In Aristotle’s theory of moral development, pleasure and pain are used as guiding principles to educate young people. Shareholders of Banco Santander underwent an especially illuminating ethical lesson yesterday: the amortizations registered in the United Kingdom contrasted with the solid behavior in Latin America. If Ana Botín is able to limit the damages of the pandemic, she will be able to close the wide discount with respect to the book value at which the bank is trading.
Understandably, Santander was careful to point out that the 12,600 million euros in impairments recorded during the first half correspond to virtual charges that do not affect basic capital. That’s important, because its Tier 1 capital ratio of 11.8%, which has risen slightly in quarter-on-quarter terms, is lower than that of many European rivals.
Around half of the amortizations have to do with past acquisitions in the United Kingdom. In 2004, the Spanish bank paid much more than it was worth to take over the Abbey National credit union. The British banking market accumulates disappointments for all those who compete in it, as shown by the low profitability of tangible capital (ROTE) of the Santander UK division, which fell by a weak 2% in the first half. Ironically, the bankers often referred to the Abbey purchase as a relative success, compared to the unions between European banks that came later.
In a flattering contrast to Botín, his dedication to the most lucrative markets in Latin America seems to be paying off. A slight rise in non-performing loans cut profits in Brazil, Santander’s most profitable market, which accounts for around a third of the group’s total profit. Even with the drop, an impressive ROTE of 17% has been taken out. Underlying profits in Mexico grew 4% yoy, despite the Covid-19 onslaught.
If the group’s reserve for defaults doubles to 1.5% of loans in the second half of the year (above the recommended margin), Santander would still get a ROTE of 5%, according to a calculation from Breakingviews that assumes income stable and uses a tangible book value of € 66.4 billion. That more or less agrees with the shares valued at half the tangible book value, assuming a cost of capital of 10%.
If Brazil and Mexico are able to maintain their solid behavior, thereby continuing to offset losses in Europe, Botín could obtain a lower discount. It would be the cherry on top of the lesson.