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Morningstar | Mortgages, Consumer Loans, and Business Financing Drive Solid 4Q Results for Santander Chile

Narrow-moat Santander Chile posted an adequate fourth quarter, with net income up 16.3% from last year’s fourth quarter and net interest income up 3.2%. Much of the improvement in the bottom line came from a decline in provision for loan losses. In the third quarter, the bank recognized a one-time CLP 20 billion accounting charge in anticipation of changes to the loss model. Excluding this charge, quarter-over-quarter numbers were moderately positive. The Chilean economy experienced strong GDP growth of 4% in 2018 as the economy continued its rebound from the sub-2.0% growth in the two years prior. We’re maintaining our fair value estimate of $19.50 per ADR share, and we don’t anticipate significant changes to our valuation as we consider management's updated guidance.

Santander Chile’s net interest margin was under pressure from rising rates in the fourth quarter, with cost of funding rising to 2.9% from 2.7%. In the long run, rising rates drive improvements in margins. However, since the bank’s liabilities adjust faster than its assets, rate increases compress NIM in the short run. With inflation expected to be lower in 2019, we anticipate risk-adjusted NIM remaining stable at about 3.5%, and we recognize the possibility of NIM compression from rising rates and lower inflation in the near term.

In the fourth quarter, Santander Chile realized loan growth of 1.0%. Just like last quarter, mortgage loans drove overall loan growth, expanding 3.4%. Though consumer loans are a smaller portion of total loans, the consumer segment also experienced strong growth, at 4.1%. These gains were mitigated by a large decline in corporate and investment banking loans. We don’t view this drop in corporate and banking loans as material given the segment’s 5% contribution to the loan portfolio. We reiterate our concern that increased competition could be inducing lowered underwriting standards, thereby increasing underlying risk of the portfolio.

The main driver for the top-line growth in the fourth quarter was a rise of 30% in net financial transactions revenue. We don’t expect Santander Chile to be able to maintain this level of transactions revenue growth going forward, since this revenue is partially based on providing ad-hoc financing for investment projects that had been waiting for economic conditions to improve. One of the weaker line items in Santander Chile’s fourth-quarter results was fee income, which declined 2.4% compared with the third quarter. While fee income from debit, ATMs and brokerage tends to be volatile, the primary reason for the segment decline was the implementation of an updated methodology for collecting insurance fees. Interestingly, Santander Chile decided to install additional ATMs in branches, reversing a trend of ATM reduction. Although we believe branches can be an effective tool to drive product growth, moving ATMs to branches may inconvenience customers who would prefer ATMs with a nearby location. We also view the quarterly 18% growth in ATMs as peculiar from a strategy perspective, given that the bank took ATM numbers down by the same amount over the first three quarters of the year.

We continue to view Santander Chile as a well-run and innovative bank and believe that Santander is effectively investing in the future of banking by expanding its WorkCafe concept to a smaller branch format. These WorkCafes tend to be more efficient and profitable on average than regular branches, and Santander is ahead of its competitors in this arena. In the earnings release, the bank mentioned artificial intelligence being integrated into the WorkCafes to match clients with product offerings. We’re skeptical of artificial intelligence often being used as a buzzword to drive client and investor interest. However, Santander has shown that it prioritizes innovation, and we view the potential of AI to drive revenue with cautious optimism.

The Central Bank of Chile increased interest rates last quarter to 2.75% from 2.50%, the first increase since December 2015. This rate increase was implemented to keep inflation below 3% in the medium term, as it had reached 3.1% in September 2018. While overall GDP growth is still positive, annualized GDP growth has cooled somewhat and was below 3% in the second and third quarters. While Chile plans to diversify its economy in the long run, copper is still the top export and the country has high exposure to the ongoing volatility in copper prices.