Chile has the most advanced economy in Latin America along with what I believe is the most advanced banking and finance sector in the region. When this is considered in conjunction with its solid economic growth, political stability and low country risk, it is a market that presents considerable opportunities for investors. There are currently three Chilean banks listed on the NYSE, Banco Santander-Chile (BSAC), Banco de Chile (BCH) and Corpbanca (BCA), with the first two being the two largest Chilean banks by assets. Many investors have yet to recognize the quality of the investment opportunities available in Chile's banking sector. In this article, I will take a closer look at Banco Santander Chile to determine whether it offers investors a value driven banking investment opportunity.
Recent financial performance
Unlike its parent, Spain's Banco Santander (SAN) or other major regional competitor and Spanish bank BBVA (BBVA), Banco Santander Chile has continued to post strong financial results regardless of the current headwinds. But for the second quarter 2012 it missed the consensus forecast earnings-per-share by 15%, reporting EPS of $1.14.
This disappointing result can be attributed to the bank's revenue decreasing over the second quarter. In comparison to the first quarter, second quarter 2012 (QoQ) revenue fell by 3.5% to $633.5 million and net income fell by almost 11% to $207.4 million. But for this period, the bank's balance sheet strengthened significantly, with cash and cash equivalents rising by 84% to $4.4 billion and long-term debt falling by 8% to $8.7 billion.
Furthermore, unlike its parent, or its Latin American stable mate Banco Santander Brasil (BSBR), the bank's loan loss provisions QoQ remained steady at $154 million. This also represented a 9% fall in the value of loan loss provisions in comparison to the fourth quarter 2011, which is quite an achievement given the difficult operating environment.
The key reason for the fall in net income was due to deterioration in the bank's net interest margin, which QoQ fell by 40 bps to 5%, caused by a greater than expected fall in the rate of inflation, with the bank having significantly more inflation linked assets than liabilities. In addition, the bank saw its wealth management revenues fall with its assets under management (AUM) falling by almost 2% QoQ, predominantly because of the poor performance of global equity markets.
Asset quality and risk management remains strong
Despite the difficult operating environment, Banco Santander Chile's asset quality has remained consistently high. The bank's non-performing loan ratio (NPL), a key measure of asset quality, fell by 16bps to 2.88%, as the chart below illustrates. While it is higher than the Chilean national banking and finance industry average, it still compares favorably with its peers and is significantly lower than the Santander Group wide NPL ratio as the chart shows.
The loan segment with the highest level of impairment is consumer loans, which includes the higher risk, but higher revenue credit card, personal loan and finance lease lines. This segment has also seen the greatest degree of deterioration QoQ increasing by 50bps to 3.4%, while commercial loans have remained stable with an NPL ratio of 2.73% and residential mortgages improved by 5bps to 2.88%.
Banco Santander Chile's NPL ratio is within a similar range to its Latin American peers, with many banks outside of Brazil having NPL ratios of 1% to 3%; while Brazil's largest private banks have NPL ratios in excess of 4%. However, as the chart shows Banco Santander Chile's NPL ratio is still higher than either Banco de Chile or BBVA's South American operation.Source data: Banco Santander Chile, Banco de Chile, Banco Santander Brasil Earnings Reports 1Q11 to 2Q12, BBVA Quarterly Report January - June 2012.
In conjunction with the moderate NPL ratio, Banco Santander Chile has a healthy NPL coverage ratio of 97.80%. This is significantly higher than the Santander group wide coverage ratio of 65% and as the chart shows has remained relatively steady over the last three quarters.
Source data: Banco Santander Chile Earnings Reports 1Q11 to 2Q12, Banco Santander Activity and Results 1H12.
However, Banco Santander's NPL coverage ratio as the chart shows is inferior to its Chilean competitor Banco de Chile, BBVA's South American business and its stable mate Banco Santander Brasil.Source data: Banco Santander Chile, Banco de Chile, Banco Santander Brasil Earnings Reports 1Q11 to 2Q12, BBVA Quarterly Report January - June 2012.
Overall, Banco Santander Chile's asset quality is quite high and all of its risk indicators are well within acceptable parameters.
Liquidity and capital adequacy are within optimal ranges
Another aspect of Banco Santander Chile that is appealing is its solid capital adequacy and high liquidity. Currently, the bank has a tier one capital ratio of 10.4%, which is well above the required minimum of 6% and marginally higher than the 10% or better that investors should be seeking when investing in a bank. It also closely matches the Santander group wide tier one capital ratio and has remained consistently at this level for some time as the chart shows.Source data: Banco Santander Chile Earnings Reports 1Q11 to 2Q12, Banco Santander Activity and Results 1H12.
In comparison to its peers, its tier one capital ratio is lower than many but still within acceptable parameters and the industry wide range of 6% to 20%. It is also substantially higher than its Chilean peer Banco de Chile, which as the chart shows at the end of the second quarter had a tier one capital ratio of 6.8%.Source data: Banco Santander Chile, Banco de Chile, Banco Santander Brasil Earnings Reports 1Q11 to 2Q12, BBVA Quarterly Report January - June 2012
*Banco Santander Brasil Tier 1 capital includes good will.
Based on these results, it is clear that Banco Santander Chile is well capitalized and above the minimum acceptable standard.
Another indicator of Banco Santander Chile's strong balance sheet is the bank's loan-to-deposit ratio of 96.5%, which indicates that the bank is predominantly funding its lending activities through its deposit base. Furthermore, as the chart shows it lower that the Santander group wide loan-to-deposit ratio of 117%.Source data: Banco Santander Chile Earnings Reports 1Q11 to 2Q12, Banco Santander Activity and Results 1H12.
Banco Santander Chile's loan-to-deposit ratio is also superior to many of its peers including its main Chilean competitor Banco de Chile as the chart below illustrates.
This loan-to-deposit ratio is within what is considered to be the optimal range of 95% to 105%, which allows a bank to generate the maximum benefit from its deposit base while ensuring sufficient liquidity to cope with extraordinary events. It also indicates that the bank is less reliant upon wholesale funding minimizing its exposure to short-term interest rate movements and the effect this can have on funding costs. Impressively, it has been able to consistently keep its loan-to-deposit ratio within the optimal range indicating that management are focused on building sustainable business with a strong appreciation for risk.
Consistently delivering solid performance metrics
Despite the difficult operating environment Banco Santander Chile's consistent focus on cost control is enhancing the bank's ability to efficiently grow revenue and improve profitability. The bank has historically delivered an outstanding efficiency ratio, which despite deteriorating just over 4% QoQ is still at 41% as the chart below shows. It is also superior to the Santander group wide efficiency ratio of 44.5%.Source data: Banco Santander Chile Earnings Reports 1Q11 to 2Q12, Banco Santander Activity and Results 1H12.
The deterioration in the bank's efficiency ratio can primarily be attributed to a seasonal increase in expenses in conjunction with increased expenditure on a business transformation program. This program should enhance the bank's ability to efficiently generate revenue over the long-term.
Despite the decline in Banco Santander Chile's efficiency ratio, it is equivalent to or superior than many of its peers including its main Chilean competitor Banco de Chile and as the chart shows.Source data: Banco Santander Chile, Banco de Chile, Banco Santander Brasil Earnings Reports 1Q11 to 2Q12, BBVA Quarterly Report January - June 2012.
Along with maintaining control of operational expenses, Banco Santander Chile is delivering a solid net interest margin (NIM) of 5% as the chart below shows. The bank's NIM is also comparable to its Latin American peers and superior to its Chilean competitor Banco de Chile.Source data: Banco Santander Chile, Banco de Chile Earnings Reports 1Q11 to 2Q12.
While the bank's net interest margin has declined over the last quarter, I expect it to remain stable because of the bank's increased focus on reducing funding costs and improving its funding mix. This can be seen with its optimal loan-to-deposit ratio and focus on building its deposit base, with deposits being a cheaper and more stable form of funding. This bodes well for the bank's profitability and is reflected in its exceptional double digit return-on-equity (ROE) of 21% as the chart below shows.
This is well above the industry wide average of 13% for commercial banks, as well as being almost five times higher than the Santander group ROE of 4.3%. It indicates that the bank is performing strongly despite the global headwinds that have affected the profitability of other banks. Source data: Banco Santander Chile Earnings Reports 1Q11 to 2Q12, Banco Santander Activity and Results 1H12.
The bank's ROE also compares favorably to its peers, being only one full percentage point lower than Banco de Chile and higher than many of its other peers including BBVA and Banco Santander Brasil.
Source data: Banco Santander Chile, Banco de Chile, Banco Santander Brasil Earnings Reports 1Q11 to 2Q12, BBVA Quarterly Report January - June 2012.
The exceptional ROE can be attributed to the bank's high asset quality, outstanding efficiency ratio and low funding costs, which allow it to maximize its margins and leverage profitable returns from its lending operations.
Macro environment and market outlook
The Chilean economy has defied the global economic headwinds caused by the European financial crisis and China's soft landing and continued to grow. In 2011, Chile's economy grew by 4.5% outpacing its regional neighbor and investment hot spot Brazil. More impressively, Chile's economy has continued to grow strongly in 2012, expanding by 5.6% in the first quarter and then by 5.5% in the second quarter.
Despite Chile being the world's number one producer of copper, and China being its single largest export partner, the Chinese soft landing has had a minimal impact on Chile's economy unlike its regional neighbors such as Brazil. Much of this can be explained by Chile's more advanced domestic economy, which is still seeing considerable economic activity and growing domestic demand.
The consensus view is that there should be a gradual recovery in the global economy through 2013, in conjunction with momentum picking up in China over the same period. This bodes well for continued economic growth in Chile and despite the view that economic growth will slow slightly for the second half of 2012; full year GDP growth should be around 4.5%. The Chilean economy is also expected to continue expanding at that rate in 2013. Obviously such strong rates of economic growth bode well for Banco Santander Chile to continue growing its core commercial lending business and expand its consumer loan portfolio.
There is still room for banking industry growth in Chile
While the World Bank defines the Chilean economy as upper middle income economy, there are many indicators that show it has the potential to become a high income economy. The most important of which are high levels of political and economic stability, high literacy and decreasing levels of poverty along with a high average income than all of Latin America except Argentina.
This not only bodes well for continued economic growth but also for the increased penetration of banking and financial products. Currently, Chile's uptake of banking products is quite mature in comparison to the rest of Latin America as the chart illustrates with a private credit to the domestic sector representing 89% of GDP. Source data: World Bank
However, this is still quite low in comparison to other emerging economies such as China or Thailand and less than half of the ratios for the developed U.S. and U.K. economies. This indicates that there is still considerable opportunity for the uptake of banking and financial services to increase. For all of the reasons discussed, I believe that there are still considerable opportunities available to Banco Santander Chile to grow its core business of lending and deposit taking.
Country risk for investing in Chile is low
While investing in Latin American countries is fraught with a higher degree of risk than investing in the U.S., or other developed countries, Chile is the exception. In the Transparency International 2011 Corruption Perception Index Chile was rated 22nd on a scale where the higher the ranking the greater the degree of corruption. This places Chile well ahead of other countries in the region, with the next ranked Latin American country being Uruguay at 25th and then Brazil at 73rd. It also ranks Chile ahead of the U.S which was ranked 24th, implying that corruption in Chile is lower.
This in conjunction with a stable political environment indicates that the risk for foreign investors in Chile is particularly low and very different from investing in other countries in the region. Accordingly I don't believe the same geopolitical risk applies, but investors should be aware that there are still risks including:
- Growing regulatory risk coming from a lower global risk tolerance towards banking and with a renewed focus on regulation. This has seen Latin American governments become increasingly focused on ensuring their regulatory frameworks comply with international standards. Potentially this will increase the regulatory burden for banks operating in the region.
- Increased currency risk with emerging market currencies tending to be more volatile than those of developed markets. For example for the year-to-date the Chilean peso has fallen by as much as 8.6% against the US dollar and then recovered to now by 7.5% at the time of writing.
Investing in emerging markets, in most cases, brings increased risk for investors but in the case of Chile is it is considerably less than that associated with investment hot spots in the region such as Colombia, Brazil or Peru.
Banco Santander Chile has a generous shareholder remuneration program in place and has normally paid out 60% of net income to shareholders by way of dividends. These dividends are paid annually with the last dividend going ex-dividend on 19th April 2012 for a total of $2.97 per share net of tax. This gives the bank a credible yield of almost 4%. Furthermore, as the chart shows, it has a strong record of dividend growth paying a steadily increasing dividend since 1997.Source data: Banco Santander Chile Investor Relations, Nasdaq.
All of these factors make Banco Santander Chile a particularly attractive international stock for income hungry investors. However, foreign investors should be aware that when investing in a Chilean company they are subject to a 35% withholding tax on dividend payments. This is reduced to 18% when the dividend payment is made from income where First Category Tax of 17% has already been paid.
Future outlook and valuation
Banco Santander Chile is currently trading with a trailing twelve month price-to-earnings (P/E) ratio of 18, which makes it appear expensive in comparison to many of its peers. These include its parent Banco Santander which has a P/E of 14, its Spanish competitor BBVA which has a P/E of 13 or its Chilean competitor Banco de Chile which has a P/E of 14.
Furthermore, as the table below shows, with the exception of its dividend it does not have a particularly strong growth record, with one of the lowest net interest income and earnings-per-share growth rates that I have seen for a Latin American bank.
However, given the cautiously positive economic outlook for Chile, it is likely that these rates of growth will improve over the short to medium-term, particularly as the bank's focus on costs reduces operational expenses and loan loss provisions unwind.
Banco Santander Chile has demonstrated that it is an impressive high performing Latin American bank and one of the consistently strongest performing businesses in the Santander group. It is undeniable that its laudable efficiency ratio, solid double digit return-on-equity and high asset quality combine to give the bank solid growth prospects. But with a P/E ratio of 17 it is expensive in comparison to many of its Latin American peers, many of which provide superior growth prospects. However, for income oriented investors seeking to diversify their portfolio through the addition of a dividend paying international bank it would certainly make a first-class addition with its solid yield and strong dividend history.
Disclosure: I am long SAN.