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Morningstar | Rising Rates and Low Inflation Sting Santander Chile in 1Q; Interest Margin Hits a Multiyear Low

Earnings at Banco Santander Chile took a hit in the first quarter from lower inflation and rising rates, driving shares down to a one-year low. Still, we continue to view Santander Chile as marginally overvalued and reiterate that Chile is highly exposed to a slowing Chinese economy. Net interest margin dropped to 3.9% from 4.5% the previous quarter, leading to net interest income falling nearly 10%. Santander Chile’s balance sheet is uniquely structured, with about 50% of interest-earning assets denominated in Unidad de Fomento, a currency indexed to inflation. Annualized inflation in Chile in the first quarter was well below the central bank’s 3% target, at just 1.83%. The bank's high percentage of UF-denominated assets protects against high inflation but strains interest income in periods of low inflation. Margins were also compressed by rising rates, given the bank’s lower duration of interest-earning liabilities compared with interest-earning assets. The negative impact of these two factors outstripped positive developments, including 4.8% growth in fees and commissions and a 1.8% decrease in operating costs. Net income was down about 20% for the quarter and 17% year over year. Even considering the hefty drop in interest margins, results were generally in line with our overall 2019 forecasts, and we’re maintaining our fair value estimate of $24.60 per share.

Looking ahead, management provided guidance for net interest margin of 4.3%-4.4%, which we think is reasonable, and we expect margins to rebound as the year progresses. We believe the bank’s efforts to reduce its asset exposure to the inflation-index UF currency, while perhaps overdue, bodes well for future results. Inflation in Chile has been stable over the past three years and, given the central bank’s commitment to the 3% inflation target, we think it makes sense for Santander Chile to continue drawing down the sensitivity of its balance sheet to inflation.

Year-over-year gross customer loan growth in the first quarter of 8% compares favorably with our full-year forecast of 7.8% but is a slight decrease from fourth-quarter loan growth of 9.2%. The main growth drivers for the loan portfolio were residential mortgage loans, up 1.8% for the quarter, and middle-market loans (companies with sales exceeding CLP 1.2 billion), which rose by 2.5%. The Santander Life program, a consumer credit program that rewards customers with benefits for keeping up with payments, continued to experience strong growth, at 21% for the year. Though we view this program as an effective way to drive credit growth and improve asset quality, loans in the program account for just 0.1% of the total loan book.

In March, Santander Chile announced its entry into the auto loan business, with an upcoming 49% ownership acquisition of Santander Consumer Chile from SKBergé Financiera for CLP 49 billion. Santander Consumer Chile is the second-largest auto lender in Chile, with an 8.2% market share. This acquisition will bring Santander Consumer Chile back into the Santander portfolio of companies, and Santander Chile’s parent, Banco Santander, will own the remainder of shares. Santander Chile also announced plans to develop a payment processing business by early 2020, with testing starting later this year. We take a cautiously positive view of these plans, with payment processing and auto loans providing additional business diversification. We also see potential synergies from the acquisition of Santander Consumer’s auto loan book, given that parent Banco Santander will have effective control over the full business.

Annualized GDP growth in Chile in the fourth quarter was 5.2%, up from just 0.8% in the third quarter. The International Monetary Fund is forecasting 2019 real GDP growth in Chile to reach 3.4%, evidence that the Chilean economy is set to continue its momentum from 2018’s full-year 4% growth. The Central Bank of Chile kept interest rates at 3% after its March meeting, holding the benchmark rate stable since the 25-basis-point increase in January. In its policy statement, the bank advised that the lower level of inflation—under 2% in the first quarter—justifies ongoing monetary stimulus and that rates will be adjusted as needed to meet the two-year annualized inflation goal of 3%. Though a strengthening economy provides a tailwind for Banco Santander Chile, the Chilean economy remains highly exposed to Chinese demand for copper, global commodity prices, and fragile economic conditions.