Chilean banks have benefited from a rare confluence of events in 2014 to book strong profits, which have in turn been used to diversify funding sources and prepare for coming banking reforms. Analysts say the healthy state of the banking market means that upcoming banking reform, which will adopt (for the most part) Basle III regulations to the Chilean market, won’t require extra capital, although banks may still seek to issue hybrid transactions for capital optimization purposes.
Chile’s banks are essentially long inflation – they have more assets than liabilities linked to inflation and, as a result, margins have a positive sensitivity to variations in inflation. In 2014, the falling currency led to a surge in pass-through inflation in Chile. This meant that banks’ funding structures have generated strong returns: Chile’s inflation linked currency the UF (Unidad de Fomento) is still indexed to most of the Chilean economy, including some commercial loans and 99% of the country’s mortgages. As the banks have been selling inflation linked loans and mortgages, the gap between assets and liabilities linked to inflation widens naturally.
The Chilean banks also benefited from the unusual combination of interest rate cuts occurring at the same time as this high inflation. The central bank sees medium term inflation expectations as anchored and has cut interest rates by 200 basis points to try to encourage growth as the economy slows due to falling copper prices. The banks have a negative sensitivity to interest rates as their assets (loans) have a longer duration than their liabilities (deposits). Therefore as the central bank has been cutting rates the banks have been able to reprice liabilities (as they are rolled over) rather than assets – which increases net interest margins.
Santander Chile’s net income in the nine months to the end of September grew 53.6% compared to 9M13, with the ROAE up to 22.8%, compared to 16.6% in the same period the year before. The net interest margin in the period was 5.5% (4.9%).
André Bergoeing, director of strategic planning and finance at Santander in Chile, acknowledges these structural reasons for the bank’s recent strong earnings but also points to internal reasons. “2014 has been a good year for the banks, in some extent thanks to inflation but also due to the fact that demand for loans hasn’t dropped in line with the overall slowdown in the economy,” says Bergoeing. “We have seen a drop in demand for credit from corporates and SMEs but mortgages have remained very strong, and consumer loans to a lesser extent. Santander in particular has also been reaping the benefits from tackling early the quality issues in our consumer credit portfolio – right now we are seeing provision expenses dropping and risk adjusted margins improving.”
|We have a very large share of wallet in investment banking in the country. Our future growth [of these IB revenues] is expected to come from the overall investment banking market growth rather than from a gain in market share
Alfonso Eyzaguirre, JPMorgan
Santander has also been seeking to improve performance by diversifying funding sources and lessening the bank’s reliance on domestic institutional investors. Last year, this strategy saw the bank raise funds in Australia and Japan – opening markets for other Chilean banks to tap. For example, at the end of November, Banco de Crédito e Inversiones raised $140 million-equivalent in Japan, as well as raising a further $156 million-equivalent in Swiss francs.
“Santander has been following a diversification strategy in our funding over the last five or six years in terms of currencies and geographies. We have an EMTM programme in place that allows us to issue in any currency,” says Bergoeing. “The only caveat is that we have is to achieve competitive pricing with regards to local funding. We have to consider the all-in cost but as long as it is cheaper [compared to local] we might go abroad depending on our funding needs. We have changed our funding strategy to rely less on institutional funding and more on core or client deposits – those tend to remain with us for a longer time and are usually cheaper when compared to institutional deposits, thus also helping to enhance margins.”
However, this year promises to be more challenging: inflation is set to fall and interest rates are only expected to be cut by 50bp at most. Meanwhile, BTG Pactual’s Chilean subsidiary is expected to get its banking licence in early 2015, a prospect that Juan Andres Camus Camus, head of BTG Pactual’s Chilean operations (previously Celfin), says will, when combined with a newly capitalized balance sheet, make the bank “a more interesting proposition” to clients when competing with leading international investment banks in the country, such as Deutsche Bank and JPMorgan.
However, Alfonso Eyzaguirre, managing director and senior country officer at JPMorgan in Santiago, is phlegmatic about the Brazilian bank’s challenge, saying balance sheet competition is a thing of the past.
Eyzaguirre is instead looking to compete with Chile’s existing commercial banks to deliver and believes JPMorgan’s Chilean growth, will come in areas other than investment banking: “We have a very large share of wallet in investment banking in the country. Our future growth [of these IB revenues] is expected to come from the overall investment banking market growth rather than from a gain in market share,” says Eyzaguirre, who also expects capital markets deals from Chilean issuers to be muted next year. “Over the last few years we have been building our flow business with local corporates and institutional investors, as well as making significant inroads into treasury services. As a result of these business initiatives we’re making our revenue base more stable and recurrent.”