DBRS: Santander’s Q1 2014 Earnings up on Lower Cost of Risk and Expenses

Summary:
• Net Income increased 23% QoQ driven by a reduction in operating expenses and lower cost of risk.
• The Group’s NPL ratio improved 9 bps in Q1 2014 and there are signs of asset quality stabilization in Spain.
• DBRS rates Banco Santander’s Senior Unsecured Long-Term Debt & Deposits at “A” with a Negative trend.

DBRS Ratings Limited (DBRS) views Banco Santander S.A.’s (Santander or the Bank) Q1 2014 results as solid, with net profit increasing 23% quarter-on-quarter (QoQ) and 8% year-on-year (YoY). It is worth noting that since H2 2013, the Bank’s consolidated results have been negatively impacted by the depreciation of most of the currencies in which Santander operates in relation to the Euro. As a result, excluding the impact of foreign exchange rates, net profit would have increased circa 26% both QoQ and YoY.

Bottom line results were primarily driven by a decrease in operating expenses (down 4% QoQ and YoY) and a reduction in loan-loss provisions and impairments losses on other assets (down 5% QoQ and 14% YoY), which helped to partially offset weaker revenues YoY. Operating expenses declined by EUR 213 million QoQ with the implementation of a three-year efficiency plan that aims to reduce total operating expenses by EUR 1.5 billion. The Bank´s target for this year is to reduce operating expenses by EUR 750 million. This decline helped to offset weaker net revenues, which increased just modestly sequentially but declined 6% YoY. Positively, excluding the impact of foreign exchange rates, net interest income (NII) has shown an upward trend since Q1 2013 with the favourable evolution of the customer spreads in Europe, due to a decrease in the cost of deposits. Santander’s cost-to-income ratio stood at 47.9% in Q1 2014, down from 50.5% in Q4 2013.

The Q1 2014 results continue to demonstrate the importance of the Group’s international franchise and the mix between developed and emerging economies. A slowdown in certain emerging economies has had an impact on Santander’s attributable profit composition structure with bottom-line profitability reducing in countries such as Mexico and Brazil. On the other hand, the recovery in Continental Europe and the sustained growth levels in the U.S. and UK reflected positively in the bottom-line profitability of most of Santander’s operations in developed economies. Overall, in Q1 2014, emerging economies accounted for around 44% (down from 53% at Q4 2013) of attributable profit and developed markets represented 56% (up from 47% at Q4 2013).

The Group’s credit quality has shown signs of improvement with the non-performing loans (NPL) ratio declining for the first time since Q1 2007 to 5.52% in Q1 2014 down from 5.61% at end-2013. Net NPL entries have shown a downward trend since Q3 2013, with total NPLs decreasing by EUR 120 million in Q1 2014 to EUR 42 billion. Cost of risk has also improved to 1.65% in Q1 2014 down from 2.45% a year earlier. In Spain, although NPL ratio (excl. Real Estate) has moderated the pace of increase compared to previous quarters, it still remains quite elevated and above some of its main peers, with a total NPL ratio of 7.61% at Q1 2014. The run-off Real Estate portfolio has kept the declining trend of previous quarters, with a total decrease of 14% YoY to EUR 10 billion. Yet, NPL ratio for this portfolio stood at a high 69.9% in Q1 2014, remaining on the high-end of the peer range.

Santander reported Core Capital Tier 1, according to Basel III phased-in, of 10.6% in Q1 2014 as compared to 10.9% in Q4 2013. The ratio has been negatively affected by an increase in Risk-Weighted Assets, the consolidation of Santander Consumer USA and the Brazil´s capital optimization operations. The Bank stated that its target for Common Equity Tier 1 ratio, according to Basel III fully loaded, by year-end 2014 was of 9% which DBRS considers as adequate.

Finally, Santander has announced an offer to acquire the minority interest in Santander Brazil, which represents around 25% of total equity, with the intention of enhancing the value of its total franchise by increasing the weight of markets with attractive structural growth potential. According to the Bank, after this transaction, emerging markets will contribute c. 49% to Santander´s franchise in terms of assets versus its current 43% contribution.

DBRS rates Banco Santander’s Senior Unsecured Long-term Debt and Deposits at “A” with a Negative trend. The rating is one notch above DBRS’s rating on the Kingdom of Spain of A (low) with a Negative trend.

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