(Recasts to add potential Citigroup bid, details, comments throughout)
By Guillermo Parra-Bernal and Aluísio Alves
SAO PAULO, July 27 (Reuters) - Banco Santander Brasil SA could gradually disburse more loans and possibly seek an acquisition, executives said on Wednesday, as early signs of a turnaround in Latin America's largest economy translated into stronger-than-expected second-quarter profit.
The outlook for credit demand in the second half of the year looks better as economic and political turmoil eases, Chief Executive Officer Sérgio Rial said at an event to discuss results. Santander Brasil will probably bid for Citigroup Inc's local unit, although at a reasonable price, Rial said.
Rial pointed to better retail data and signs of a revival in stock offerings to reflect the recovery in Brazil, which is struggling with the harshest recession in eight decades and fallout from President Dilma Rousseff's ongoing impeachment proceedings.
"We foresee a more positive scenario" for the rest of the year, Rial said. On Wednesday, the central bank said loans in arrears in Brazil fell for the first time in a year in June.
Rial's strategy of charging more for loans and financial services helped Santander Brasil offset weak disbursements and post the biggest quarterly profit in five years.
Net income, excluding one-time items, totaled 1.806 billion reais ($551 million), beating the consensus estimate of 1.397 billion reais, as compiled by Thomson Reuters.
Santander Brasil's beat buoyed results at parent Banco Santander SA of Spain, which posted profit slightly above expectations. Executives at the Madrid-based bank expect Brazilian loan defaults to peak by the end of this year.
Still, gains in Santander Brasil's units lost steam in late-morning trading, suggesting investors fear default risks still lie ahead for Brazil's biggest foreign-owned lender.
Some investors worry that the bank's assumption of a recovery may be ill-timed, as the recession forces lenders to reclassify hundreds of troubled corporate loans, Also, a doubling in bankruptcy protection filings this year is hobbling lenders with a deluge of requests to renegotiate loans.
While the benchmark, 90-day default ratio fell last quarter, Santander Brasil stepped up refinancings, reversed 400 million reais in provisions and sold bad loans to mitigate rising early delinquencies, said Marcelo Telles of Credit Suisse Securities.
Early defaults, or loans in arrears between 15 days and 90 days, rose due to the reclassification of an unidentified corporate client, Rial and other executives said, noting that there was no "across-the-board deterioration of the indicator."
"While we are unsure about provisions on this exposure, we believe it will likely impact 90-day ratios next quarter," said Domingos Falavina, an analyst with JPMorgan Securities.
Return on equity, a measure of profitability for banks, hit 13 percent, beating the 10.3 percent consensus estimate for the quarter.
Interest income topped the consensus estimate by 3 percent, while fee income beat the consensus by 6 percent, partly because of Rial's loan and fee repricing efforts. Still, Falavina said such price hikes might have reached a limit as the central bank prepares to cut interest rates in coming months. ($1 = 3.2768 Brazilian reais) (Editing by W Simon and JS Benkoe)