With the performance of the U.S banking sector not expected to improve in 2012 after its poor performance in 2011, it is time to consider alternate ways of gaining exposure to the banking sector. One opportunity that many investors have yet to consider is gaining exposure to the banking sector by investing in Latin American banking stocks.
While many U.S and European institutions are still grappling with the residual effects of the financial crisis, the eurozone debt crisis, and a slower-than-expected U.S recovery coupled with a depressed U.S housing market, the Latin American banking sector has been surging ahead. Many of the region's banks have seen strong growth in their lending portfolios, deposit bases and market share, which has seen their revenue streams and value grow.
One standout performer is Banco Santander Chile (SAN), an independently managed and listed subsidiary of Spain's Banco Santander (STD). It is also the largest bank in Chile by assets and since the start of 2012, its stock price has grown by 13% to now be trading at around $86. In a previous article, I formed a bullish view on the its stable-mate Banco Santander Brasil (BSBR) and I will analyze Banco Santander Chile to determine whether it holds the same investment potential as Banco Santander Brasil.
Banco Santander Chile is a full service bank offering the complete suite of banking and wealth management products and services. It is the largest Chilean bank by assets and it currently holds 25% of the market share for retail banking, 29% of the SME market share and 18% of the corporate market. This gives it a dominant position in the Chilean banking and finance market.
The bank reported reasonable results for the fourth quarter 2011, with a 14% increase in revenue to $506 million and a 9% rise in net income to $196 million. For the same period, its balance sheet strengthened with cash and cash equivalents rising by 59% to $6.3 billion, although long-term debt rose by 30% to $10.6 billion. However, Banco Santander Chile delivered a disappointing full year 2011 result, because despite revenue rising by 25% to $3.4 billion, net income dropped 9% to $836 million.
However, despite the disappointing full year result for 2011, Banco Santander Chile did deliver some solid figures that I believe augur well for its future revenue and income growth, including reporting:
- An outstanding efficiency ratio of 38.4% for 2011.
- An impressive 13.8% fall in loan loss provisions.
- A 10.8% rise in loans with a 0% increase in net provision expense.
- Deposits and mutual funds increasing by 10.8%.
- Core deposits, which are deposits from non-institutional clients, rising by 29.2%.
- An improvement in the bank's loan to deposit ratio of four full percentage points to 95.4%.
In fact, the last three points are of considerable importance as they indicate that the bank's cost of funding should decrease during 2012, which will see a positive impact on its bottom line.
However, there were also a number of events in 2011 that had a direct impact on Banco Santander Chile's net income. Until they are resolved, they will have a continued negative impact on the bank's bottom line, and are:
- An over reliance upon external funding for lending operations, which leaves the bank exposed to the vagaries of short-term interest rate fluctuations. In 2011, this saw a 72% increase in funding costs, causing margin compression and increased costs.
- An increase in non-performing loans, which for the fourth quarter alone increased by 0.14% to 2.95%. This was attributed to the growth of the bank's retail lending book and raises further concerns for 2012, as a key plank in the bank's growth strategy is to grow its retail lending book.
- Having its credit ratings placed on credit watch negative, by both Standard and Poor's and Fitch in December 2011, because its parent Banco Santander was placed on credit watch negative, because of qualitative issues surrounding its lending operations and balance sheet.
Yet, despite a disappointing 2011 full year financial result, Banco Santander Chile has some particular strong performance and valuation indicators, which bodes well for future growth. In many cases these are notably better than many of its competitors as the table below shows:
Debt to Equity Ratio
Banco Santander Chile
Banco de Chile (BCH)
With a PEG of 1.54, Banco Santander's price in comparison to its earnings growth looks expensive especially when compared to Corpbanca, Santander and Citigroup. However, it does have a solid profit margin, which is similar to its Chilean competitors and substantially higher than both its parent Santander and the U.S based JPMorgan and Citigroup. I also like Banco Santander Chile's return on equity, which only lags 5 percentage points behind Banco de Chile's and is superior to Corpbanca's, Santander's, JPMorgan's and Citigroup's. Furthermore, its strong return on equity coupled with a double digit profit margin bodes exceptionally well for the bank's future earnings growth.
Banco Santander Chile's debt to equity ratio of 2.4, is lower than its Chilean competitors and its parent, as well as being significantly lower than both JPMorgan's and Citigroup's. Yet, despite having less leverage, than those banks, it is still delivering a superior return on equity. However, the debt to equity ratio is still considerably high and higher than its stable mate Banco Santander Brasil, which has a debt to equity ratio of 0.63. This indicates that Banco Santander Chile is highly reliant upon using wholesale debt to fund its lending operations. This means it is exposed to movements in short-term interest rates that can have a direct impact on its bottom line, as occurred in 2011.
Banco Santander Chile's credit rating of A is well above the minimum investment grade of BBB- and it is equal to Banco de Chile's but superior to Corpbanca's and Citigroup's, but lower than its parent Santander and JPMorgan's. Essentially a credit rating of A, means that the bank has a strong capacity to meet its financial commitments, but is somewhat susceptible to adverse economic conditions and changes in circumstances.
While the performance indicators show that Banco Santander Chile is performing strongly in comparison to its competitors, these are not the only basis on which to form a view of whether it constitutes an investment opportunity. It is also important to examine the bank's forward valuation in comparison to its competitors to see whether it is a fairly valued investment opportunity.
With a 2012 consensus EPS of $5.51 and a current trading price of around $86, Banco Santander Chile has a forward PE of 16, which I believe makes it appear expensive in comparison to its competitors. Its main Chilean competitor, Banco de Chile is trading at $94 and with a 2012 consensus forecast EPS of $6.39, has a forward PE of 15. While another Chilean competitor Corpbanca, has a 2012 consensus EPS of $1.85, which at its current trading price of around $20 gives it a forward PE of 11, making it the cheapest of the three Chilean banks reviewed. In fact, based on its forward valuation, Banco Santander Chile is expensive in comparison to its parent Banco Santander as well as JPMorgan and Citigroup.
Banco Santander has a 2012 EPS consensus of $1.19, which at a trading price of $8 gives it a forward PE of 7. While JPMorgan has a 2012 consensus forecast EPS of $4.76, which with a trading price of $46 gives it a forward PE of 10. Finally, Citigroup, which is trading at around $37 with a 2012 consensus forecast EPS of $4.07, has a forward PE of 9.
I also do not find Banco Santander Chile's dividend yield of 2.5% particularly attractive in comparison to its parent Banco Santander, which has a yield of 6% or its stable-mate Banco Santander Brasil, which has a dividend yield of 4.5%. This yield is also lower than its competitor Corpbanca which has a yield of 6% as well as JPMorgan's 3%.
However, it is higher than Citigroup's yield of 0.1% and equal to Banco de Chile's 2.5%. Furthermore, the dividend yield for U.S or foreign investors will be reduced by the 35% Chilean withholding tax that is levied on dividend payments to foreigners, further reducing the effective yield to around 2%. There is however, on distribution a 17% tax credit for "first category tax" paid by the company, which may be credited against taxes paid on dividends. This low yield and the taxation issues in my opinion make this stock unappealing for income hungry investors.
I also believe that with an earnings yield of 6% Banco Santander Chile is over-valued at its current price. After allowing for an additional minimum equity risk premium of 4% over the risk free rate, plus what I believe is an appropriate country risk premium for a Chilean investment of 1.5%, Banco Santander Chile needs an earnings yield of around 7% to be fairly priced.
A key concern regarding any investment in Banco Santander Chile is its degree of financial and management independence from its troubled Spanish parent, Banco Santander. However, the Santander model for its international subsidiaries ensures that any risk of financial contagion caused by financial issues within one entity is limited because:
- Each subsidiary has and manage its own capital and liquidity.
- Each subsidiary funds their own operations independently of other group entities.
- There is no structural cross-funding between entities.
I also like Banco Santander Chile's future growth strategy because it is simple and easily executed with a focus on the addressing the issues highlighted earlier in this article. The successful implementation of this strategy should see a reduction in costs and an increase in revenue by:
- Improving the quality of its loan book.
- Reducing the number of non-performing loans and bad debts.
- Increasing the bank's deposit base, increasing 'customer share of wallet' through cross selling.
- Increasing customer retention through improved customer relationship management.
However, much of the success of this growth strategy also depends on whether the Chilean economy will grow at a reasonable rate through 2012, given the gloomy global economic outlook. The Chilean economy is internationally recognized as one of the most stable, open and competitive in Latin America. This has come about through the Chilean government implementing a number of structural modifications including the privatization of state companies, creating greater regulatory transparency and implementing strong fiscal policy.
Much of Chile's economic growth is reliant upon the mining and exportation of raw materials notably copper, although the agricultural and forestry industries are also key drivers of growth, which may be impacted by the predicted slow down in the Chinese economy. Yet, despite this, the IMF has forecast a GDP growth rate of 4.7% for Chile, which is triple the 1.8% forecast for the U.S.
Furthermore, there are other economic factors and indicators that indicate continued economic growth with improved consumer and business sentiment, which should see an increase in domestic consumption. Therefore, driving increased demand for credit and other banking products. These factors include:
- The Chilean Central Bank lowering the official interest rate by 25 basis points to 5% at its 12 January monetary policy meeting. This is the first rate cut since July 2009 and should drive increased economic activity.
- For January 2012, the business confidence index rose by 5.7 points to 59.5 points, which is above the 50 point threshold that separates optimism from pessimism.
- For February 2012, the consumer confidence index rose by 0.9 points to 49.6 points, which is the highest level since January 2011. It is also just below the 50-point threshold that separates optimism from pessimism. Furthermore, respondents reported a higher willingness to make major purchases.
Accordingly, as the economy continues to grow at a strong rate Banco Santander Chile, as the largest bank in Chile by assets and with considerable market share, is well positioned to capitalize on this growth and expand its market share and revenues.
Since the end of the military dictatorship, successive Chilean governments have made considerable efforts to modernize the economy and introduce a free market economy based upon modern economic principles. This has included economic deregulation, reform of the legal system and the implementation of sound macro-economic policies all of which have seen the Chilean economy gradually integrated into the global economy. This is evident when analyzing Chile's key country risk indicators, which in my opinion gives it the lowest country risk of any Latin American country.
Firstly, when considering the degree of corruption in Chile the outlook is quite favorable with Transparency International's Corruption Perception Index for 2011 rating Chile as 22nd out of 184 countries. For 2011, New Zealand was rated as the least corrupt and Somalia, along with North Korea, as the most corrupt. In comparison to Chile's position, Brazil was rated as 73rd, Argentina as 100th and the U.S came in marginally higher than Chile at 24th. Secondly, from an overall qualitative assessment of country risk, in January 2012 the OECD rated Chile as a 2 on a scale of 0 to 7, where 0 is the least risky and 7 the most, which according to this assessment makes Chile the least risky country in South America.
Finally, Chile has a Standard and Poor's credit risk rating of A+, which is the highest credit rating awarded to any Latin American country. In fact, there were comments from Standard and Poor's through 2011 that Chile is on the road for an AA rating, partially due to its strong fiscal policy. In comparison to Chile, other Latin American countries such as Mexico and Brazil are rated BBB, while Argentina has a credit rating of B, which is lower than investment grade.
Clearly, Chile has little to any significant country risk as the indicators show, which means there is little if any additional country risk associated with investing in Chilean stocks.
Despite Banco Santander Chile's robust financial position, strong management, solid market share and compelling growth strategy, I believe that at its current price of $86 it is over-priced. I have formed this opinion on the basis of:
- The bank's forward valuation, which gives it a forward PE of 16, making it more expensive than the other bank's considered in this article.
- Its earnings yield, which when adjusting it for an appropriate equity investment risk premium and a country risk premium, gives it an earnings yield of less than the risk free rate of return.
In addition, while I quite like Banco Santander Chile's growth strategy, there are still a few live issues that I believe will negatively impact its net income for 2012 and push down its value. These are primarily the bank's over reliance on wholesale funding and the growth of non-performing loans in its lending portfolio. Therefore, my recommendation would be for investors to either wait for a solid dip in the stock price or consider an alternate Latin American banking investment with a more attractive valuation combined with a higher quality loan portfolio and stronger deposit base.