DBRS Comments on Banco Santander SA’s Q2 2009 Results; AA Rating Unchanged

DBRS has today commented on the Q2 2009 results of Banco Santander SA (Santander or the Group). DBRS rates Santander’s Senior Unsecured Long-Term Debt & Deposits at AA with a Stable trend. Despite the difficult operating environment, Santander continues to generate solid operating results. The Company reported attributable profit to the Group of EUR 2.4 billion in the quarter, an increase from EUR 2.1 billion in the prior quarter and down marginally from EUR 2.5 billion in Q2 2008. On a linked quarter basis, higher net interest income and expense control boosted net operating income, or income before provisions and taxes (IBPT), to EUR 6.1 billion in the quarter, which helped Santander to absorb increased provisions and asset impairments of EUR 2.7 billion.

Revenue growth was largely driven by net interest income, which jumped 9.6% quarter-over-quarter and 25.9% versus the prior year’s quarter, boosted by the consolidation of acquired entities, the maintenance of customer spreads and loan growth. While the overall customer spread earned on loans and deposits declined by 26 basis points (bps) due to a decline in the spread earned on deposits, the customer spread earned on loans increased by 14 bps. Fee income increased 9.7% on a linked quarter basis, but was up only 5.4% versus the prior year’s quarter, as volumes were down.

The Group’s expertise in controlling costs and realizing the expected synergies of integrations was evident in the quarter. Operating expenses grew just 3% on a linked quarter basis and 10% year-over-year, even with the ongoing integrations of Sovereign Bank in the U.S., Banco Real in Brazil, Bradford & Bingley and Alliance & Leicester in the U.K, and GE and RBS in Germany. Santander’s efficiency ratio improved to 41.6% versus 43.9% a year ago as the Group realized expected synergies with these acquisitions. As a result, IBPT increased by 15.3% quarter-over-quarter and 21.6% year-over-year to EUR 6.1 billion.

With the economies across Santander’s footprint, such as Latin America and Mexico, slowing and non-performing loans (NPLs) in Santander Consumer Finance (SCF) rising rapidly, asset quality weakened substantially in the quarter. NPLs increased to EUR 21.8 billion, up 15% quarter-over-quarter and up over 150% year-over-year, driving provisions to a record EUR 15.7 billion. With a 72.3% total coverage ratio, which includes generic provisions that provide a cushion during the downturn, the Group is well-prepared to handle further deterioration. At 44.0%, the Group’s specific coverage ratio (i.e. excluding generic provisions) is down only moderately from the prior quarter (46.9%) and the prior year’s quarter (45.6%), as Santander has only recently begun to use its generic provisions. Santander’s capitalization is the strongest of its Spanish peers, with a Tier 1 capital ratio under Basel II of 9.4% and a core capital ratio of 7.5%.

Santander intends to use various transactions to support its capital ratios and add to its generic provisions. In Q2 2009, capital gains of EUR 262 million from the Company’s participation in the IPO of Visanet and proceeds from the sale of its 32.5% stake in Cepsa were used to bolster its generic provisions. Additionally in the quarter, the Company announced an offering to exchange certain of its outstanding hybrid securities in an effort to manage capital efficiency and strengthen the balance sheet. Capital ratios will be maintained with the new issues and any capital gains generated will be added to generic provisions.

Separately, the Group announced today its plan to combine its consumer finance business in Poland with that of AIG, of which Santander will hold a 70% stake in and full management of the combined entity. As Santander has demonstrated a proven ability to integrate entities efficiently and successfully, DBRS views this combined entity as a positive development for the Group. The resulting entity will be one of the top players in the Polish consumer finance market and will benefit from AIG’s leading positions in personal loans, credit cards and deposits combined with a strong distribution network, which complements well with Santander’s strength in the auto financing business.

DBRS maintains a Stable trend on Santander’s ratings, incorporating the Group’s solid recurring earnings generation, strong risk management and conservative culture, which is evident in the current economic downturn. With its broad, diversified franchise and successful integration of acquisitions, the Group is better positioned than many large institutions, not only to weather this economic down cycle, but to benefit from market dislocations and constantly changing competitive environment. While DBRS remains concerned that Santander is facing a significant period of elevated credit costs, the Group has conservatively provisioned and should be able to continue using generic provisions at the current pace for at least two years. If credit performance deteriorates more extensively than anticipated or significant losses emerge in the Company’s business and corporate exposures, the Group’s ratings could come under negative pressure. DBRS continues to monitor for Group’s reserve levels and capitalization, as significant signs of weakness could also negatively pressure ratings.

Note:
All figures are in Euros unless otherwise noted.

The applicable methodologies are, Analytical Background and Methodology for European Bank Ratings, Second Edition and Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments, which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.