Banco Santander Chile (BSAC) 2008 Q4 法說會逐字稿

Good day, everyone, and welcome to our fourth quarter 2008 earnings release conference call. Today's call is being recorded. At this time for opening remarks and introductions, I'd like to turn the call over to Raimundo Monge. Please go ahead.

Thank you very much. Good morning, ladies and gentlemen. Welcome to Banco Santander-Chile's fourth quarter and year-end 2008 results conference call. This is Raimundo Monge, Director of Strategic Planning, and Robert Moreno, Manager of Investor Relations. Thank you for attending today's conference. Next two slides, please. You should be on slide three.

Today we will discuss the bank's recent results and strategy as well as a quick update on the adoption of International Accounting Standards by the bank in 2009. Afterwards, we will be happy to answer your questions.

Next slide. In the fourth quarter of '08, net interest income attributable to shareholders totaled CLP77,566 million, increasing 9.6% year on year. With these results 2008 net income increased 6.3% compared to the rest of the banks that we compete with, which saw their combined net income drop 0.5% compared to 2007.

In 2008, the bank showed a solid evolution of its commercial activity and core revenues accompanied with world class levels of efficiency. The strong growth of core revenue was partially offset by higher credit risks and lower gains from financial transactions due to the volatility of interest rates and FX markets. The net interest margin in 2008 reached a record level of 6.1% compared to 5.8% in 2007. The efficiency ratio reached 38%, improving from 39.4% in the same period of 2007. ROE reached 23% in 2008.

Next slide. The bank faced a more challenging operating environment during 2008, especially in the fourth quarter as the global financial crisis impacted the Chilean economy. Despite this, the evolution of our results was positive as the bank stuck to its yearlong strategy of focusing on profitability. Throughout 2008, we stressed the importance of actively managing the balance sheet in order to continue expanding net interest income. The bank ended 2008 with better capitalization ratios, higher liquidity and strong deposit growth. At the same time, loan volumes continued to expand while shifting our focus to grow in the less riskier segments. We have also been increasing our spreads in order to absorb potentially higher funding cost, lower inflation, and deteriorating credit risks.

Our second strategic objective is the proactive management of risks. The bank has taken a number of actions in order to curb the provision expense growth in the coming quarters. Nevertheless, as mentioned in previous earnings release, we expect some further deterioration of asset quality throughout 2009 as the economy slows down. The third strategic objective is to increase cross-selling and product use to boost fee income. We believe we have two very important advantages to succeed in this goal.

First of all, Santander-Chile has the largest client base in Chile among private banks. Secondly, we have IT systems that are unparalleled in Chile and that allow our account executives to cross-sell more easily their client base. In line with our last strategic goal, the growth rate of operating expenses was effectively curbed in the fourth quarter. In this period, the bank focused in cost control and limiting the opening of new branches in order to maximize the profitability of the system network and client base. Cost control should be a key driver of our bottom-line performance in 2009.

Next slide. You should be on slide number six. Concerning the first pillar of our strategy, balance sheet management and increasing spreads, the bank has experienced a favorable evolution of deposit growth in the quarter. In fourth Q '08, our deposit base increased by a record 10.1% Q on Q, outpacing loan growth and reflecting our focus on liquidity and improving the funding mix. As the impact in Chile of the global financial crisis deepened, the bank was able to benefit from its better risk rating, the highest of any company in Latin America. The bank's market share of deposits increased from 20.4% as of September 2008 to 20.8% at the year-end of 2008, led by a 16% Q on Q increase in time deposits.

Next slide. As a consequence, the bank improved its healthy loans to deposits ratio in 4Q '08. As of December 2008, loans represented 94.1% of our deposits, excluding the portion of mortgage loans funded with long-term bonds after represented 100.2% as of September 30, 2008. In the quarter, the bank continued lengthening its liabilities. In total, in 2008, the bank issued $550 million in long-term bonds with a duration of 11 years at attractive spreads. At the same time, the portion of the bank's funding from foreign sources was also reduced to 6% of total liabilities.

Next slide. The bank year-end based Basel ratio reached 13.8% with a core capital ratio of 10% compared to 13% as -- for the Basel ratio at the end of third Q of '08. Despite solid loan growth in the quarter, capitalization ratios improved as the bank issued more subordinated bonds and optimized its risk-weighted assets, which were flat Q on Q.

Next slide. The strong capitalization ratios were achieved without compromising our return on capital, reflecting our profitability-driven strategy. The bank finished 2008 with the highest pretax return on capital in the Chilean banking system and, at the same time, the highest Basel ratio, generating an optimal relationship between risk and return. This has given us a strong starting point in 2009.

Next slide. You should be on page ten of the webcast. The evolution of our loans has also been concurrent with our recent strategy. In the fourth quarter of '08, total loans increased 5.9% Q on Q and 19.1% year on year. During the quarter, loan growth was mainly driven by the corporate segment in line with our strategy of continuing to expand the loan book, but with a conservative approach to credit risks. Corporate lending increased a record 24.5% Q on Q. Total commercial loans increased 8.8% Q on Q and 22.6% year on year in the fourth quarter of '08. The bank's market share in total loans improved from 20.6% in September to 20.8% at the end of 2008.

Next slide. The bank's selective approach to lending was also apparent in loan growth to individuals in the quarter. Total loans to individuals increased 2.7% Q on Q and 16.9% year on year. By segment during 2008 loan growth to high-income individuals was up 35.9% year on year compared to 5.2% year on year to middle income individuals and a decrease of 11.9% to lower income segments.

Next slide. Another key part of the bank's first strategic driver has been to focus on spreads to compensate for higher funding cost and provisioning levels. Following the drive we started early in 2007, loan spread to companies and consumer have kept increasing. Spreads earned over commercial loans reached 2.63% in the fourth Q of '08 and were up 30 basis points Q on Q and 45 basis points year on year.

Consumer loan spreads reached 18.8% in the fourth Q of '08 and increased 18 basis points Q on Q and 75 basis points year on year. Despite this positive evolution of spreads, the net -- the bank's net interest margin reached 5.8% in the quarter compared to 6.2% in 4Q '08 and 6.9% in 3Q '08. This lower net interest margin was mainly due to the lower quarterly inflation in 4Q '08 compared to 3Q '08 and 4Q '07.

Next slide, page 13 of the webcast. As a result of the bank's proactive management of the asset and funding mix, coupled with the loan growth and rising spreads, in fourth Q '08, net interest income was up 17.7% year on year, despite decelerating inflation rates. The banks lead the financial system in net interest margin and gross loan yields, which we think will be a key factor in maintaining net interest income growth in the coming quarter as the growth of loan volumes and inflation descends.

Next slide. Concerning our second strategic objective, proactively managing our risks, the bank has taken a number of actions in order to curb provision expense growth in the coming quarter, mainly refocusing growth to the corporate and high-income individual businesses segments as already seen. In 4Q '08, the bank's net provision expense increased 14.4% Q on Q and [50.7%]year on year. As mentioned in previous earnings reports, this rise was driven by higher charge-off in consumer loans due the economic slowdown as well as an increasing provision in the middle market, following negligible levels in the past three years.

The expected loan loss ratio, which is a ratio that measures how much the -- of the bank's loan portfolio is at risks remained steady Q on Q at 1.95% of loans due to the bank conservative charge-off policies. The rising risk has been offset by higher spreads. As a result, net interest income after net provision expense, increased 5.1% year on year and 20.7% -- sorry, 5.1% year on year -- in 4Q and 20.7% year on year in the 12-month period ended December 31, 2008. Going forward, the expected loan loss ratio and the cost of credit should rise, given the expected lower economic growth.

Next slide, page 15 of the webcast. The bank continues to focus on expanding cross-selling and product usage as a cost efficient way to continue expanding fee income in a lower economic growth period. As a consequence, net fee income increased 3.2% Q on Q and 9.8% year on year. The total number of cross-sold clients increased 7.9% year on year. Fees from credit, debit and ATM cards increased 13.1% Q on Q and 11% year on year. We also saw strong growth in other lines such as insurance.

Next slide. Regarding the last strategic objective, cost control, we saw also an effective curbing of the growth rate of operating expenses during the quarter. Operating expenses decreased 1.7% Q on Q and increased 6.1% year on year in the fourth quarter of '08. Administrative expenses in 4Q '08 decreased 7.5% Q on Q, and increased 1.7% year on year on nominal turns. In the fourth Q of '08, the efficiency ratio reached 38.8% compared to 42.4% in the fourth quarter of '07. We have the highest level of efficiency among the larger banks in Chile and are among the best -- and our efficiency is among the best in emerging markets.

Next page. Before we move into Q&A, I would like to hand over the call to Robert Moreno who will briefly comment on the new accounting standards being adopted by the Chilean financial system. Next slide.

The adoption of international accounting standards is a positive step for the Chilean financial system as it will bring greater transparency, consistency and uniformity to the financial data that we've published beginning this year. It is important to point out that there will be some impacts on the balance sheet, income statement and general presentation of our figures, which are briefly summarized in the next slide, which for the most part are in line with either US and Spanish GAAP standards already published by the bank.

Next slide. The main impacts of switching to IFRS are the following. First of all, the perimeter of consolidation will be amplified from the current seven subsidiaries the bank consolidates and the seven companies the bank recognizes as investments in other companies, we will further consolidate seven more other enterprises. These are companies in which we do not have an equity interest, but over which we exert full management and business control of their operations. These companies are mainly related to our external sales force and collections.

The net effect on net income of this change is minimal, but there will be impacts on individual line items such as personnel expenses, administrative expenses and fee income. Secondly, the fees paid to our sales force expense up to 2008 were deferred with the life of the products being sold. We now must recognize this cost up front. This is a one-time impact against reserves, but going forward this should not have a relevant impact on results. Thirdly, the bank's published effective tax rate will decline as the bank's tax books will still include the results from price level restatement. In periods of positive inflation, the effective tax rate should decrease and in periods of deflation, the tax rate should rise.

At the same time, the Chilean financial system will begin to present non-performing loans in line with international standards. The current definition of past due loans is all installments over 90 days that are past due. Beginning in 2009, when one installment becomes 90 days overdue, the entire balance of all loans a client has will be classified as non-performing. This will not modify current provisioning levels, which are defined by the bank's credit risk models and expected loan loss.

Finally, IFRS contemplates the elimination of inflation accounting. This basically means that the bank no longer has to adjust for variations in CPI or the unidad de fomento, non-financial assets, liabilities and shareholders equity. This also means elimination of price level restatement from results. This should, in general, be positive results except in a deflationary environment such as the one the bank is facing in the first quarter of 2009. As fixed assets are no longer adjusted by the US, we must mark-to-market these assets and any difference with the current historically inflation index values must be adjusted against reserves.

In summary, the new non-performing ratio will be approximately 2.4%. The bank's new equity base will contract by approximately 5% and results will positively be impacted with restated 2008 ROE reaching 30%. These are preliminary and unaudited estimates and may be modified. Please go to the next two slides.

Okay. You should be on page 21 of the webcast. In summary, 4Q '08 results were of high quality, especially considering the adverse environment that affected the global financial industry and we clearly outperformed our main competitors in key indicators. Our high margins, ample liquidity and capital base, improving funding mix, conservative asset quality policies, solid fee income growth and world class efficiency give us a clear, competitive advantage in the local market.

Going forward, we will continue to focus strongly on profitability as we stated throughout this presentation. The issue continued to boost our net interest income and fees although at a lower rate than in 2008. We are also undergoing many actions to curb provision expense growth, but we expect further deterioration of asset quality. Finally, we will moderate our investments in the distribution network and control costs. At this time, we will gladly answer any questions you might have.

Thank you. (Operator Instructions) Our first question comes from Saul Martinez with JPMorgan.

Hello. Good morning, gentlemen. I know there are a lot of moving parts here with the accounting and the movement to IFRS, but I guess I do have a general question about the earnings environment and the profitability environment. It seems on the surface that, on a lot of levels, things are more challenging, obviously. You did see there -- as you mentioned, you do expect asset quality to worsen further and provisions to go up. You have much lower inflation this year which, notwithstanding the loss, the elimination of loss from price level restatements, will probably hit your margin on a certain level. The economy is still weak.

But do you -- I mean, do you think in this environment you can grow earnings and at what level and what kind of profitability? I know there would be -- there are a lot of accounting changes that change the ROE and change profitability dynamics, but as you look out in 2009 and in 2010, do you think earnings growth is something that is possible and what kind of return on equity do you foresee in the next year or two?

Okay. Thank you for your questions. First of all, we don't give firm advice of our expected profitability. But just to give an idea, our view of the profit and loss statement next year will be that we can achieve, on average for the whole year or trialing average of 4Q, for example, because there will be some ups and downs throughout the year, probably similar to what we have seen in 2008. But we will be achieving to that result by different ways. In 2008, we saw strong top-line growth followed by strong growth in provisions and also higher growth of cost -- operating cost -- which were impacted by inflation because inflation, as you correctly point, is going to go down.

But inflation has been impacting not only margins positively but also has been impacting provisions negatively because up to now most of the deterioration has to do with inflation more than with unemployment growth because the number of people actually employed has been rising according to the latest information. And thirdly, inflation also has an impact in our cost base, which is rising -- the lag because of inflation. So inflation is -- has an impact, but it's less relevant at the bottom line that what you might expect simply by seeing what has -- what is the impact on the net investment income.

So bottom line, we think that we should be able to compensate the decrease of inflation and the only concern is how much will be asset quality deteriorating. But again, the fact that in the last 18 months we have been basically growing in the high end of the consumer market and in the large corporate segment, which is something completely different of what we saw in 2007, 2008 and the year before, make us believe that we can sustain our current level of performance with more challenges. Remember that this year we are entering an economic cycle that will result in the duration of clients, but it's something that banks are prepared to cope.

What it was really a little bit a concern in last year was that we were facing risks that were not common in any cycle -- liquidity risks, banks that were not able --for several foreign banks that were not able to renew our lines of credit and things like that. Those are the type of risks that banks are not as prepared to cope as the fact that many, in 2009, some clients will have more problem paying their debt and things like that. So now we're entering, hopefully, a more kind of predictable sort of risks, the ones that banks have been managing for many years and for many cycles before this one. Yes?

So that's why, to make a long answer to a short question, we expect our bottom line performance to move in line with what we saw in 2009. Basically that we will be achieving through a different combination of factor -- less top-line growth, less growth of provisions, less growth of cost and the fact that we won't have inflation adjustment, which should have a beneficial impact throughout the year. Not in the first Q because, as Robert was pointing, in the first Q we have a negative inflation, it's an area which is relatively not a normal situation for this country at least.

(Operator Instructions) We'll take our next question from Lucas Ramirez with Merrill Lynch.

Hi. Thank you. I have actually two questions. One is on net interest margins and the other one on credit growth. On net interest margins, leaving aside the issues of inflation and of the changes in accounting, the Central Bank is cutting rates aggressively, which should pressure margins down, but at the same time you have been successfully increasing spreads over the past year and I was wondering if, into 2009, you see that you can keep raising spreads to the point where you offset the negative drag from lower base rates coming from the Central Bank?

That's my first question on interest margins. And on loan growth, just wondering if, going forward, you still expect most of the growth coming out of the corporate sector and if you expect lending to low-income individuals in -- for Santander to continue to decline as it did in 2008?

Okay. Regarding net interest margin, what happens is the following. That there are a number of forces coming and interacting. There are some negative forces, one of them being the lower inflation that we're expecting because, as you know, given the asset and liability structure, the bank benefits from a high inflation environment. So that would be negative news, followed by the fact that we're growing in the less risky, less yielding asset categories, mainly high end of the consumer market and large corporations.

And thirdly, the other factor that will be impacting net interest margin is that growth will be slowing down. So there are three forces that will be reducing the growth rate of net interest margin. And that is partially compensated by two positive factors. One is that spreads are growing worldwide. As you know, in all financial institutions abroad are increasing their spreads and therefore banks in Chile are forced to, because of the higher cost of funds, to increase their spreads as well.

And secondly, the fact that the Central Bank is expected to start slashing rates quite actively because of the rapid decrease of inflation, will result, given the asset and liability structure, given that our liabilities are much shorter than our assets, then we will have some margin expansion because the repricing of liability is much faster than the repricing of the assets.

Yes, so because of that, five factors -- three negative, two positive, we will see some deterioration in net interest margin, but probably not as intense as you would expect simply by seeing the overall economic or the growth of the loan book. So there are five forces we believe to take -- at least five forces to take into consideration. So we expect net interest margin to be under pressure and probably going back to more "normal" level for net interest margins after followed by the very high levels that we saw in 2008. Yes.

In terms of loan growth, it will depend on the evolution of the international situation. Yes. We see kind of a window of opportunity because many banks that used to fund Chilean companies now are unable or their charging spreads are very high compared to the ones that were charged 18, 24 months ago. So many companies are coming back to that market. That is an opportunity for the bank that has the liquidity and the strong capital base that we have seen throughout the presentation. If they will start to normalize, and hopefully everybody suspects -- everybody is wishing that will going to happen, probably we'll go back to our medium-term strategy which is basically to increase our penetration in the middle market and in the second 20%, 25% of the working population.

So it's kind of a window, at least for 2009 or at least until the world is in a sluggish mood. If the world starts growing, probably we might go back. So the mix this year will be biased towards the less risky, less yielding activities and going forward in 2010 it's difficult to know. But depending on the footing of the external economy, we can see a reverse and more growth in individuals in the middle to lower end of the consumer bracket or middle-market companies as was the case in the last three or four years. So we think it's a way to compensate and it's a window of opportunity for 2009 to take advantage of this opportunity in the corporate segment. For the first time in many years we can operate with them at attractive profitabilities.

(Operator Instructions). We'll take our next question from Tito Labarta with Deutsche Bank.

Hi. Good morning, Raimundo and Robert. Just a couple of questions. I know you mentioned the NPLs will increase to like 2.4% given the accounting adjustment, but excluding that, like how much of a deterioration do you think we could see this year? I mean, could it be NPLs double or just a 50 basis points increase? What -- just what would be the worst-case scenario? And then second question, just in terms of expenses, I know you say you're cutting back your expansion plans, but how many branches would you expect to open this year and what kind of impact would you expect to have on costs? Thanks.

Okay. Well, Tito, as we mentioned, we expect the asset quality to deteriorate. Asset quality has two sides to be -- to look. One is how much risk you keep in your balance sheet as measured by the expected loss ratio or as measured by the past due loan and now the new definition according to IFRS, the nonperforming loans. That is one side of the coin. The other side of the coin is how much you are charging off on provisioning, which is kind of a reflection of how much you are cleaning on an ongoing basis of your loan book. So there is kind of a trade-off in the sense that the more you clean, the higher the impact in your profitability. But at the same time, the lower the risks you keep in your book.

So up to now, Santander has been quite orthodox in its asset quality management. We have kept relatively stable levels of risks as mentioned by the expected loss ratio, which is, we think, the relevant metric in the Chilean financial system, but at the cost of increasing our provisioning and charge-off levels in order to keep that level sound.

Going forward, we think we will keep our conservative provisioning and charging off policies and therefore, although we expect a deceleration of the growth rate, we don't see provisions being neither stable or growing at a relatively low level. We expect provisions to keep on growing, probably not at the level that we saw in 2008 as a year, for the whole year, but we expect a more moderate growth or provision level.

And at the same time, we expect some deterioration of the retained risk in our books, but we don't see a dramatic shift. And of course, here assuming our basis in area that the economy managed to grow around 1% and we don't see further crisis in the international market. So assuming a more, kind of stable low-growth world, which will mimic in the same low growth for the Chilean economy, we expect some deterioration of asset quality, the one that is kept in our books and at the same time, a moderation in the growth of provisions. But still at -- growing at a relatively high two-digit rate.

In -- regarding the second part of your question in terms of branches, we expect to keep more or less the same number of branches. There will be small changes in terms of the profile of segment of clients that we are targeting. But we don't expect the branches to change neither up or down. Here remember that Santander, in the last four years, has opened close to 40% of the branches. So we have a relatively young branch network and therefore what we have been doing lately is to concentrate on rushing things in order to have those branches to be fully contributing to our bottom-line performance.

As you know, once you open a branch, it takes some two, two-and-a-half years to have it fully profitable and therefore what we have done is to kind of freeze our investment plan or reduce the investment plan in order to concentrate on rushing things and bring those branches and those new clients into full profitability, which is the short-term focus to -- which is very cost effective because you already have assumed most of the cost and therefore all the incremental income goes directly to your bottom line.

So that's why we expect in line of what we were telling before, some deceleration of the growth rate of provisions. We think that costs will be pretty much under control. You know Santander has a strong cost culture and therefore we are much -- I mean, in terms of asset quality, something that is beyond your full control. You can take actions, but at the end, it will depend on how the microenvironment evolves.

In terms of cost control, we have much more control of our expense and our focus has been to increase productivity. We have been given better tools to our sales force. We have been -- better tools to our commercial areas. And therefore, they can do their job much effectively and therefore you can increase your margins and you can increase your -- the sale every manager does without increasing the total pool of costs.

We'll take our last question, a follow-up from Saul Martinez with JPMorgan.

Hi. Just a follow-up, Robert, on your comments that -- or your -- the estimates internally that you have that ROE would have been 30%, I believe, in 2008 and book value would have been 5% lower if you had adopted IFRS throughout -- or if you had been implementing IFRS throughout the whole of 2008. Correct me if I'm wrong. That implies that 2008 earnings would have been, by my calculations, something closer to CLP400 million in 2008.

Should we be thinking about that, kind of be -- obviously, the first quarter is going to be tough because of the deflation in December, in January and perhaps even February. But should we be thinking about that being sort of the run rate of earnings that we should be thinking about in 2009? I know you don't give guidance, but just trying to put some parameters around how we should be thinking about estimates next year. I mean, could you share kind of what the net income would have been in 2008 in IFRS and whether that's a good representation of what we should be expecting going forward?

Okay. You're correct in what you're saying and basically the effect there, why the ROE goes up, is just the elimination of price level restatement. It's actually pretty much as simple as that. There are other effects, but basically more than 90% is just because of the elimination of price level restatement. For the same reason in 2009 you can't exactly go -- make the comparison you're making because it really depends on what your level of inflation would be. Okay?

So basically, 2009 earnings, as Raimundo stated before, will depend a bit on how the margins will evolve, how costs will evolve, the provisions. And then we'll have to really see the level of inflation, which has an impact on margins. And if we didn't have IFRS, we would have a probably much lower loss and price level restatement which we're not going to have now. And always remember in the first quarter of '09, we have a deflationary environment. So that's something that, with IFRS, it negatively impacts because in a normal case, if we didn't change our accounting we would have had a positive price level restatement.

So going forward, we have to see how the whole situation with inflation evolves. And finally -- and basically, and when we report our first quarter earnings of '09, you're also going to see the first quarter of '08 comparables. So then I think then you're going to be able to make a clear model of how the results will go forward. Okay? And as Raimundo stated, we're basically looking at, on a comparable basis, a level of earnings growth similar to what we saw in 2008.

It appears there are no further questions at this time. Mr. Monge, I'd like to turn the conference back over to you.

Okay, well, thank you all very much for taking the time to participate in today's call. We look forward to speaking with your again soon. Have a good day.

This concludes today's conference. We thank you for your participation. Have a good day.