- by GJ Prasad
LATAM is where it is growing…
SANTAN delivered in line earnings this morning driven by growth in its LATAM franchises and consumer finance businesses in Europe. For the year 2018, net income increased by 18% to EUR 7.8 billion, translating to a ROE of 8%.
SANTAN is now becoming more and more reliant on LATAM, which now contributes to more than 40% of overall earnings. And it is seeing earnings pressure in its domestic market and in UK. There is nothing to suggest that these trends will reverse anytime soon.
The overall ROE of 8% is a bit low for the bank’s business model especially when compared to its cost of equity (which I think is in the double digits). Whilst these are good earnings numbers it should not be a surprise to see where the real drivers are coming from – strong growth in LATAM (especially in Brazil) and low credit costs. It remains to be seen if both these trends hold up.
Good credit fundamentals thus far..
Asset quality continues to firm up with NPLs declining to 3.73% and loan loss reserve coverage at 67%. The real estate portfolio in Spain is also getting cleaned-up reflecting progress post the Popular acquisition. Going forward, expect a normalization of credit costs (which seem low) if growth slows down in the main markets and more so in the consumer finance business.
Whilst liquidity is not an issue given the high LCR of 160%, the reliance on wholesale funding is still a negative given the loan-to-deposit ratio of 113%. Though the bank is focusing on meeting its TLAC/MREL requirements, this reliance on wholesale funding could yet result in margin pressure.
Capital ratios are moving towards the bank’s end state targets with CET1 ratio now standing at 11.3% and leverage ratio of 5.1%. But given the exposure to LATAM, consumer finance business and potential capital trapped in the UK, the parent bank may yet need more capital buffers for a unexpected sharp downturn and it seems that the bank hopes to raise that through internal capital generation (by the way, they have generated internal capital – post distributions – of almost EUR 10 billion in last 3 years). To some extent, it is the leverage situation at the parent bank level that needs attention.
Issuance plans reveal
That brings me to the most important issue – still no announcement on AT1 call decision until now and we will have to wait and see how that plays out. But critically in their 2019 funding plan they do mention two important things – 1). EUR 1.5 billion of hybrid issuance and 2). NO issuance of non-preferred senior.
They would like to issue EUR 3 to 5 billon of covered bonds and a similar EUR 3 to 5 billion of preferred senior paper this year. Given this, the existing non-preferred senior should perform very well and we should see a compression in spreads between preferred and non-preferred senior debt.
In conclusion, another year of decent earnings and good balance sheet management in terms of asset quality, liquidity and capital. But, underlying market concerns about their exposures in LATAM, and a potentially levered balance sheet at parent bank level are not going to go away any time soon.
From an equity perspective, with the stock trading at P/TNAV of almost 1.05 times, it seems to be fully valued for the current moment. And from an AT1 perspective, yields of 6.5% and above are probably needed to compensate for the tail risks. The most value seems to be in the existing NPS debt, given no more issuance this year (as per their funding plan).