going to have greater profitability.”


Is Confidence in Latin America Returning?

More and more, observers are wondering if the latest move by BBVA reflects the definitive return by international investors to Latin America. For Garland, “it’s not a question of the return of confidence in the entire region, but in specific countries such as Mexico or Brazil. You don’t see that confidence in other areas such as Venezuela and Argentina. There are still doubts about Argentina because of [Argentine President] Kirchner’s problems negotiating with the IMF and the freeze in prices of public services.”


In contrast, Sebastián believes the Bancomer deal means that investors once again have faith in the region. “In my view, it clearly shows confidence in Latin America. If you look at the accounting results, provisions for bankruptcy have significantly declined. Long-term, Latin American countries offer interesting opportunities. It’s about markets that are less developed where you can see greater opportunities for growth, even if that also means greater risks.”


Growth projections for the Mexican economy call for a rate of between 2.5% and 3% this year. Next year, the projections are for 3.3%. At the press conference where González made his announcement, he said Mexico “is by a long shot the best economy in Latin America. It doesn’t have any debt or any fiscal deficit.” Moreover, “[Mexico] has nothing to do with other emerging countries.” The president of BBVA emphasized that both Mexico’s GDP and its per capita income are twice as high as Brazil’s.


Although he didn’t name any competitors, Gonzalez was clearly referring to Santander, which has a large stake in Brazil, because of its purchase of Banespa. In that country, BBVA owns only a 4.4% stake in Bradesco, an institution that has a capitalization of 5.2 billion euros.


As Sebastián points out, “In Latin America, Santander and BBVA have introduced traditional products that have had a great deal of success in Spain.” At the outset, BBVA’s strategy for entering the region was based on agreements with local banks that allowed BBVA to control management. That approach changed with BBVA’s purchase of Banco Frances in Argentina in 2001. However, the crisis in that country led BBVA to search for safer markets such as Mexico. Above all, that’s what happened after BBVA reduced its ownership in Brazil by selling shares of BBV Brasil to Bradesco in January 2003.


Although Spain’s two big banks have carved up the two largest financial markets in Latin America, that isn’t because of any desire to avoid excessive competition. “BBVA and Santander are betting on different markets [within Latin America]. But it’s not because they don’t want to compete in the same countries. It is because Santander paid a very high price for Banespa, which BBVA couldn’t offer.”


Industrial Sales

In another key aspect of the Bancomer deal, part of the cost was paid by selling BBVA’s holdings in various industrial firms. Sales of shares have brought in more than 1.4 billion euros. The bank sold its 0.25% stake in Telefónica; 1.2% in Iberdrola, and 2.3% in Reposol. It also sold a 2.3% stake in Gas Natural along with 0.47% of that firm owned jointly with Endesa. Moreover, in recent months, BBVA generated 466 million euros by selling non-strategic shareholdings. It sold 24.4% of Banco Atlántico to Sabadell, 50% of Direct Seguros to AXA and 9.9% of Morocco’s Wafabank.


In Sebastián’s view, “This trend breaks with what we saw ever since the great mergers of Spanish banking, when banks were diversifying by investing in telecom companies and electric utilities, among others. Now we are seeing a move away from investing in growth companies via ownership in industrial firms. Instead, banks are turning toward investments within the financial sector.” What factors are behind this change? “Styles and economic cycles are important. The disadvantage of investing in industrial companies is that it has a double impact on financial results. First, when economic conditions take a downward turn, late payments increase and earnings suffer from an increase in bad checks. Next, when markets fall, that reduces the value of shares that banks own in industrial companies.”


Moreover, the newly emerging rules of Basel II could provide incentives for banks to sell off their industrial shareholdings. These rules, which are being developed to regulate bank solvency, could mean financial institutions have to increase the capital they deploy when they invest in companies if such investments involve high risk.


If Bancomer’s minority shareholders accept BBVA’s offer, and Mexican authorities don’t step in to prevent it, BBVA will acquire total ownership of an institution with nine million customers and 1,650 branches. Bancomer is the leader in the business of providing bank transfers for Mexican immigrants, with a 40% market share. With a market capitalization of 7.75 billion euros, it ranks fourth in the country.


For Sebastián, “the key question is if the [Bancomer] deal creates value. For that to happen, the profitability of the investment will have to exceed the cost of capital. The deal has to give shareholders more than they would get from investing elsewhere. The more BBVA can improve [Bancomer’s] management and raise its efficiency, the more profitable this will turn out for BBVA.”