Santander 2Q16 Results Decrease by 32% To EUR 2.911 Bn For One-Offs And Currency Depreciation

Banco SantanderBanco Santander CEO Ana Botín

Banco Santander registered attributable profit of EUR 2.911 billion in the first half of 2016, a 32% decrease compared to the same period of 2015. This decline is affected by one-offs and the depreciation against the euro of the currencies of the main countries where the Group is present.

In the second quarter of 2016, one ‐ off charges amounting to net EUR 368 million were booked, while in the same quarter last year a positive one ‐ off of EUR 835 million was registered from the reversal of loan loss provisions in Brazil. Without the impact of these one ‐ offs and the exchange rate effect, the Group’s ordinary profit grows 9% to EUR 3.28 billIion.

In the first half of 2015, currencies were stronger against the euro. For this reason, for comparison purposes, the income statement includes variations in euros and without the exchange rate impact.

In a year in which the global macroeconomic outlook has deteriorated, Banco Santander improved the quality of its balance sheet, its solvency and its profitability. This allows the Bank to reaffirm its commitment to end the year with an increase in earnings per share, while growing total dividend per share 5% and the cash dividend, approximately 10%.

Results

In this scenario, the Bank’s two main business lines, lending and customer funds, increased by 4%. In addition, the number of loyal clients increased by 10%, to 14.4 million, and digital customers 23%, to 19.1 million. These increases in business and loyalty led to growth of 3% in net interest income and 8% in fee income. This performance is mainly a result of greater transactionality and product sales that stem from the 1|2|3 strategy which has already been implemented in the UK, Spain, Portugal and, recently, Mexico. Increasing loyalty and digitalization are pillars of the Group’s commercial transformation.

Net operating income, which indicates recurring results generation capacity, reached EUR 11,275 million, a 2% increase ( ‐ 8% in euros). The efficiency ratio stood at 47.9%, a 0.2 point improvement over the prior quarter.

57% of Group profits is generated in Europe and 43% in the Americas. By country, the largest contribution was made by the UK, with 20%, followed by Brazil (19%), Spain (15%), Mexico (7%), the United States and Chile (6% each), Portugal (5%), Argentina (4%) and Poland (3%). SCF, which operates in more than ten European countries, particularly in Germany, Spain and the Nordics, contributed 13% to profits after earning 533 million, with growth of 16% in euros, 18% without the exchange rate effect.

Business

Banco Santander closed the first quarter of 2016 with total assets of EUR 1.343 trillion, an increase of 6% year on year (0% in euros). Lending volume amounted to EUR 795,182 million, 4% over last year ( ‐ 3% in euros). Overall customer funds reached EUR 765,859 million, with growth of 4% ( ‐ 2% in euros).

Spain

The loan portfolio reached EUR 157,337 million euros, with a 2% drop over the first half of 2015. Nevertheless, this figure represents an increase of almost 1% with respect to the first quarter 2016, reflecting growth in financing to businesses. The year ‐ on ‐ year decrease is tied to the 8% drop in financing to the public sector and the 3% decrease in the mortgage book. New production increased sharply, with growth of 18% in SMEs and 25% lending to retail customers due to consumer finance and mortgages.

Total customer funds (deposits plus mutual funds) amounted to EUR 218,687 million, a 4% decrease. Low interest rates and the appeal of the 1|2|3 account meant that term deposits fell 21%, while demand deposits rose 2% and assets in mutual funds rose 3%. The cost of deposits fell for the second consecutive quarter, to 0.48%, 0.08 point less than the prior year.

United Kingdom. The lending portfolio amounted to EUR 251,977 million at the end of the first half of 2016, with growth of 3% in pounds ( ‐ 11% in euros) and progress made in all segments. Financing to companies grew 11%, and mortgages and consumer financing, 2%. The mortgage book is diversified throughout the UK and is high quality, with low average amounts per mortgage, low ratios of loan over asset value and low total credit over customer income.

In the U.K., the volume of assets in mutual funds reached EUR 211,699 million and grew 6% in the year in pounds ( ‐ 9% in euros). Over the last four years, the 1|2|3 strategy, has attracted 4.9 million clients, 276,000 in the first half of 2016.

Brazil. The credit portfolio reached EUR 72,096 million, with a decrease of 2% in reals ( ‐ 5% in euros). By segments, financing to individuals increased 3%, boosted by payroll credit and mortgages, while lending to companies declined.

Total deposits and mutual funds reached EUR 91,507 million, with growth of 6% without the exchange rate effect (+2% in euros), with good progress in letras financeiras (notes) and mutual funds.

As for the rest of the Group’s main countries, United States grew lending 4% and slightly increased customer funds; in Mexico, loans rose 16% and customer funds, 14%; Chile increased both business lines 8%; Portugal grew lending 23% and customer funds, 24%; Poland increased loans 12% and customer funds, 7%; and Argentina grew its credit portfolio 46% and customer funds 53% (both impacted by high inflation). Lastly, Santander Consumer Finance, which groups the consumer finance business in continental Europe, grew deposits 5% and lending to customers 14%, boosted by the agreement with French group PSA Finance.

Capital

With regards to capital ratios, the bank closed the first half of the year with total eligible equity of EUR 79,371 million, and risk weighted assets of EUR 586,020 million. Santander has a CET1 capital ratio of 12.32%, 2.57 percentage points more than the minimum required by the European Central Bank for 2016, which is 9.75%.

The CET1 fully loaded capital ratio, which assumes capital requirements that will be in force as of 1 January 2019, is 10.36%, 0.31 point more than at the end of 2015. This capital ratio is in line to reach Santander’s goal of 11% by 2018.

Banco Santander ́s board of directors has announced its intention to distribute a EUR 0.21 dividend against the 2016 fiscal year, which would mean an increase of 5% of the dividend per share over 2015. Of this amount, EUR 16.5 cents would be paid in cash, 10% more than the prior year, and EUR 4.5 cents in cash or shares, depending on each shareholder’s preference. Next August 1, the first dividend charged to 2016 results will be paid and it will be EUR 5.5 cents per share in cash, 10% more than the same period last year.

According to Citi experts these 2Q16 results could lead to estimated results for the whole year up 1-2% or so.

We use a two -stage dividend discount model (DDM) to value Santander with the present value of 2017 -18E dividends and a terminal value assuming an ROE of 9.0% (9.6% on a basis of 10% B3 FL CET1R) and ROTE of 12.6%. We assume a 12.0% cost of equity for the group. We cross -check the valuation using: (1) justified price to book valuation on a segment basis, (2) comparable P/E valuation relative to the banks sector, and ( 3) comparable P/E valuation relative to Santander’s historical trading range and growth prospects. We derive a target price for Santander of €4.20.

Citi points to key risks for Banco Santader including: (1) Spanish Stagnation and Bad Debts; (2) Consequences of Brexit and politics in Spain; (3) Deterioration of the US Economy; (4) Slower -than – expected Recovery in LatAm – A weaker -than -expected recovery in Latin America (particularly Brazil) would affect our earnings expectations in the region for Santander.

If these risk factors have a more or less negative impact than we anticipate, then the share price could deviate significantly from our target price.