Banco Santander, S.A. (NYSE:SAN) Q3 2023 Earnings Call Transcript

Banco Santander, S.A. (NYSE:SAN) Q3 2023 Earnings Call Transcript October 25, 2023

Begona Morenes: Good morning, everybody, and welcome to Banco Santander’s conference call to discuss our financial results for the first 9 months of 2023. Just as a reminder, both the results report and presentation that we will be following today are available to you on our website. Let me just highlight that during the presentation, when we refer to global and network businesses, we are following the definition which was given during our Investor Day last February as the new reporting and full management of the group through global businesses will begin in January ’24. I am joined here today by our CEO, Mr. Hector Grisi; and our CFO, Mr. Jose Garcia Cantera. Following their presentations, we will open the floor for any and all questions that you may have in the Q&A session. [Operator Instructions] With this, I will hand over to Mr. Grisi. Hector, the floor is yours.

Hector Grisi: Thank you, Begona. Good morning, everyone, and thank you for joining us. Let me share with you what we will focus on today. First, I’ll talk about our 9 months results in the context of how we are progressing with the strategy we outlined at our Investor Day. Jose will then review our financial performance in greater detail, and then I’ll conclude with a few closing remarks. As you can see, we had another strong quarter, demonstrating the strength and resilience of our unique business model even in times of market volatility as well as a solid execution of our strategy. We delivered record profit of €2.9 billion. That’s an increase of 20% compared with Q3 in ’22, that’s 26% in constant euros. Profit for the first 9 months of ’23 was €8.1 billion, up 13% in constant euros, driven by strong customer revenue growth.

Revenue increased by double digit year-on-year, supported by all global businesses and all our regions. Commercial activity remained solid. We added 9 million new customers in the last 12 months, bringing the total to 166 million. We continue to advance towards a simpler, more integrated model through our One Transformation, which is leading to efficiency improvements and growth in profitability. As a result, our efficiency ratio improved 1.5 percentage points year-on-year to 44%. Our return on tangible equity rose 126 basis points year-on-year to nearly 15%, while our earnings per share improved by 17% year-on-year, supported by profit growth and share buybacks. We further strengthened our balance sheet generating capital in the quarter, even after deducting the share buyback on the way, and liquidity remains at comfortable levels and credit quality is quite strong.

All of this led to strong shareholder value creation and attractive remuneration. TNAV plus DPS grew 12% during the last 12 months, and we have increased the cash dividend per share by 39% year-on-year. Moving to the income statement. As always, we present growth rates in both in current and constant euros. Profit increased strongly continuing the positive trends of previous quarters, supported by, first of all, strong top line performance with growth in all our global businesses. We have improved efficiency as costs increased well below revenue, reflecting our transformation efforts, double-digit growth in net operating income to more than €24 billion, normalization of loan loss provisions in line with our expectations. And as I mentioned in the previous slide, these trends resulted in our highest quarterly profit on record, 9% above that of Q2 ’23.

Jose will go now into more detail on these points later. These results maintained us on track to achieve our ’23 targets, targets that we reiterate. First of all, good business dynamics led to double-digit revenue growth. Our efficiency ratio improved and remains at the lower end of our target range, even with investments in One Transformation. A strong balance sheet with cost of risk normalizing as expected and capital ahead of target with CET1 improving quarter-on-quarter. Our RoTE is close to 15% and should comfortably reach our target at year-end. Looking closer at capital and value creation, our CET1 ratio has grown year-to-date from 12% to 12.3%, backed by strong organic capital generation after investing in profitable growth, absorbing regulatory impacts and remunerating our shareholders according to our dividend policy.

We continued to grow our shareholder value creation, which was up 12% in the first 9 months of the year, and we’re increasing our shareholder remuneration with payout up to 50%. In September, the Board of Directors approved an interim distribution against our first half results, which is being executed as follows: a cash dividend of €0.081 per share to be paid in November, 39% higher than equivalent in ’22; a share buyback program of up to €1.3 billion that is currently underway. Since ’21 and after completing the current program, Santander will have bought back 9% of its outstanding shares, buybacks — through share buybacks. We are progressing in our new phase of value creation, transforming the bank in the right way by changing our model to improve both cost and revenue.

One Transformation, which implies creating a common operating platform and technology for our retail and commercial business across all of our geographies, will lead to improved customer service, efficiency and profitability. In simplification, we have reduced the number of products by 8% in ’23. That’s almost 800 less products. In digitalization, we are making good progress with our digital self-service model, increasing the availability of products and services in our digital channels and reducing the use of our contact centers by 16%. We have set up a fully digital end-to-end onboarding process in Mexico that takes just 6 minutes to complete. Since its launch in July, we have opened 36,000 new accounts. In the U.S., we have already captured around €114 million in savings from transformation and simplification.

As you can see on the slide, the initial efficiencies from One Transformation and the impact of our active spread management in a context of higher interest rates have already contributed 117 basis points in efficiency improvements. Our global and network businesses contribute to the group’s profitability and have delivered 39 basis points in efficiency gains. For example, multi-Latinas and multi-Europeans, initiatives to better serve our multinational corporates and SMEs through our regional coverage model, are growing at very high rates, with revenue up by 50% in ’23 year-on-year. In Private Banking, we continue boosting collaboration with CIB and corporates, which has generated over €160 million revenue this year or 13%. In Brazil, we have acquired 117 new relationships that brought BRL 6 billion in net new money.

In payments, Getnet already operates in 5 countries. We expect implementation in Chile in the next few months and in the U.K. in ’24. In auto, we continued to strengthen our relationships with global OEMs. Since January ’23, we have expanded 3 of our OEM partnerships to new countries. Finally, our global technology capabilities have already resulted in a 29 basis points improvement in the efficiency ratio. Our global approach to technology has allowed us to capture €125 million savings this year, €55 million from the recent deployment of Gravity, €60 million from the new global agreements with vendors and €9 million from the implementation of new IT & Ops shared services. Let’s look at how One Transformation is reflected in cost and operational efficiencies.

Simplification is driving significant improvements in our cost and revenue per active customer. Process automation is enabling us to spend less time on operations in branches and turn this into a powerful sales and advisory channel. Since our Investor Day, we have reduced the number of operational FTEs per million customers by 5%. We are already deploying global platforms to improve customer experience, leverage economies of scale and spread best practices. We have implemented across the group, proprietary back-end Gravity, already deployed in 3 countries and CIB. This is delivering €55 million in efficiencies in ’23, and we have executed 75 billion transactions this year alone, that’s 10% of the group’s total. We’re expanding our cards platform across the group, delivering real-time digital processing capabilities to our banks and accelerating our business growth and will generate operational synergies of around €100 million per year when it’s fully deployed.

Finally, we are being able to transfer the best-in-class products and processes from the country of origin to the rest of the group, which led to a strong value creation. The contribution of our global and network businesses is clear. In CIB, we continued to grow strongly. Our global presence has allowed us to grow revenue by 21% year-on-year as we provide a one-stop shop service to all our clients, capturing cross-border flows and making CIB products and services available to our wealth, retail and commercial customers across the group and vice versa. As a result, revenue from these 2 concepts, our network revenue grew by 27% year-on-year to €3 billion. Wealth Management and Insurance grew revenue 22% year-on-year, well above target, boosted by benefits of the Santander network effect.

In Private Banking, a fundamental part of our value proposition is that our customers can move and transact easily from one country to another. Today, customers have €52 billion of assets under management booked abroad. That’s 12% higher than a year ago. Our payments business is growing strongly and faster than the market. Our Payments Hub has become one of the largest processors of account-to-account payments in Europe. Spain, the U.K. and CIB are already processing a significant payment volume through PagoNxt, while we execute full migration of all the group’s A2A payments in the next 18 months. In auto, we continue to prioritize profitability over market share growth in the context of rising interest rates. Global auto revenue was affected by lower lease income in the U.S. and the new regulation in Germany.

One Transformation is now being extended across the group, and the increasing contribution from our global and network businesses are helping us to reach our ’25 profitability targets across regions and businesses. Some geographies and businesses have benefited from rising rates, and they should continue to do so in ’24. As for those countries and the businesses that do not benefit from higher rates, they are already showing signs of improvement. This diversification, which is a clear competitive advantage, will lead to consistent profitable growth and value creation. The group’s RoTE rose 126 basis points year-on-year to around 15%, as mentioned before. Jose will go now in more detail to the group’s performance. Thank you, Jose.

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Jose Garcia-Cantera: Thank you, Hector, and good morning, everyone. I will take you through the main lines of the P&L in more detail. Starting with revenue. There was strong growth driven by customer revenue again this quarter, which made up more than 95% of total revenue and explained almost all the growth in the quarter. This was primarily supported by our retail business as we actively managed the interest rate tailwinds in Europe and Mexico and due to the positive fee performance in Latin America. We delivered double-digit growth across most businesses, in particular, our network businesses, which made up 38% of total group revenue. The only exception was auto, which was affected by lower leasing income in the U.S. Revenue at the Corporate Center also improved by more than €500 million year-on-year due to higher liquidity buffer, remuneration and a lower impact from FX hedging.

Most of our revenue growth came from NII, which continued its upward trend, increasing 7% in the quarter, driven mostly by Europe and Mexico. We see upside potential for further growth in the coming quarters. Nine months 2023 was 16% higher year-on-year in constant euros on the back of positive sensitivity to rising rates, mainly in Europe and Mexico and volume growth in DCB, North America and South America. In terms of profitability, we have improved our net interest margin every quarter since the first quarter of 2021. Gains from credit yields outweighed higher funding costs, thanks to our disciplined deposit remuneration leading to a clear margin expansion. In Europe, we are strictly managing deposit costs, especially in Spain and Portugal, where there is excess liquidity in the system and lower credit demand.

The U.K. has a more competitive environment, but betas remain in line with our expectations. In South America, deposit rates are more directly linked to market interest rates, which results in negative sensitivity to rising rates. Therefore, as interest rates are starting to decline, we are seeing improved NII trends. In North America, in the U.S., betas continued to increase, although in line with our expectations, while net interest margin in Mexico expanded. Going forward, in Europe, we expect further benefits from portfolio repricing in the context of stable interest rates or a slight increase, which we expect will more than outweigh potential cost of deposit growth, at least in the first half of next year. At the same time, as I said, we expect to benefit from interest rate cuts in South America.

Turning to fees. In an environment of low fee income growth in general as a result of subdued loan demand and weak consumer activity, our net fee income grew 9% compared to the third quarter of ’22 and 6% year-on-year with good performance across regions and businesses. Retail Banking grew well, supported by a larger customer base and our tailored and targeted value propositions. Our global network businesses represented 42% of total group fees which — with Corporate Investment Banking and PagoNxt leading the way in terms of growth. Corporate Investment Banking is increasing its share of leading roles and PagoNxt continued to expand its businesses, increasing total payment volumes 24% year-on-year and transactions 32%. Wealth Management and Insurance was slightly up as customers move to lower value-added funds than bringing lower fees.

However, we saw increased activity in both Private Banking and Santander Asset Management with 3 consecutive quarters of positive net sales. Auto performance increased year-on-year, driven by good performance in all our main markets. In terms of costs, savings from One Transformation initiatives, which will become more evident in the coming quarters, are already offsetting our investments in tech and digitalization. Group cost declined 0.5% in real terms. And driving down the transaction cost per active — the transactional cost per active customer, 2% in real terms, as Hector mentioned earlier. This in turn is reflected in efficiency gains led by Europe, which improved 6 percentage points with costs flat in real terms. In North America and DCB, cost increased slightly in real terms, reflecting investments to accelerate transformation.

Additionally, costs were also slightly affected by some perimeter effects, such as the incorporation of APS in the U.S. and MCE Bank acquisition and new Stellantis agreement in DCB. As a result, group efficiency remains at the bottom end of our target range where we expect it to stay for the rest of the year. Credit quality remains robust across our footprint and in line or actually slightly better than our expectations, which is supported by strong labor markets and resilience in used car prices in the U.S. The NPL ratio was stable and in line with expected levels, and we remain comfortably on track to meet our 2023 cost of risk target of less than 1.2%. Spain continues to perform well with a 12-month cost of risk down 9 basis points year-on-year, supported by the quality of the loan book and resilient economic conditions.

In other units such as the U.K., Portugal and the Digital Consumer Bank, the cost of risk is normalizing from very low levels, and we expect it to remain below or in line with through-the-cycle averages. Mexico is also increasing, although it remains at comfortable levels, mainly due to a change in mix towards unsecured loans in line with our strategy to improve profitability. Normalization continues in the U.S. in line with expectations. As we mentioned last quarter, cost of risk in Brazil seems to have reached a turning point. The 12-month cost of risk decreased for the second quarter in a row, and the NPL ratio improved 28 basis points in the quarter, reflecting the improving macro conditions and our focus on more secured and high-rated customers.

To close with our balance sheet structure, as we have discussed in previous presentations, our credit portfolio is well diversified by segment, product and country. Our balance sheet is low risk. The portfolio is highly secured with quality collateral and has low loan to values — average loan to values. Loans decreased 2% year-on-year as a consequence of higher interest rates, reducing credit demand and driving early repayments, especially evident in Europe and especially evident within European mortgages. Positive dynamics continued in North America, South America and DCB. On the other hand, deposits continued to grow well, up 4% year-on-year and 2% in the quarter as deposit inflows more than offset mortgage prepayments. Growth in the year was concentrated mainly in time deposits as customers seek higher rates.

Our deposit base is diversified and highly stable. Using LCR criteria, 75% of our deposits are transactional, which are stickier and a high proportion of our deposits from individuals are covered by deposit guarantee schemes. Mutual funds rose 11% with broad-based growth across all countries except the U.S., following a year of instability in 2022. Our fully loaded capital ratio improved to 12.3%, backed by strong organic generation of 45 basis points in the quarter which included 33 basis point charge in shareholder remuneration, 21 basis points related to the latest program of share buybacks that we are currently executing and 12 basis points for the cash dividend accrual. We continue to focus on profitable growth opportunities, and this was reflected in a front book return on risk-weighted assets of 2.7%, up from 2.5% in the first 9 months of 2022, equivalent to a return on tangible equity above our current group return on tangible equity, which will support profitability going forward.

Additionally, we continue to increase balance sheet mobilization and the percentage of risk-weighted assets with positive economic value added, progressing well towards our Investor Day target of 85% in 2025. Increased profitability will help us continue to build capital over the next few years. We are confident our fully loaded capital ratio will remain above 12%, even after taking into account the final implementation of Basel III in 2025 on a fully loaded basis. That’s all from my side. Hector, over to you. Thank you.

Hector Grisi: Thank you, Jose. To wrap up, these are the messages I will leave with you. Q3 was another strong quarter with customer and double-digit revenue growth supported by all regions and businesses. We are accelerating One Transformation towards a simpler and more integrated model, which is extracting value from our global and network businesses, driving efficiency gains and profitable growth. We have strengthened our balance sheet and increased our CET1, while credit quality remains strong, in line with our expectations. All of this contributes to double-digit growth in shareholder value creation and increased remuneration, and we remain on track to meet our ’23 targets. The execution of our strategy, the progress we are making in our platforms and our local leadership makes us confident we can continue to grow and to increase profitability.

We see further upside potential for NII growth from the portfolio repricing and potential interest rate hikes in Europe and positive outlook for the margins in South America. Efficiency, already at the lower range of our ’23 target, is expected to keep improving our revenue and cost as we increasingly realize One Transformation benefits. We expect the cost of risk to end the year better than target, and we expect it to remain at similar levels in ’24. At our Investor Day, we set a RoTE target of 15% to 17%. We expect to reach a RoTE above 15% by the year-end and continue to improve significantly during ’24, and we see our fully loaded CET1 clearly above our 12% target even after the implementation of Basel III in January ’25. As a result, we expect to progress in our target of double-digit shareholder value creation through the cycle, further supported by our last step towards the full implementation of One Santander, which will enable us to fully capture our in-market and global value.

And now, thank you. We would be happy to take your questions.

Begona Morenes: Thank you, Hector. We’re ready to start the Q&A session. Can we have the first question, please?

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Q&A Session

Operator: [Operator Instructions] We already have the first question from Francisco Riquel from Alantra Equities.

Francisco Riquel : Yes. I want to focus on loan growth. In Spain has been particularly weak. It’s down 10% year-on-year. The sector is minus 3%. I see that most of the 4% is related to CIB, which is down over 20%, but SMEs and mortgages are also weak. If you can comment the gap with the sector? We know demand this week, but you are below the sector. And then more broadly in other regions, I mean, loans in the U.K. are also down 5%, sector is up 1%, Brazil is up by just 3%. The sector is growing 9%. So if you can elaborate on whether you are repricing margins over volumes, if you are more prudent on risk taking at this point in the cycle? So loan growth in general and in Spain, in particular.

Hector Grisi : Francisco, yes, basically, as you have said, loan growth has not been good in the — all the year, I would say, Spain mainly. As you basically say, it’s also being affected by the prepayments in some of the mortgages. If you see the portfolio of mortgages, we have seen — I mean, normally, basically, we go down 3.5%. This basically, we have had prepayments up to €6.5 billion so far this year. And you’re right. SMEs and mortgages basically have been not demanding credit as much. I believe people are being cautious in the way and trying to see how the economy evolves, even though employment has continued to be strong and demand continues to be strong. This is a fact, and we have seen the clients basically being cautious.

Nevertheless, if you see our portfolio in the rest of the countries, mainly Latin America has continued to grow. There, we have been maintaining and being very, very cautious in credit appetite, but also very focused on profitability. So we’re growing the portfolio in Latin America in a very good way, but in a profitable way. And also, you have seen that DCB has increased and has a substantial good development during the year, and we will continue to see that over the next few months. So all in all, we are 2% below in loans this year, but we foresee that once clients basically see that rates are starting to stabilize and the market basically has a more clear view of what’s going on, I believe that credit will come back, little by little. I don’t know, Jose, if you would like to just complement…

Jose Garcia-Cantera : No, just one final comment. Risk-weighted assets are down €2 billion in the quarter, but it’s exclusively due to FX. So if we look — if we exclude FX impacts on risk-weighted assets, risk-weighted assets are actually flat in the quarter, which is what matters most for profitability and capital.

Operator: Next question from Antonio Reale from Bank of America.

Antonio Reale : It’s Antonio from Bank of America. Two questions from me, please. The first one is on the profitability outlook. And the second one on asset quality in the U.S. So starting with the first one. You’ve reiterated your guidance for the full year, which, if I’m not mistaken, implies a net profit of around €10.9 billion for this year. Can you confirm that’s right? And how do you see profitability in 2024? It would be great if you could talk us through how you see the main units performing into next year, particularly Europe, Brazil and the U.S. My second question is with respect to asset quality in the U.S. There was a big uptick this quarter, and you’ve been talking about normalization in cost of risk. And now we’ve seen lower used car prices and higher delinquencies, but neither of them were material changes.

So the question is what’s driving this? Can you talk a bit more about what you’re seeing specifically on asset quality? And related to that, I think you’ve confirmed your 200 basis points cost of risk for this year. What do you expect this number to look like next year?

Hector Grisi : Yes. Thank you, Antonio. Okay. On profitability, as I said during the presentation, I reiterate the 15% RoTE. So that basically gives you the numbers that you’re looking for, okay? So in that sense, we’re pretty comfortable on that. On ’24, as I basically said, we see also the portfolio repricing. So we see a strong first half of the year in Europe. And then we see a strong second half of the year in Latin America when we see basically the dynamics changing. And you have seen that and you’ve seen that in the numbers of this quarter when basically you have seen Latin America basically performing better, okay? So in that sense, that can give you a very good idea and Jose will give you more details on that. In terms of asset quality in the U.S., and I’ve been saying all along that in the past few quarters, it’s very important to understand that it’s always seasonal.

If you take a look at what happened last year, in the third quarter, it was actually the same and we expected that, and we told you so. And — but it’s important to tell you that it’s actually better than we expected. And also it’s not going to go beyond the 200 basis points, as you correctly pointed. In that sense also, we see that the portfolio is performing better in the sense that we see that people with 90-day delinquencies or above when it used to happen is we used to repossess about more than 90% of those cars is basically performing much better, and we are repossessing between 60% and 65% of those. If the threat continues like that and used car prices in the U.S. continue like that, we expect a better performance than we normally expect.

It’s important that you understand that we have a completely different mix today in the portfolio. The portfolio that we had pre-COVID didn’t have as much prime and near prime as we do today. Prime and near prime is at around 41% of the mix of the portfolio, though that basically tells you that we expect the asset quality to maintain at good levels. And also, the U.S. has been performing with a strong employment as well and the dynamic as well. So in that sense, I’m comfortable with the numbers we’re giving you. Jose, please, would you like to complement on the profitability?

Jose Garcia-Cantera : Yes. Just one final comment on U.S. asset quality. The cost of risk in 2019 was 2.85%. And given the changes in the mix that Hector mentioned, we don’t expect to reach that — those levels at all. And we would expect cost of risk in 2024 to be fairly flat, maybe slightly up compared to 2023 in the U.S. In terms of profitability, well, we have — we still have negative sensitivity to rates in Latin America. So as rates start going down, we will see accelerated momentum in NII in Brazil, in particular, coupled with higher loan growth and flat or slightly improving asset quality. So clearly, the profitability in South America as Hector mentioned is going to gain momentum throughout the year with a much better second half relative to the first half.

Hector Grisi : And in Europe, as he said, we still have a lot to reprice on the asset side. That’s one example. In Spain, we have around €80 billion of mortgages. You know that they reprice around 112% every month. Well, in fact, we repriced 60% of the total in the first half relative to the second half. So in the first half of ’24, we will still reprice a big chunk of our mortgage portfolio in Spain up year-on-year as they come to repricing. So, asset repricing, particularly in Spain and, obviously, some beta pressures and the cost of deposit pressures with profitability still improving in the first half of the year. So when you look at the total year, we actually — we remain constructive on profitability, and profitability improving actually in ’24 relative to ’23.

Operator: Next question from Sofie Peterzens from J.P. Morgan.