DBRS Lowers Santander to “A” After Downgrade of Spain to A (low), Trend Now Negative

DBRS, Inc. (DBRS) has today downgraded the ratings of Banco Santander SA (Santander or the Group) following DBRS’s downgrade of the Kingdom of Spain. DBRS has downgraded Santander’s Senior Unsecured Long-Term Debt & Deposit rating to “A” from A (high) and Short-Term Debt & Deposit rating to R-1 (low) from R-1 (middle). The trend on all long-term ratings is now Negative; the trend on all short-term ratings is now Stable. The aforementioned ratings have been removed from Under Review with Negative Implications, where they were placed on 24 May 2012, following DBRS’s similar action on the Kingdom of Spain.

At the same time, Santander’s intrinsic assessment (IA) has been lowered to “A” from AA (low). Additionally, DBRS maintains its SA-2 support assessment for Santander, which indicates an expectation of timely systemic support in case of need. However, with the current rating for the Spanish sovereign below the “A” intrinsic assessment for Santander, there is currently no uplift to the Group’s ratings.

These rating actions follow DBRS’s downgrade of the Kingdom of Spain’s long-term foreign and local currency debt ratings to A (low) from A (high). The sovereign ratings have been removed from Under Review with Negative Implications; the trend is now Negative. The sovereign rating action reflects DBRS’s assessment that there has been a severe deterioration in Spain’s credit profile warranting the two-notch downgrade. The Negative trend reflects considerable downside risks to the economic growth outlook. Five factors are behind the downgrade: (1) the outlook for Spain’s economic growth has worsened as private sector deleveraging continues and fiscal austerity measures intensify; (2) Spain’s public debt dynamics have deteriorated from the capitalisation needs of the banking system; (3) reducing fiscal imbalances is increasingly difficult due to the weak economic environment; (4) stressed economy wide financing conditions are increasing downside risks to the growth outlook and prospects for public debt stabilisation; and (5) persistent doubts over the effectiveness of the policy response at the Euro area level appear to be contributing to investor uncertainty.

The downgrade of Santander reflects DBRS’s view that the higher systemic risks and challenging environment in Spain continue to pressure the ratings of the Group. The Spanish economy has deteriorated and the prospects of recovery have receded, which is likely to weaken credit performance and put pressure on revenues. Problems in the real estate sector are likely to be exacerbated by the deterioration in the economy and increased uncertainty about the prospects for the economy not only in Spain, but more broadly in Europe. Uncertainties over Spain’s property values and its banking sector stability have contributed to ongoing financial weakness in Spain and significant distress in the savings bank sector. The ongoing crisis and disrupted financial markets are elevating the stresses facing universal banks, such as Santander, particularly from a funding perspective. While Santander’s subsidiaries have retained access to wholesale markets, the Parent bank’s access to market funding has been pressured as 2012 has progressed by heightened market concerns regarding the adequacy of liquidity and capitalisation of Spanish financial institutions, as well as the position of the Spanish sovereign.

Supporting Santander’s “A” rating level is the Group’s strong international retail banking franchise and skillful management, which contributes to operational efficiency and resilient earnings, combined with bolstered levels of provisioning and capital. DBRS views the Group’s significant international scope, which contributed 77% of consolidated net operating income (excluding Corporate Activities) in 1H12, or income before provisions and taxes (IBPT), as demonstrating the diversity of Santander’s franchise outside of Spain. Despite elevated credit provisions that reflect both credit deterioration and regulatory requirements, Santander continues to generate enough IBPT to absorb these provisions and strengthen capitalisation.

DBRS considers Santander’s significant geographic diversification with its international franchises outside Spain as an important underpinning of the current rating level. By maintaining the Group’s rating at “A”, which is positioned one-notch above DBRS’s rating of the Spanish sovereign, DBRS reiterates its view that the Group benefits from the geographic diversification and resilient performances of its businesses. In terms of IBPT in 1H12, approximately 14% was generated in Spain from Banesto and the Santander Branch Network, 9% from the U.K., 41% from Brazil and 11% from other countries in Latin America (LatAm), with smaller contributions from Global Wholesale Banking, Santander Consumer Finance, Poland, Portugal and the U.S. The Group benefits from regular dividends from each of its subsidiaries to the Parent, which offsets some of the liquidity pressures within Spain. Santander generated consolidated attributable profit of EUR 1.7 billion in 1H12, EUR 5.4 billion in 2011, and EUR 8.2 billion in 2010. DBRS notes that Santander has remained profitable throughout the crisis.

DBRS also notes that 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’s subsidiaries have continued to have access the wholesale markets through debt issuance, such as in the U.K. and LatAm. Helped by various actions including the sale of businesses, 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.

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. Future rating actions could be driven by further deterioration in Santander’s home market of Spain and the impact of sustained market stress within the Eurozone. Additionally, lower earnings prospects in its international subsidiaries would likely put negative pressure on Santander’s ratings, as this would reduce the benefit of the Group’s international diversification.

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 the DBRS rating of the Kingdom of Spain. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

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

Lead Analyst: Roger Lister
Rating Committee Chair: Peter Burbank
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.