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Santander lowers forecasts for UK, but analysts see light in emerging markets

has cutearnings forecasts for its British unit in the wake of the U.K.'s vote to leavethe EU, but analysts highlighted the earnings potential of emerging marketssuch as Brazil, where return on tangible equity is still expected to meettargets set out a year ago.

In aSept. 30 investor update, the Spanish lender said the "new macroeconomicscenario" prompted it to revise its 2018 ROTE guidance for to between 8% and 10%, down from the 12% to 14% it had projected in September2015. The unit reported first-half 2016 ROTE of 10%.

Santanderalso tweaked the targeted 2018 cost-to-income ratio for the U.K. subsidiary tobetween 50% and 52%, compared to under 50% in the original plan and 53% in thefirst half of 2016. The division will also now aim for a nonperforming loanratio of under 2% in 2018, an increase of half a percentage point relative tothe previous target.

Worsening environment

Thedownward revision of the ROTE target for the U.K. unit was attributableprimarily to lower interest rates putting pressure on margins, said GVC GaescoBeka equity analyst Javier Bernat, who noted in an interview that despiterevising its earnings guidance, Santander had not presented a new strategy forits British unit. He said no revamp was needed given that the marketenvironment, rather than any strategic flaws, prompted the outlook revision.

Intheir presentation on the U.K. business, Santander executives did not allude tothe recent revision of the interest policy on the U.K. division's 1-2-3 currentaccount, which saw the bank halve to 1.5% the rate it pays on account balancesbetween £3,000 and £20,000. The account had been the bank's main driver of newbusiness in the country, according to an Aug. 29 Financial Times report, which also pointed out that the associatedcosts had been £1 billion a year.

Bernatsaid, though, that the changes will not significantly impact Santander's U.K.business, given that small and medium-sized business customers are moreimportant than retail clients.

Emerging markets to the rescue

Santanderalso nudged down targets for its Spanish business, saying it would aim for ROTEof 13% by 2018, instead of 14%, and a cost-to-income ratio of around 55%,compared to the previous 50% target and up from 53% recorded in the first halfof 2016.

However,Santander still expects ROTE at Banco Santander (Brasil) SA to rise to around 17% in2018, compared to 14% in the first half, and the unit's cost-to-income ratio tofall to 37% from 39%.Haitong Research analysts pointed out in an Oct. 3 note that Santander was alsoconfident about the performance of its Mexican and Chilean units, with the ROTEforecast for 2018 raised slightly to 17% from more than 16%.

"Themessage on Brazil remains one of confidence, stressing that the worst is behindthem, and supported by the recent government change, higher FX stability andseveral quarters where Santander Brazil has outperformed the market," theywrote.

Bernatsaid the diversification of Santander's business in the past few years waspaying off in the current market environment, adding that units in emergingmarkets such as Brazil had the potential to make up for any declines inprofitability in the U.K. or the U.S.

On agroup-wide basis, Santander nudged down its ROTE target to above 11% from 13%and tweaked its cost-to-income ratio guidance to between 45% and 47% from below45%. Yet it said it continues to target double-digit EPS growth, a yearlyper-share dividend increase and a cash dividend payout ratio of 30% to 40% by2018.

Thebank's targeted common equity Tier 1 ratio remains 11% by 2018, somethingHaitong's analysts described as conservative in the context of Santander'sexpectation that it can organically generate 10 basis points of capital aquarter — enough, in theory, to reach 11% by the end of 2017. But they said the"conservative" approach was likely down to the implications ofBrexit, a potential rise in foreign-exchange volatility, the risk of a further— if unlikely — fall in interest rates and the potential capital erosion posedby new international regulatory standards that have been dubbed "".

Haitongsaid Basel IV could hit Santander's capital position if risk weights onmortgages were to rise past about 18% and if surcharges to account for bigbanks' operational risks exceed the lender's expectations.

"However,after various reviews by regulators, Santander expects a broadly neutral impactfrom Basel IV and in any case an impact lower than that of its peergroup," the analysts added.