Banco Santander, S.A. Q4 FY2023 Earnings Call

Good morning, everybody, and welcome to Banco Santander's Conference Call to Discuss our Financial Results for the Fourth Quarter of 2023. Just as a reminder, both the results report and presentation we will be following today are available to you on our website. I am joined here today by our Executive Chair, Ms. Ana Botin; our CEO, Mr. Hector Grisi; and our CFO, Mr. Jose Garcia-Cantera. Following their presentations, we will open the floor for any and all questions that you may have in the Q&A session. With this, I will hand over to Ms. Botin. Ana, the floor is yours.

Good morning, everybody, and thank you, Begona. It’s a great pleasure to be with you all and thank you for joining. As a reminder, we have recently announced a last step towards one Santander. We finished the creation of the five global businesses, which we began a few years ago. I will come back to this in more detail in a moment, but I would like to note that any reference to these global businesses today relate to the new business definitions that were communicated last December. So, the focus today will be, first, main highlights of our results and update on our strategy. Hector will then review our financial performance in greater detail and then I'll conclude with a few closing remarks on our guidance for '24. So, the high level messages we're presenting record results, €11.1 billion. We have delivered again on all our financial targets. Our customer focus and scale are driving consistent, sustainable profitable growth. In '23, we added 5 million customers and our revenue increased double-digit. We did this while continuing what we have reiterated year after year. We are investing for the future, and we are also making excellent progress towards a simpler and more integrated model. This is the driver of the improvement in efficiency year after year, 173 basis points. It's also the driver of our profitability this year increasing to about 15% as we committed. We have also strengthened our balance sheet, growing deposits, sound asset quality, again, below our guidance, and increasing our gross organic capital generation. So, in summary, backed by strong profit growth with fewer shares following the buybacks, our earnings per share grew 21%, our TNAV and cash DPS by 15%. Once approved by shareholders, we expect our dividend per share to be near 50% higher than last year. To the income statement, you can see the successful execution of our strategy and a strong top line performance. Our net interest income rose 12%, 16% in constant euros, with strong performance in retail and commercial banking in Europe and Mexico. Net fee income was also higher, driven by network effects across our global divisions. We're growing costs less than revenues, indicating positive operating leverage, including investments in our transformation where we're already seeing results. We achieved record net operating income of 32 billion, which is the second highest among our global peers, again, demonstrating our focus on operational performance. The strength of our model is evident in our cost of risk, finishing at 1.18, again better than our guidance, delivering on all the targets. Ultimately, this means a CET1 ratio at 12.3%, maintaining our capital generation strategies. We're ending the year 50% increase in cash DPS and repurchased 9% of our outstanding shares since '21. The investments we made put us in a position to continue to drive profitable growth while we increase our shareholder remuneration significantly. Thanks to our structural changes, we've generated approximately 26 billion of capital over the past nine years, strengthening our CET1 ratio and the dividend per share is five times that of 2014, helping us to build sharper earnings growth paths in the coming years. It ensures sustainable business performance focused on efficiencies and profitability. We're on track to achieve targets contributing to a robust outlook. The strength in each of our core markets drives our solid performance creating a competitive differentiation. I am convinced that with our scale, we have immense opportunities. I'm excited about Santander's potential, so let me now turn it over to Hector to elaborate on our financial performance for '23.

Thank you, Ana. Good morning to everyone. Moving on to the income statement, remember that as we always do, we present growth rates both in current and constant euros. As Ana already mentioned, we achieved a record profit last year with double-digit revenue and net operating income growth. But we also had a solid quarter with profit growing 1% in euros, even after seasonal effects in Q4 from the deposit warranty fund contribution in Spain and the bank levy in the UK, which represent around 210 million post-tax. On the line trends remain strong as profit excluding the decisional factors grew about 8% in the quarter. Differences between growth in euros and cost in euros became evident in the quarter as the devaluation of the Argentine peso introduced some distortions across the P&L. Excluding Argentina, profit would have grown by 7% in the quarter in current euros, and there is no material impact from other currencies, so growth in constant and current euros is aligned across all lines. Starting with revenue, strong growth was driven by custom revenue again this quarter, making up more than 95% of total revenue and explaining almost all the growth. The year was primarily supported by net interest income in retail, as we actively managed interest rate tailwinds in Europe and Mexico, and the positive fee performance of CIB and payments mainly in Latin America. We delivered double-digit revenue growth across most businesses, especially those benefiting from network effects. Revenue in the corporate center improved by more than 1 billion due to higher liquidity buffer remuneration and lower impact from FX hedging. NII continued to be the main driver of our revenue growth. In '23, it was 16% higher year-on-year in constant euros, largely due to positive sensitivity to rising rates in Europe and Mexico and volume growth in the Americas. We expect lower rates to drive net interest income higher through our consumer businesses and retail business in South America while the positive impact from interest rates in Europe starts to moderate. Turning to fees, in an environment of low fee growth due to subdued loan demand and weak consumer activity, our net fee income grew by 7% in constant euros compared to Q4 '22 and 5% year-on-year. CIB and payments saw double digits, compensating for other businesses affected by lower activity or market volatility, which again demonstrates the value of diversification. We saw strong growth in CIB across regions and products while strengthening our capabilities in the U.S. Total payments volume grew 22% year-on-year, driven mainly by Brazil, Europe, and Mexico. In '24, we expect fees to grow supported by the increase in customers and transactionality as we implement our common platforms and reap the benefits from our new operating model. Our efficiency ratio stands at 44.1%. Savings from transformation initiatives offset our technology and digitalization investments. Cost remained flat in real terms in 2023, and efficiency gains of almost 2 percentage points were led by Europe, which improved by 5 percentage points driven by strong revenue growth. We expect savings from transformation to become more evident in '24 and beyond. We're transforming the bank correctly, structurally changing our model to improve both cost and revenue. The efficiencies captured from transformation and active spread management in a higher interest rate context contributed to 112 basis points in efficiency improvements. Credit quality remained robust across our footprint and ended '23 in line with our expectations supported by our prudent risk approach. The NPL ratio was stable and in line with expected levels, and we met our cost of risk target ending '23 below 1.2% despite specific cases and extra provisions related to Swiss franc mortgages in Poland. Both metrics remained stable across the quarter. Our global technology capabilities generated 32 basis points in efficiencies this year. Our focus remains on capital management and balance sheet mobilization, improving RWAs with positive economic value added. We're confident our CET1 ratio will remain above 12%, even post Basel III implementation. That's all from my side, Ana. Thank you. Over to you.

Thank you very much, Hector. Let me sum up very briefly so we can go to questions. So, three points: '23 was a very strong year in our new phase of value creation. The best is yet to come. We grew customers, increased revenue and profits double-digit across all regions and businesses. Second, much of this was driven by the structural change and the progress of our transformation strategy. Lastly, we further strengthened our robust balance sheet, increasing our CET1 ratio, maintaining high credit quality in line with our expectations. This led to a 15% growth in value creation and a 21% increase in EPS. Once again, we've delivered on all our '23 targets. We're on track to achieve our '25 goals communicated last year; the results of our transformation begin to show in our '23 outcomes. The foundation allows us to sustain profitable growth and elevate returns to our shareholders. Our confidence remains high for the next years as we roll out our retail and consumer strategy. So, our guidance for '24 indicates clear expectations. Our diversified customer base drives our strategy from retail consumer to payments to CIB. We remain confident that each division will show significant improvement in performance in 2024, with growth supported by increased customer engagement. We see continued revenue growth in the mid-single digits, attributed to net interest income growth across our consumer businesses. Pricing dynamics are becoming favorable as we anticipate a turn in economic activity. The '24 cost of risk remains roughly flat as we ensure prudent risk management in our operations. We aim to maintain positive operating jaws leading to our cost income below 43% and a return on tangible equity of 16%. We are now happy to take your questions. Thank you very much.

Thank you. Can we start the Q&A session? The first question comes from Ignacio Ulargui from BNP Paribas. Please go ahead.

I have two questions if I may, linking to the revenue growth. The first one is related to the mid-single-digit revenue growth. With the clarity you provided earlier, what do you view as the primary drivers of that growth, NII or fees connected to the customer engagement? In terms of business sectors, which, in your opinion, has the most potential heading into 2024? My second question focuses on costs; you've made a case for one transformation throughout the presentation. I'd like to understand what you mean by flattish costs moving forward, and how exactly your global footprint is expected to translate into cost efficiency beyond 42% by 2025, since we still have work to do.

In terms of revenues, we have delivered a very strong year. Our guidance for the next three years was high single-digit revenue. We've delivered double-digit. Importantly, this year we've achieved strong results, particularly in retail, which has shown high customer activity. This year, our transactions per customer are up 10% year-on-year with strong tailwinds in retail Europe. We expect this positive momentum to extend across our five global businesses, though they will perform differently across regions. For revenue growth, we'll see positive development primarily in the retail business, especially in South America, with higher sensitivities to falling rates, and in our consumer business, we expect better performance in Europe and the U.S. for next year driven by volume growth. Overall, growth in fees should be driven by customer engagement and should see high growth from corporate banking and payments sectors. Hector, do you want to add more specifics?

Certainly. The key drivers for growth will originate from retail, CIB, and consumer sectors, particularly in mid-single digits globally. Europe may moderate but Latin America, especially Mexico, is anticipated to contribute positively. The consumer business is set to perform better overall, bolstered by credit growth and our strategic focus on improving customer connectivity, which increases fee generation. We firmly believe in positive revenue growth, resulting from better customer engagement. Regarding cost, we aspire to drive efficiency while continuing to invest in transformation. This means diligently managing operational efficiency and improving profitability across all our businesses over the coming years. Ana, would you like to add anything?

You've guided for UK NIM to decline in 2024. Can you quantify the NIM pressure anticipated versus the Q4 exit rate, or if it's easier, express this as a percentage expectation for NII change in the UK for 2024 compared to 2023? In addition, the structural hedge notional in the UK rose 7 billion, or 7%, quarter-on-quarter. This contrasts with a drop in current accounts by about 1.6 billion, which feels counterintuitive. Can you clarify whether this is driven by increased savings deposits or if it signifies you managing the structural hedge using a dynamic rather than a static approach? Also, could you clarify your expectations for the structural hedge notional in the UK for 2024?

Let me lay the groundwork regarding the UK NIM in the context of our retail operations. Our retail business overall for 2024 will do better than in 2023, primarily led by the Americas—Latin America and the U.S. In general, we anticipate single-digit to mid-single-digit revenue growth including net interest income. The UK has shown a 13% RoTE this year, which will continue to be double-digit yet lower than before. It’s pertinent to note we’ve focused on managing for profitability. Our UK operations stand strong in mortgages and current accounts, driven primarily by competitive pressure. For the year ahead, despite expected declines, we will work to ensure a flattish cost structure alongside a low cost of risk, maintaining a stable balance sheet. Hector, do you have more details to share on NII and volumes?

Absolutely. For the UK retail sector, mortgages and current accounts represent our core business. We anticipate cost structures to remain flattish, mostly benefiting from the transformation model we've implemented. While we predict lessened volumes amid rising competition and economic conditions, we assert the quality of our loan books. We foresee a gradual recovery in mortgage rates and a resurgence in loan approvals this coming year.

Addressing your questions regarding the hedge: the structural hedge on a quarterly basis can vary due to the dynamics involved with maturities. In December last year, the structural hedge stood at £108 billion, decreasing to £106 billion. The duration has also slightly adjusted from 2.5 to 2.4 years. We aim to maintain stability going forward, focusing primarily on managing structural risks rather than attempting to bring forward profits on the hedging side. Overall, we expect the structural hedge notional to remain consistent for now, linked to our sensitivity to interest rates from current accounts.

On your guidance for 2024, you're at 16% RoTE which implies a net profit of more than €12 billion based on current tangible book value. It would be strong if delivered. Can you provide insight into how you view main unit performances this year, especially in Europe, Brazil, and the U.S? How will changes in the UK affect your operating outlook? Also, in terms of strategy, you've been hiring investment bankers in the U.S., yet other European peers have faced challenges with capital allocation in their CIB businesses, leading to negative consequences. Can you elaborate on your expectations here?

Regarding our guidance, while we don't provide specific numbers, it's important for stakeholders to look at the broader context, primarily focusing on our operating leverage which drives performance. Our five global businesses are projected to perform better in 2024. Revenue growth is anticipated across all units, particularly retail and consumer, where we expect a rise in net interest income. Retail will display excellent performance in the Americas, particularly South America. Although the UK may face challenges ahead, Spain and other markets within Europe continue to show positive momentum.

One question about fees: can you clarify the reasons behind the mid-single-digit growth in fee income this past year? What gives you the optimism for stronger growth in 2024? And regarding the cost-to-income ratio in the digital consumer segment versus retail, why are the experiences similar? I expect digital consumer lines to show superior efficiency. What investment needs and IT development constraints impact these figures?

You're correct that we've invested significantly in our consumer segment, mainly in Europe and the U.S. As we streamline our digital channels, we're expecting improved performance in 2024. From a fee perspective, we experienced lower activities in retail compared to expectations, however, we anticipate a strong push in volume-driven customer activity next year. We foresee the consumer bank performing at high-single-digit fees due to increased transaction volume. Overall, our CIB has the potential for robust double-digit growth, driven by leveraging our existing relationships. The gradual improvement in our cost structure results from diversified portfolio management and optimizing operations.

Focusing on U.S. asset quality, we observed an increase in NPL ratio. Could you clarify your expectations on cost of risk going forward considering recent trends? Additionally, the Corporate Center appears to have made a profit this time. How should we view this contribution going forward?

On asset quality, we've not witnessed significant deterioration. We aim for a cost of risk around 1.2%, which we consider a stable through-the-cycle number. While fluctuations can occur, the overall trend remains stable. Our strong underwriting practices and quality of our portfolio continue to support this prediction. Our corporate center's performance represents the underlying health of our business balance, indicating better integration and efficiency.

In the U.S., our auto finance business continues to grow robustly. With new OEM relationships, we expect sustained loan growth and profitability. Our recent pricing reflects consumer trends while maintaining a focus on prime-quality lending. The robust economy supports our outlook going forward.

The Corporate Center's net income arises from our balance sheet interactions, where we strategically manage interest rate risk while facilitating liquidity across our operations. We anticipate continued traction in profits from the Corporate Center, particularly as we benefit from rising rates. However, as the economic environment evolves, we'll maintain flexibility in our approach to risk management.

Considering your 16% RoTE guidance and 50% payout ratio, how should we analyze regulatory impacts on capital ratios for 2024? Furthermore, in light of Basel IV, do you believe the 12% capital target remains feasible going forward?

We are comfortable with our current capital levels, exceeding the 12% CET1 ratio under Basel III. Our stringent approach to capital management allows us to effectively balance growth with the delivery of strong returns to our shareholders. This will support ongoing compliance and market value, resulting from our organic capital generation strategy. Our capital targets remain grounded in reality, ensuring continued operational resilience.

Can you address your expectations surrounding NII and the variable mortgage portfolio? With the current interest rate sensitivity, how are you hedging to protect NII moving forward?

We are indeed hedging our variable mortgage portfolio. The sensitivity of our net interest income to movements is dependent on current positions. For a hypothetical parallel shift of 100 basis points, it would result in a negative impact of approximately €1 billion. Conversely, maintaining a flat cost of deposits would yield an approximate €500 million in positive NII growth, although that scenario is not entirely realistic given market dynamics. Nonetheless, we are poised for continued strength in our income trajectory through prudent management.

Looking ahead to Argentina in 2024, what might we expect for earnings? Additionally, how are discussions on motor finance in the UK developing, and should we expect restructuring charges or impairments in 2024-25?

Our operations in Argentina are performing well, though exchange rate volatility has created some fluctuations. We aim to present clearer financials to represent the underlying business performance accurately. Regarding motor finance in the UK, while FCA reviews are ongoing, we're confident that the impacts on our portfolio will not be significant. We're monitoring closely and adapting our strategies as needed.

What can you tell us about NII growth in Brazil and about your card growth strategy? With the recent cap on loan rates, how might that impact your growth forecasts?

Brazil is showcasing robust NII growth prospects driven by various business lines. Our targeted strategies in cards have indeed contributed positively, and as we refine our lending practices, we expect quality growth in loan portfolios under better economic conditions. Our focus on balancing loans across diverse segments will help alleviate impacts from the newly implemented loan rate caps.

Do you anticipate positive jaws in 2024 for the U.S.? How do you reconcile shrinking loans and deposits in the UK while pursuing profitability? What ultimately is the endgame in such a competitive environment?

Yes, we absolutely expect positive jaws in the U.S. for this year driven by our operational performance and revenue growth. Regarding the UK, our focus remains on profitability, streamlining functions to maintain competitiveness without compromising on service quality. Our longer-term plan is to adapt our strategy to minimize risk while maximizing value across all segments.

I appreciate your ongoing disclosure of country-level reporting—it’s incredibly valuable. Regarding customer growth, with 5 million added to 265 million—what portion of this is tied to the rollout of the fully digital offerings, and could this backload revenue growth through 2025?

Yes, the rollout of our digital platforms, particularly within the consumer bank, will accelerate customer growth significantly over the next few years. Our strategy prioritizes improving customer experiences and driving active engagement, which directly correlates to revenue growth. We are positioned to transition new customers to active engagement, underpinning our future revenue projections.