DBRS Comments on Santander’s 2Q12 Results – Senior at A (high), Under Review Negative

DBRS, Inc. (DBRS) has today commented on the 2Q12 results of Banco Santander SA (Santander or the Group). DBRS rates the Group’s Senior Unsecured Long-Term Debt & Deposit at A (high) and Short-Term Debt & Deposit at R-1 (middle). All ratings currently are Under Review with Negative Implications where they were placed on 24 May 2012 following DBRS’s similar rating action on the Kingdom of Spain. The Group reported net attributable profit of EUR 100 million in 2Q12, down significantly from the prior quarter due to the extraordinary provisions of EUR 1.3 billion related to new provisioning requirements in Spain. The Group reported net attributable profit of EUR 1.6 billion in 1Q12 and EUR 1.4 billion in 2Q11.

DBRS views the challenging environment as continuing to pressure the ratings of Santander, as the Spanish economy remains weak and the real estate sector remains fragile. Uncertainties over Spain’s property values and its banking sector stability have contributed to ongoing financial weakness in Spain. Santander’s consolidated credit costs have generally been trending upward over the past 6 quarters and there have also been significant jumps with extraordinary provisioning in 4Q11 and 2Q12 driven by new requirements in Spain. International subsidiaries are also contributing to elevated credit costs. In Brazil, provisions increased 16% sequentially in 2Q12, following a 54% increase in 1Q12; the U.K. continues to struggle given the recessionary environment, with provisions absorbing 37% of income before provisions and taxes (IBPT) in 2Q12 compared to just 17% a year ago. While these increases have been partially offset by reduced provisioning in other regions in Santander’s franchise, the effect on a consolidated basis continues to pressure bottom line results. Adding to the headwinds, access to market funding has been pressured by heightened market concerns with the adequacy of liquidity and capitalisation of financial institutions, as well as the position of the Spanish sovereign. DBRS notes that a negative action on the sovereign rating would likely impact the ratings of Santander (Kingdom of Spain is rated at A (high), Under Review with Negative Implications by DBRS).

Santander generated gross income (net revenues) of EUR 11.2 billion in 2Q12, down only slightly from EUR 11.4 billion in 1Q12, but an improvement from EUR 10.9 billion in 2Q11. Net revenues were driven by markets in Latin America (LatAm) that offer significant growth opportunities, helping to somewhat offset the slowdown in developed economies, such as Spain and the U.K. While Santander is also experiencing significant pressure in its Portuguese subsidiary, Santander Totta (Totta) contributes just 2% of the Group’s operating net revenues (excluding Corporate Activities).

Helping maintain Santander’s overall revenue levels, LatAm, which includes activities in Brazil, Mexico and Chile among other countries, continues to generate improving revenues and solid earnings. In LatAm, the Group generated significant gross income of EUR 6.1 billion in 2Q12, driven by strong volumes and growth, coupled with expense control. Net operating income of EUR 3.9 billion, or 57% of Santander’s operating net revenues (excluding Corporate Activities) in 2Q12, continues to support the overall profitability of the Group. DBRS notes that increasing credit costs and larger minority interests are weighing on net attributable profit in LatAm, which decreased by 14% YoY to EUR 1.0 billion in 2Q12, as compared to an increase in net revenues of 8% over the same time period.

In Santander’s home market of Spain, which generated 19% of the Group’s operating net revenues (excluding Corporate Activities) in 2Q12, conditions remain challenging. In Spain, Santander generated net profits of EUR 339 million in 2Q12. This compares to net profits of EUR 283 million in 1Q12, EUR 29 million in 4Q11 and EUR 387 million in 2Q11. Profitability has declined significantly in Spain from the pre-crisis pace of approximately EUR 800 million to EUR 1 billion per quarter in 2007. While increased provisioning is driving the bulk of the earnings pressure, DBRS notes that Santander has covered a sizable portion (more than 70%) of the Bank of Spain’s new provisioning requirements. In 2Q12, bottom line results in Spain would have been negative if the EUR 1.3 billion in extraordinary provisions related to Spanish requirements were reported within Spain, rather than in Corporate Activities. The Group continues to focus on deleveraging, particularly through a reduction of loans to real estate developers. Despite this, the nonperforming loan (NPL) ratio in Spain remains elevated at 5.98%.

The macroeconomic and regulatory environment in the U.K. remains challenging. Santander’s revenue generation ability is hindered by low volumes and very low interest rates, which have a significant impact on the Group’s large mortgage portfolio. Net interest income continues to decline, though the Group has been able to offset this with increased fees and other gains to maintain gross income of EUR 1.3 billion in 2Q12 in the U.K. Santander has been increasing its loans to higher-yielding SMEs and improving loan spreads, though not enough to offset the increased cost of deposits. Bottom line results are being pressured by growth in provisioning, related to the changing loan mix.

For the Group, asset quality ratios remain elevated, with an NPL ratio of 4.1% at 2Q12. Driving the ratio are the Group’s exposures in Spain, as well as Brazil (NPL ratio: 6.5%), Portugal (NPL ratio: 5.4%), Poland (NPL ratio: 4.9%) and Chile (NPL ratio: 4.7%). Importantly, Santander continues to position itself to successfully weather the extended economic crisis. The Group has bolstered its levels of generic and specific provisions (EUR 22.2 billion at 2Q12) to cover expected future losses. Santander has been able to access the wholesale markets through debt issuance in local markets, such as in the U.K. and LatAm. The Group also continues to bolster its capital levels, reaching a 10.1% core capital ratio based on Basel II standards and exceeding the 9% core capital requirement of the EBA.

Notes:
All figures in Euros (EUR) unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations. Other methodologies used include the DBRS Criteria – Intrinsic and Support Assessments. Both can be found on the DBRS website under Methodologies.

The sources of information used for this rating include company documents and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This commentary was disclosed to the issuer and no amendments were made following that disclosure.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: Roger Lister
Approver: William Schwartz
Initial Rating Date: 11 October 2006
Most Recent Rating Update: 24 May 2012

For additional information on this rating, please refer to the linking document under Related Research.