DESPITE CRISIS, MORGAN STANLEY BULLISH ON BRAZIL

UNCLAS SECTION 01 OF 02 SAO PAULO 000621 SIPDIS SENSITIVE STATE FOR WHA/BSC, EEB/CBA DEPT OF TREASURY FOR JHOEK, BONEILL E.O. 12958: N/A TAGS: EINV ECON EFIN ETRD EAGR BR SUBJECT: DESPITE CRISIS, MORGAN STANLEY BULLISH ON BRAZIL REF: A. 07 Sao Paulo 832; B. Sao Paulo 483 SENSITIVE BUT UNCLASIFIED ¶1. (SBU) Summary: On November 10th, Ambassador Sobel met with the senior Brazil management of Morgan Stanley to discuss the firm's prospects and how the firm is weathering the current financial downturn. Management reported that while they expect mergers and acquisition activity to be brisk, certain business lines, including stock trading and equity issuances will be down significantly. Despite this, Morgan Stanley remains bullish on Brazil and lists Brazil as its top emerging markets investment opportunity. Senior management also noted that they are starting to see a significant reduction in new consumer credit loans due to interest rate ceilings on loans to retirees. End Summary. MERGER ACTIVITY PROMISES TO BE BRISK - - - - - - - - - - - - - - - - - - - ¶2. (U) On November 10, Ambassador Sobel met with Charles Stewart, Head of Latin American Investment Banking and Daniel Goldberg, Head of Mergers and Acquisitions for Morgan Stanley. Goldberg re-affirmed prior statements that mergers and acquisition activity in Brazil continued to be strong - especially in the financial and telecommunications sector. Using the Banco Itau merger with Unibanco as an example, he pointed out that many financial players are consolidating as a defensive measure. He noted that Banco Itau was a large bank with a $30 billion market capitalization and a strong balance sheet prior to its merger. However, despite its relative strength, it was suffering from customer withdrawals after the financial crisis hit. While the banks insisted that they had been in discussions long before the merger was announced, Goldberg opined that Unibanco was likely driven into the merger by fear, and Itau wanted to reassure its shareholders and depositors that it had the strength and scale to weather the current financial storm. ¶3. (U) Goldberg indicated that the financial crisis would also affect the way companies paid for their acquisitions. While in more normal markets, cash deals are very common and are used as incentives to shareholders to approve a merger, he expects the volume of stock-for-stock deals to rise in the coming months. As the number of "survival deals" increases and companies hoard cash to maintain a strong balance sheet, he anticipates that stock, not cash, will be the acquisition currency du jour. TRADING REVENUES EXPECTED TO FALL SHORT - - - - - - - - - - - - - - - - - - - - ¶4. (SBU) Morgan Stanley and Credit Suisse share the title of top traders on the BOVESPA (Brazilian Stock Exchange). Morgan Stanley is expecting that, in 2009, both the volume of trading will decline and, as market values remain low, the profitability of the trades will decline as well. They are assuming trading profits for customer accounts will be down 40 percent next year. He noted that Morgan Stanley also expected significantly reduced trading profits from its proprietary trading accounts (stock trades for Morgan Stanley's own account). BRAZIL REMAINS THE BEST OF THE BRICS - - - - - - - - - - - - - - - - - - - ¶5. (SBU) Stewart stated that while Morgan Stanley expected profits to be down in Brazil in 2009, the firm remained committed to the Brazilian market. He shared that Morgan Stanley's research department tracks over 150 emerging market nations and that Brazil is the top investment pick in the group. He expects to see a rotation of money out of Russia and the Middle East and into Brazil as investors grow disillusioned with the lack of profitability of their other emerging markets investments. Stewart noted that within the past month, billionaire real estate investor Sam Zell invested another $50 million in Brazil. (Comment: Econ/Poloff was unable to independently verify the size/type of investment made by Mr. Zell although public filings indicate that he recently increased his stake in Brazilian real estate developer, Gafisa, to over 18 SAO PAULO 00000621 002 OF 002 percent. End Comment). THE LAW OF UNINTENDED CONSEQUENCES - - - - - - - - - - - - - - - - - - ¶6. (SBU) Goldberg noted that originations of new consumer credit loans fell by 90 percent in October. He explained that a significant portion (28 percent) of consumer financing to Brazilian middle and low-income earners is repaid through automatic payroll or pension deductions (credito consignado) (Ref A). In an effort to protect its retired population from usury, the Instituto Nacional do Seguro (INSS),the Brazilian Social Security Administration, mandated that interest rates to retirees be capped at 2.5 percent per month. While this was not a problem in a relatively lower interest rate environment, tighter credit markets are driving up consumer credit rates (approximately 80 percent per year on fixed-rate consumer loans),making it uneconomic for banks to lend to the retired population. (Note: See Ref B for more on credit and interest rates in Brazil. End Note.) Goldberg referred to the result as proof of "the law of unintended consequences" - INSS attempts to protect its retirees from high interest rates has resulted in them being shut out of the current credit market. (Note: Analysis of the growing credit market and whether concerns are warranted regarding recent increases in nonperforming consumer loans will be forthcoming Septel. End Note.) ¶7. (SBU) Comment: The observations of Morgan Stanley senior management reinforce market commentary that Brazil maintains investor interest despite the market downturn. More troubling, however, are Goldberg's comments regarding the tightening of the consumer credit market and whether this indicates a more serious credit problem longer term. Post will continue to monitor this situation and report on any possible negative impacts this tightening credit could have on the overall economy. End Comment. ¶8. (U) This cable has been cleared by Ambassador Sobel and coordinated with the U.S. Treasury Financial Attach in Sao Paulo. WHITE