STD Banco Santander, S.A. Sponsored Adr (Spain)

By Paul J. Davies 

Two of Banco Santander's biggest markets are giving it a headache, but for very different reasons.

At home in Spain, bad loan losses are falling fast, but ultralow interest rates are crushing lending margins and have left the bank with very limited pricing power. In Brazil, it is the other way round.

Santander must tackle its problems because its capital cushion, which remains thin, leaves no room for error.

The bank did manage to finish 2015 with a small rise in net profits over 2014, it reported Wednesday. However its equity raise at the start of last year means earnings per share fell 7%, disappointing investors.

In Brazil, recession, unemployment and high inflation are taking a toll. Santander's bad loan provisions there rose in the final quarter, pushing charges for the year to EUR3.3 billion ($3.58 billion). That was 5% worse than 2014 in local currency terms, but the collapse in the Brazilian real meant the charges were about 10% lower in euros.

When looking at these charges relative to total loans--known as the cost of credit--Santander finished 2015 still in a better position than a year earlier and below the 5% level it said it wouldn't breach at last year's investor day.

Santander has managed to hold down this cost of credit in Brazil by making fewer riskier loans and more higher-quality ones in the past couple of years. High interest rates also allow it to bake in more profit on good loans. However, as more people lose jobs, problem loans will inevitably grow and the bank now thinks its cost of credit will go back above 5% over the next couple of years, hurting profits.

In Spain meanwhile, the problem is ever-shrinking lending margins. To tackle this, the bank aims to earn more money in fees from selling its clients more products and services. It has plans in place to do this in Spain as well as in markets like the U.K. (where it recently hiked retail account fees by 150%).

But the early signs aren't great. Net fee income in Spain fell almost 6% in 2015, worse than the fall in net interest income.

Across the group, Santander says it can add 0.1 percentage points to its common equity tier one capital ratio each quarter. It finished 2015 at 10.05% and expects to need more than 10.5% by the start of 2019.

If all goes to plan, it should have more than 11%, but that entails no nasty surprises from Brazil. Amazingly, it is also still entertaining the possibility of acquisitions if something like the small bank being spun out of Royal Bank of Scotland in the U.K. can be had cheaply enough.

Santander needs to be careful. It is walking a very fine line.

Write to Paul J. Davies at paul.davies@wsj.com

(END) Dow Jones Newswires

January 27, 2016 08:03 ET (13:03 GMT)

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