EUR 850.00 For Business Accounts Only

Morningstar | Santander 2Q 2018: Decrease in Loan Losses Drives Solid Numbers

Narrow-moat Santander reported solid second-quarter 2018 results with net attributable profit growth of 14% compared with second-quarter 2017, excluding a EUR 300 million nonrecurring restructuring charge related to the integration of Banco Popular. We anticipated that the consolidation of Banco Popular would have a more material impact on the group's efficiency ratio. We increase our estimates for full-year earnings for 2018 by 10% to reflect the better-than-anticipated efficiency, and we maintain our EUR 5.30 fair value estimate and narrow moat rating.

Earnings growth in euros was virtually solely driven by a 12% decline in loan-loss provisons compared with second-quarter 2017, confirmed by the 2% decline in preprovision profits. While this is reflected in our estimates, we believe it is important that investors take note of this. According to our calculations, Santander's loan-loss provisions currently equate to 1.0% of loans, while the average ratio since 2005 has been 1.2%. We would thus argue that Santander's credit losses are already approaching midcycle levels. Earnings support from lower loan-loss provisions is finite.

We have previously expressed our dislike of Santander's consumer finance business in the U.S. We believe that this is a business with no barriers to entry and that it exposes Santander to high credit risks. The 40% earnings increase in the US operation is only driven by lower loan losses. What concerns us, however, is that nonperfoming loans have started picking up again. Nonperforming loans fell in all jurisdictions, except in the U.S., where the NPL ratio deteriorated by 0.3 percentage points to 2.9%. The lower U.S. loan losses are therefore solely due to a lower coverage ratio.

In constant-currency terms, earnings grew by 25% year on year. However, we are not big supporters of constant-currency numbers. Inflation differentials are captured in currency movements over the long term, and the potential for currency weakness should form part of management's capital-allocation decision-making.