Santander's LatAm units a key crutch in effort to recover from 1st annual loss

As Banco Santander SA toils to recover from its first-ever annual loss, there will likely be a greater onus on the Spanish bank's major subsidiaries in Latin America to deliver return on equity and net income over the coming quarters.

Provisions related to the coronavirus pandemic, write-downs and a €12.6 billion noncash, nonrecurring impairment charge weighed heavily on the group's results in 2020, pushing it to an attributable full-year loss of €8.77 billion from a profit of €6.52 billion in 2019.

With the bank aiming for a rebound in profitability this year, it could nudge units in Latin America to produce greater revenue growth than subsidiaries in other regions, Domingos Falavina, head of Latin America financials research at JP Morgan, said in an interview.

Santander's Latin American operations have been important cash cows in recent years, in part due to the region's comparatively higher interest rates. That geographic diversification has allowed the company to mitigate the impact of sluggish economic growth and a low rate environment in Europe.

"The fortunes of Latin America, and specifically Brazil, will be vital to Santander's prospects," Morningstar equity analyst Johann Scholtz wrote in note following the release of the bank's 2020 results. "Credit growth will be higher in Latin America than in Europe, which positions Santander on a different growth path to most other European banks."

Counting on Brazil and Chile

While the Brazilian economy has been hit hard by the COVID-19 crisis, Santander still expects its Brazilian subsidiary to keep offsetting margin pressure at other units and support loan growth in 2021.

On the bank's fourth-quarter 2020 earnings call, CEO and Vice Chairman Jose Antonio Alvarez Alvarez said the company is targeting double-digit revenue growth this year at Brazilian unit Banco Santander (Brasil) SA. Continuing market share gains in agribusiness loans and auto financing, as well as the performance of Brazilian payments business GetNet — due to be separately listed later in 2021 — will be among the main drivers of growth, the executive said.

While not as sizeable as Brazil, Santander's Chilean operations will also prove important to the group's overall recovery.

A net interest margin of above 4% and a decline in provisions and cost of risk should allow Banco Santander Chile to show a return on average equity of above 15% in 2021, up from 14.36% last year, according to Credicorp Capital analyst Sebastián Gallego Betancur. That would represent "one of the best profitability levels out of any bank in the Andean region," the analyst said in an interview.

Growth in Santander Chile's consumer loan book in a post-pandemic scenario should help improve spreads and boost cross-selling, while fiscal stimulus from the Chilean government and a world-class vaccination campaign will also aid recovery, Gallego Betancur added.

In Mexico, where the economy suffered its sharpest contraction in decades last year and where certain government policies have negatively impacted investor sentiment, local unit Banco Santander México SA is likely to take a conservative stance in an effort to avoid a pile-up of bad loans, according to Luis Alvarado, an equity analyst at Banco Base.

"For the time being, Santander Mexico will probably continue to focus on more defensive and lower risk credit segments, such as mortgages, auto financing and payroll, while commercial and consumer will decline," Alvarado said.

No need for major cost cutting in LatAm

While some cost-cutting will take place in 2021, it will mainly focus on Santander's more mature European markets, where the bank sees greater room for expense reduction, said Cristina Torrella, senior director for Spanish financial institutions at Fitch Ratings. Santander in late 2020 signed an agreement with unions to cut 3,572 jobs in Spain and close nearly a third of its branches in the country.

The company last year recorded efficiency ratios, or noninterest expenses divided by revenue, of 32.6%, 42.5% and 39.8% in Brazil, Mexico and Chile, respectively. The ratios were close to or even better than the bank's medium-term targets of 35% for South America and 40% for North America, as per the bank's latest earnings presentation.

By contrast, the efficiency ratios in the U.K. and Spain were 60.9% and 53.2%, respectively, considerably higher than the 45% target for Europe.

Given that Santander Brasil's branch footprint is smaller than its Brazilian competitors, JP Morgan's Falavina said cost reduction efforts at the Brazilian unit would only be necessary if fee pressure rises substantially due to stiff competition from financial technology firms.

"If management in Latin America, especially in Brazil, which is the most relevant LatAm operation for Santander, is delivering earnings growth driven by revenue, the pressure is not going to be large on expenses, simply because the ratio will improve based on the denominator," Falavina said. "The pressure will be to deliver more ROE and net income growth than their peers, not necessarily on cost reduction."