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Two Brazilian Bank Stocks to Watch

Stocks in this article: ITUB BBD FIS

NEW YORK ( TheStreet) -- Brazilian banks are among the most profitable banks in the world, with an average return on equity of 15%-25%. The country's banking sector and economy are benefiting from the burgeoning middle class. Statistics show that Brazil's middle class is expanding, with 50% of the population (200 million) categorized as middle class. Credit card purchases in the country have been rising at 22% per year, since a decade now.

Banks are the second-best performing sector in Brazil, with the MSCI indicator of financial stocks increasing 34%, as of date from June 30, against the 35% rise in the industrial index, and 14% for the benchmark Bovespa.

We have listed two Brazilian banks -- Itau Unibanco Holding (ITUB) and Banco Bradesco (BBD), with potential upsides in the future, supported by the country's strong banking sector.

JPMorgan Chase and Credit Suisse foresee Brazilian banking stocks benefiting from interest rate hikes. As per the median estimate of a central bank survey of 100 economists, it is likely that policymakers will raise the benchmark interest rate to 12.25% in 2011 from the current 10.75%, in order to combat spiraling inflation, which is currently hitting 28-month highs.

Credit Suisse has raised banks' ratings to overweight, as higher lending rates will boost earnings.

Marcelo Gil de Souza, global head of Accenture's Corporate Strategy, says the rate of home mortgage loans is growing rapidly, although from a small base. Home mortgages are expected to experience the best movement in Brazil over the next few years. Currently, real estate credit accounts for only 3% of GDP, while total credit to GDP is at 45%. Accenture believes that the growth in the mortgage market will narrow the existing gap. By year-end, overall bank credit is estimated to reach 48% of GDP, a 22% jump from 2009 levels.

During October, outstanding loans were up 1.9% month on month and 20.3% year over year, as per Brazil's central bank data. Lending to the private sector rose 2% on a monthly basis, while housing loans to individuals and housing cooperatives grew 3%. The average interest rate on consumer credit stood at 40.4% in October, compared to 39.4% in September, increasing for the first time in three months.

Credit operations of financial institutions are on a positive trend, coupled with favorable developments in income and employment levels, as per the central bank. This has led to demand growth in investment and working capital of not only enterprises, but also household consumption of durable goods, the bank added.

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