The merger announced yesterday will have repercussions outside of the Brazilian stock market. Banco Itaú Holdings S.A. (U.S. ADR: ITU) and Unibanco (ADR: UBB) will merge in an all stock deal to form Itaú Unibanco Holding S.A. The merger will have a ripple through emerging market stocks because:

• The newly formed bank will be the largest in Brazil.
• The bank will be the largest in Latin America.
• The bank will be the largest in the MSCI Emerging Markets Index

I consider the last bullet to be of some importance because the MSCI Emerging Markets Index is the benchmark for the widely held ETF the iShares MSCI Emerging Markets Index Fund (EEM). Itaú Unibanco is setting itself to become the banking powerhouse of Latin America.

The news had a positive impact on the Brazilian market, with the Bovespa gaining 2.7%. Itaú shares gained 14% and Unibanco tacked on 10%. Rival bank Banco Bradesco (BBD) tacked on 4.4%. Bradesco will be losing its place as the largest non-government owned bank in Brazil when this merger is completed. Before yesterday's news Brazilian stocks and these bank shares had fallen 25% to 40% year-to-date on the Brazilian exchange and the ADRs even further on the recent softening of the Real (Brazil's currency).

The new Itaú Unibanco will have total assets of $265 billion and a market capitalization of about $40 billion. For comparison, this asset base would make it the 6th largest bank in the U.S. While Unibanco has been struggling, Itaú has earned $3.7 billion in the first nine months of 2008. The more profitable run South American banks have profits that U.S. based banks can only dream of. For the first 3 quarters of 2008 Itaú had a ROE of 26%, return on assets of 2.4%, net interest margin of 10.4% and an 147% loss reserve coverage of non-performing loans.

I believe the growth engine of South America still has gas and the predictions of 5% annual economic growth for the region seem plausible. The new Itaú Unibanco banking conglomerate will have tremendous opportunities to generate growth. Also, competitors Banco Bradesco (BBD) and Spanish banking giant Banco Santander S.A. (ADR: STD) will be looking to grow through acquisitions. Banco Santander has a deep presence in South America and entered the Brazilian market a year ago with the stated goal of becoming the most profitable bank in the country. These banks have had their stock values driven lower as investors shun banks worldwide on fears of the widening financial crisis. I think the fears are overblown in regards to these Latin American banks and their stocks look very attractive at current valuations.