Investment banks have seen a profitable first half in LatAm with overall wallets swelling after a strong run in equity and bond offerings, as well as steady transaction flow for M&A and loans. But they are facing an increasingly uncertain environment going into the rest of 2011 as risk aversion spikes on worries about global growth and as fees shrink amid tougher competition in places like Brazil.

Brazil is starting to lose some of its luster among banks that earlier rushed to establish beachheads in the region’s largest economy. Unsurprisingly, fees have shrunk in that country as more and more institutions compete for the same plain-vanilla business.

Having a presence in Brazil may be pivotal for growth strategies, but both local and international banks are looking at the larger pan-regional picture as well.

“The Brazil profitability equation is changing,” says Facundo Vazquez, a managing director on Bank of America Merrill Lynch’s ECM team. “Even though Brazil is still the most relevant market in the region in terms of volumes and aggregate fees, it is becoming more important to be involved outside of Brazil.”

This holds just as true for the Brazilian banks, which for many foreign players are seen as their biggest competitors these days. Brazilian banking giant Itaú continues to expand abroad, and BTG Pactual announced in August that it would merge with Chilean shop Celfin to create what it believes will be Latin America’s largest investment bank.

Long-term Optimism

Senior bankers are clinging to the prospects of long-term growth, but the immediate horizon looks less promising. European debt problems and concerns about a double dip recession in the US have the potential to slow capital inflows into the region, and put equity and bond offerings on the backburner. M&A may be the bright spot as activity remains robust but fees are shrinking as more and more banks compete in this space as well.

For the most part, corporate, LatAm corporates can afford to wait and the assumption is that the pipeline will start moving once markets settle down.

“We have had a strong first half and a record pipeline which makes us very optimistic,” says Pedro Chomnalez, head of LatAm investment banking at Credit Suisse.

This comes after another profitable first half for the Swiss bank, which once again is number one in terms of overall wallet. Indeed, with IB revenues at $152 million year to August 18, Credit Suisse has exceeded the $110 million level it achieved over the same period last year, according to Dealogic.

The trend has been similar for other leading banks working in the region. This is hardly surprising given how robust business has been across the IB spectrum after the region’s economies got into full swing after the global financial crisis.

M&A activity in the year to August 19 outpaced last year in terms of sheer number of deals, though the dollar size was smaller, totaling $98.57 billion versus $154.02 billion over the same period in 2010.

The pace of bond issuance has been strong, despite some intermittent lulls. Volumes as of August 26 hit $91.95 billion from 224 transactions, putting them within spitting distance of beating last year’s record. Equity and loan volumes also reached $23 million and $29 million, marking 18% and 33% increases.

Some businesses will inevitably lose their stride even during what is typically a busy September. The biggest question mark hangs over public equity issuance after several companies struggled to price within range or simply cancelled deals.

Waning economic activity in the US and Europe may have heightened risk aversion and left stock markets vulnerable to excessive swings, but in some ways this could benefit Latin America, as investors look to put their money to work in higher growth economies.

Fed Chairman Ben Bernanke’s promises to keep hands off rates over the next two years may be enough to goad investors into the arms of higher-yielding EM instruments.

“I am of the camp that if anything economies like ours should do well,” says Jean-Marc Etlin, vice president for investment banking at Itaú BBA. “Given the relatively low returns offered by perceived safe asset classes such as gold or Swiss franc, some of these funds will be put back to work in Brazil, once the risk aversion levels abate.”

In the meantime, however, the gloomy mood pervading market sentiment is likely to put a dent in what has been a profitable year. The region may be better prepared to weather external shocks but it still relies on foreign capital for growth. Yet few bankers are predicting a shut down of activity.

“Growth could be impacted by external volatility especially if it impinges on companies’ ability to raise funds abroad. Companies need to be mindful that when there are windows they should consider them carefully,” says Daniel Wainstein, head of Brazil investment banking at Goldman Sachs.

Indeed, if a flight to safety bid for US Treasuries keeps yields lower, this could spur high-grade names to venture forth to lock in record low rates.

Finding funding solutions

The story is likely to be different for new names and high-yield credits. Yet it is this sub-segment of the corporate universe that holds most promise.

Etlin points out that in Brazil there are 400 listed companies but another 800 unlisted companies with $100 million-plus in revenues. “If the country continues to grow, it is natural to think these companies will require capital that will come through the local, dollar debt or equity markets,” he says.

Itaú is clearly not the only bank thinking this way, and many others are expanding their coverage to include small and medium sized companies as they look beyond the standard layer of blue-chips.

Often it is here where pure investment banks believe they can hold sway over powerful commercial banks that deploy large balance sheets.

The more arcane areas of structured credit and leverage finance can be high revenue generators as banks help growth companies that don’t necessarily have the size to access the public markets.

Expanding into M&A

This comes at a time when more and more banks are beefing up their M&A teams in the region, as activity increases.

“It has been a quiet year (for M&A) although it has picked up,” says Mark Rosen, who heads Latin American investment banking at Merrill Lynch. “This is partly because valuations in the equity market have been robust across the region and therefore companies saw an opportunity to raise capital and grow, not necessarily sell.”

It is questionable whether lower valuations will change this dynamic, but the playing field is looking increasingly interesting. Everything from consolidations within local sectors, to US and European companies seeking to acquire or even divest high-growth Latin American assets is part of the equation.

“We see a lot of Latin American companies looking for assets in the US,” says Gerardo Mato, CEO of HSBC global banking, Americas. “The US is still the largest economy in the world. It may get bumpy but it still has a lot to offer.”

Not only are LatAm companies looking to gain a foot hold globally as they search for bargains on the back of strengthening currencies, but they are also expanding within their own region.

“We are seeing a lot more intra-regional LatAm M&A activity,” says Martin Werner, Goldman Sachs’ head of LatAm investment banking, ex Brazil. “The growth of domestic stock markets will only strengthen this trend more.” LF