Santander’s geographic spread matched with painful exactness those regions and countries hardest hit by Covid-19: Spain, the UK, Brazil and the US.
Partly because of this, its shares underperformed every other big bank in Europe over the year to its third-quarter results, falling to a 30% discount to book value.
This is a big change even from two years ago, when Santander was one of the continent’s highest-valued banks, trading at a 30% premium to its book value. Is a post-Covid turnaround at hand?
A goodwill impairment charge of €12.6 billion and loan loss provisions of €3.1 billion led to a loss of €10.8 billion in the second quarter, but Santander bounced back to a profit of €1.75 billion in the third.
After the third-quarter results, a better-than-expected loan loss of €2.5 billion and a pledge to cut another €1 billion of its costs in Europe over the next two years, KBW and long-time Santander bears Berenberg upgraded their recommendations on the bank to hold.
With good news on Covid vaccines following shortly after, Santander’s share price rose by about a third in November, outperforming all its peers, with the notable exception of arch-rival BBVA.
‘One Santander’
More importantly, Santander’s new costs pledge reflects a push to generate more international synergies, a project executive chairman Ana Botín dubs ‘One Santander’.
Doing more to share its technological capabilities internally is vital, says chief executive José Antonio Álvarez.
“Retail is a local business; it will still be managed by the local subsidiaries. But new technology is allowing us to have more commonality in the mid and back office.”
Ideally, One Santander could give investors new reason to own the bank, beyond its geographic diversification. The group’s biggest problem is that while efficiency is the name of the game in banking today, especially in Europe, achieving economies of scale is easier in a big single market.
This conundrum is not easily solved. Botín’s late father Emilio did not build a global digital bank, he acquired incumbents.
Diversification still plays to our favour
José Antonio Álvarez, Santander
Those banks’ lack of connections – between the UK and Spain, for example – was even an advantage, as it meant they were less correlated. But over the last decade investors have increasingly questioned Santander’s justification of a relatively low capital ratio because of its cross-border setup.
Covid-19 has made this situation worse by dragging down Latin American currencies and hurting bank earnings everywhere Santander is present. It is making it even harder to argue that its geographic spread can provide better business stability than rivals.
Furthermore, BBVA’s share-price boosting sale of its US business could make Santander’s capital ratio appear even more of an outlier. Finding synergies between the group’s two biggest European banks will also be harder due to Brexit.
The big second-quarter loss may have finally scuppered Santander’s claims about its relative quarter-on-quarter earnings volatility versus peers. The markdown, however, was not due to the short-term effects of the coronavirus, rather, it was mainly to write off goodwill associated with Emilio Botín’s acquisitions, mostly in the UK but also in the US and Poland.
The pandemic made the old value ascribed to those assets even less tenable.
Serious implications
Before the outbreak, the UK business was particularly exposed to a mortgage price war. Covid-19 has made ultra-low rates even more entrenched. Talk of negative Bank of England rates, US Federal Reserve rate cuts and nose-diving interest rates in Brazil and Mexico all have serious implications for Santander’s profit margins.
Quite how much the bank will have to write off in loan losses over the next few years remains uncertain. According to Álvarez, however, lower rates are relatively helpful in Brazil, where the number of retail defaults is at the lowest level in almost a decade.
“Brazil has been living in a world of interest rates of between 10% and 20%; now suddenly they’re at 2%,” he notes.
Indeed, lower expected credit losses in Brazil were a big factor in those better-than-expected third-quarter results.
“The investor view of emerging markets, especially Latin America, is fairly negative,” says Álvarez. “But what our results highlight is how well Brazil is performing.”
He notes Mexico’s underlying attributed earnings in the first nine months of 2020 were roughly flat on 2019, with Brazil down 11% but Europe down 44%.
“Diversification still plays to our favour,” insists Álvarez.
Nevertheless, in the context of a weaker global economy Santander’s structurally weak profitability in the US and the UK, and in parts of its continental European business, requires more attention.
“Productivity gains are a must in a world of ultra-low rates,” Álvarez admits.
This is not just about cutting frontline staff in places such as the UK. According to Álvarez, it is also about rationalizing products and interfaces – going from three European credit card apps to one, for example – and moving those products and clients to a cloud-based IT system.
As part of this, the bank will also do more to integrate data gathering and control functions such as credit scoring and anti-money laundering controls.
An international approach to technology similarly informs the banks’ decision in October to combine its cloud-based digital arm, Openbank, with Santander Consumer Finance.
Meanwhile, the bank took a decisive step in its efforts to build a global payments business in November when it announced the acquisition of technology from bankrupt German fintech Wirecard.
That should accelerate the European expansion of Santander’s previous Brazil-focused merchant acquiring business, Getnet.
