DBRS Confirms Banco Santander’s Ratings at AA, Trend Remains Stable

DBRS has today confirmed the ratings for Banco Santander SA (Santander or the Group), including its long-term rating of AA and short-term rating of R-1 (high), following the release of the Group’s Q4 and full year 2009 results. This rating confirmation reflects the diversified strength of Santander’s franchise, which has a leading domestic position in Spain, but is also increasingly well-positioned internationally.

Underpinning the rating is the Group’s success in leveraging its predominantly retail banking franchise, serving businesses and individuals, and its skillful operational management to deliver dependable revenues, operational efficiency and resilient earnings. Despite elevated credit provisions during the current crisis, the Group has continued to generate enough net operating income, or income before provisions and taxes (IBPT), to absorb provisions, bolster its liquidity and strengthen its capitalization. Besides reflecting these strong credit fundamentals and the Group’s ability to cope with an adverse environment, the Stable trend also considers its growing geographic diversification with its international franchises outside Spain generating the majority of its earnings.

The Group’s results for 2009 illustrated Santander’s franchise strength, which is supported by recurring earnings generation, conservative risk management, and solid liquidity and capital. Indicative of the Group’s earnings resiliency in a difficult environment, Santander increased IBPT by 23.8% year-over-year to EUR 23 billion, or just over 2.0 times the level of provisions and asset impairments. Benefiting from its strong franchises, Santander was able to grow net interest income by maintaining spreads on loans and improving its funding mix with strong deposit growth.

Even as competition to grow deposits as a source of stable funding increased in 2009, Santander was able to attract deposits, including low cost sight deposits. While the Group coped well with the pressure on spreads and competition for deposits in 2009, DBRS expects that this pressure will continue in the near-term. Santander was also able to maintain fee and commission income in 2009, even with reduced customer activity. With more activity in recovering markets, these revenue sources are likely to show moderate expansion in 2010, offsetting some of the pressure on net interest income.

Reflecting Santander’s expertise in managing operations and integrating acquisitions, it achieved an increase in operating expenses of 9.8% year-over-year, mainly due to acquisition costs, while revenues were up 17.6%. Driven by the Group’s consistent focus on retail banking, the Group’s efficiency ratio improved to an impressive 41.7% in 2009 from 44.6% in the prior year. Liquidity and capital remain strong and support the current rating level. The Group has focused on growing customer deposits, which increased by 21% year-over-year, to fund 45.7% of the balance sheet as compared to 40.0% at the end of 2008. With the growth in deposits, Santander has improved its liquidity profile in its franchises. Capital is also strong, as the Group maintains a Tier 1 capital ratio of 10.1% and a Core capital ratio, which excludes hybrid securities, of 8.6%.

Asset quality remains a challenge, but a manageable one in DBRS’s view. In coping with much increased credit costs, Santander has successfully maintained its IBPT to generate positive earnings, helped by necessary provisioning for specific reserves and supplemented by appropriate usage of its generic reserves. With its focus on its core retail banking business, the Group has a relatively low risk profile and high quality balance sheet with customer lending at just over 60% of total assets.

Credit impairments are likely to remain elevated through 2010, but may decline later in the year. Net entries of nonperforming loans declined 6.5% quarter-over-quarter and have declined since Q1 2009. The Group’s nonperforming loan ratio was 3.24% at the end of 2009, which is 120 basis points above year end 2008. In most of the markets where it operates, the Group has better credit metrics than the overall banking industry. In Spain, the Group’s NPL ratio was 3.41% at the end of 2009, which is 146 basis points above year end 2008, but is lower than the overall Spanish banking sector. Within Spain, exposure to real estate developers of EUR 14.6 billion still creates a drag on Santander’s earnings with an NPL ratio of 7.9%, but the Group has reserve coverage of 61% against current loss severity of approximately 30-35%.

While the conditions in Spain remain difficult due to the elevated level of credit problems, the sustained weakness in the economy, increasing market concern about Spain’s sovereign position and the continued difficulties in the Spanish banking sector, DBRS maintains its view that Santander’s broad diversity in earnings should help it cope with this level of stress. DBRS expects that the Group, being perceived as one of the stronger financial institutions, will continue to benefit from the market dislocation in Spain. DBRS continues to view Santander as systemically important in Spain. This timely systemic support underpins an SA2 Support Assessment that is reflected in the Group’s AA ratings being positioned one notch above its Intrinsic Assessment of AA (low).

By maintaining the Stable trend, DBRS reiterates its view that the Group benefits from the geographic diversification of its businesses. No more than 30% of revenues are generated from any one business area. In terms of net attributable profits in 2009, approximately 26% was in Spain from the Santander Branch Network and Banesto, 16% from the United Kingdom (U.K.), 20% from Brazil and 16% from other countries in Latin America (LatAm), with smaller contributions from Global Wholesale Banking, Santander Consumer Finance and Portugal.

Across its international franchise, Santander has shown its ability to seize opportunities through acquisitions to build market positions that enable it to be a strong competitor, such as with Abbey in the U.K., and Banco Real in Brazil. In the U.K., the Group has a 19% market share in gross new mortgage loans and is moving toward positioning itself as a full-service commercial bank, capitalising on the current disruptions in that banking sector. In Brazil, Santander successfully integrated Banco Real making Santander the third largest Brazilian bank with a 10% market share.

Facilitating these successful integrations are Santander’s powerful technology platforms, standardised operational capabilities, consistent retail strategy and conservative risk management. Importantly, these strengths drive the organic growth that is evident in Santander’s existing franchises and become evident in its acquired franchises as they are integrated. In Latin America, the Group has built up franchises in selected countries that generate solid earnings and have weathered the downturn relatively well.

In DBRS’s view, the Group’s ability to efficiently manage its businesses across its expanding international franchise is an important strength. While recognising Santander’s success in getting Sovereign to break even, DBRS views the Group as facing a significant challenge given Sovereign’s weaker market position than is typical for its franchises. Effective use of the Group’s capabilities will be needed to bring the performance of this franchise up to the Group’s level thereby opening up a large opportunity in the U.S. market.

Notes:
All figures are in EUR unless otherwise noted.

The applicable methodologies are Global Methodology for Rating Banks and Banking Organisations, 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.