Banco Santander, S.A.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 3/5

Banco Santander, S.A. is a global commercial bank, operating with a diverse portfolio of retail, commercial, corporate, and investment banking services, primarily in Europe and Latin America.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Banco Santander (SAN), founded in 1857, is a Spanish-based international banking group, one of the largest financial institutions in the world. Its core operations are centered around three main types of banking activities:

  • Retail and Commercial Banking: This involves providing traditional banking services like checking and savings accounts, consumer lending, and small business services to a wide range of customers.
  • Corporate and Investment Banking: Here, SAN provides a range of financial solutions for corporations, including debt and equity underwriting, mergers and acquisitions advice, and corporate lending.
  • Wealth Management and Insurance: In this area, the bank provides investment advice, portfolio management, and insurance products to high-net-worth individuals and families.

Geographically, SAN has a significant presence in Europe (particularly Spain, Portugal, the UK, and Poland) and Latin America (notably Brazil, Mexico, Chile, and Argentina).

A key aspect of SAN’s recent performance is that it has been a “bank for everyone”. While large investment banks do focus mainly on corporate clients, and retail banks focus on the mass consumer, SAN serves all. The bank is present in emerging markets which exposes them to local risks but also provides opportunities for higher margins.

Financial Analysis

  • Revenues: The bank’s revenues mainly come from interest income, fees and commission income, and trading income. A look at the financial statements reveals that in the first three quarters of 2023 they earned EUR 33.5 billion, this was up 10% vs the previous year. In the nine months ended September 30, 2023, Net interest income accounted for 64.7% of the total revenue, fees and commission income made 29.5%, and the rest from trading income.
  • Margins: SAN’s net income is driven by the difference between its funding costs (interest paid) and its lending rates (interest earned), along with commissions and fees. This implies that net interest margin (the interest earned from loans minus the interest paid on deposits) is a very important figure in their case. The bank also derives profit from commissions earned, like in investment banking, and wealth management. Its efficiency is usually high, that is that it operates with a low cost-to-income ratio. In their quarterly report, the management team emphasized their efficiency ratios are trending in the right direction with positive cost reductions over time.
  • Competitive Landscape: The banking industry is extremely competitive and fragmented, with many participants, including national, regional, and international banks. As of 2023, the bank operates in many countries and only has leading market share in some of them. Competition can put downward pressure on its lending rates and can also increase its expenses. With the rise of digital banking, many new players have made it increasingly difficult for many traditional banks to attract and retain customers.
  • Trends in the industry: Some trends have been present recently across the globe. One of them is the impact of interest rates, as higher interest rates can lead to lower mortgage demand (which increases loan duration and reduces interest revenue), while rates paid to depositors have been on the rise due to the higher competition for deposits. Furthermore, increased regulations have been introduced which impact the way they conduct business and can add compliance costs.
  • What makes the company different? SAN is a bank that is extremely international (it operates in a diverse range of geographies including Europe, Latin America, and North America). While there are other banks with geographic diversification, they don’t have as many business lines as Santander. Also, the bank has a very long-term outlook which allows it to grow steadily.

Moat Assessment:

I am giving the bank a Moat of 2/5, because while they have some competitive advantages they have many structural challenges to deal with.

  • Intangible Assets: SAN has a solid brand reputation in Europe and Latin America, making it one of the most recognizable banks. Also, SAN has been around for many decades, indicating a loyal consumer base. These do provide limited competitive advantage, but are not enough to form a “wide moat” around their business. These can be easily copied over time with marketing spend.

  • Switching Costs: While there are some switching costs related to banking due to complexity of financial systems and banking integrations, these are not high enough to create a huge advantage. Most people will switch banks easily if they get better offers. Banks also engage in promotions to attract new customers, and this erodes away their loyal customer base. However, SAN has significant experience in the retail banking space which is where most of the stickiness will be found.

  • Cost Advantages: SAN has a good level of efficiency in the markets they operate, and their scale allows them to achieve some cost savings. While this is useful, they don’t have any truly unique assets or locations that help give them an unassailable cost edge. They operate in countries that are easily copied, so while scale helps, it’s not a strong moat. Also, they are a very large organization, which means they are slower to change their processes and can face a lot of red tape in their actions, increasing costs.

  • Network Effect: Financial services tend to have network effects, but in most cases, these tend to be commoditized, and there’s no real benefit in sticking with just one bank. While the number of branches or users can help a company expand its reach, they don’t make it hard for others to do the same thing. Also, many new entrants have come into the banking industry offering digital banking which creates competition on the front end.

Legitimate Risks

Economic Downturns: As a bank, SAN is highly exposed to economic changes, and as many countries face the fear of recession, consumer spending and loan activity can fall dramatically. This reduces their revenue potential and can also lead to defaults on loans, impairing profitability. While they can mitigate this by focusing on retail banking and reducing reliance on trading income, a global downturn will certainly affect their profitability.

  • Interest Rate Risk: Changes in the monetary policies of the countries in which they operate can materially affect the company’s bottom line. Sudden and unexpected changes in interest rates can have an outsized effect on their lending profitability as they need to manage the gap between interest on deposits and loans. While they have implemented hedging to protect against rate risks, the net effect of rate changes can’t be eliminated entirely.
  • Regulatory Risks: The increasing levels of regulations on global banks have made compliance much more costly and complex. New rules can suddenly affect parts of their business, for example, as evidenced by the government mandated caps on fees in some products. Governments also have a great level of control over banks, which means they might impose unfavorable rules that can reduce their profit.
  • Emerging Market Risk: Since the bank operates in developing countries, its financials are prone to currency risk, inflation risk, and political risk. These are risks that they cant hedge fully.
  • Cyber Risk: Banks are a highly targeted sector for cyberattacks, and a successful breach could create huge reputation damage, and incur liability and recovery costs.
  • Competition: The financial industry is a very competitive and fragmented industry with little differentiation. This can lead to margin pressure, limited growth potential and also the rise of new and unexpected competitors.
  • Management Risk: The bank’s growth strategy of rapid expansion and acquisitions relies heavily on the management’s ability to integrate them successfully. Any failure in this part of their strategy can cause a steep decline in profitability. Also, as many of the businesses are far away geographically, keeping control over them might also be hard.
  • Credit Quality Risk: The bank is exposed to loan quality problems. The bank needs to monitor the quality of the loans it gives and how its clients are doing. Any sudden change in economic activity or some unexpected changes in the client’s business might negatively affect their ability to pay back the loans which will lead to a hit in profits and increase expenses to cover for their bad loans.
  • Leverage: Banks are prone to excessive leverage, and while they’re regulated, over-leveraging can always threaten their solvency. A sudden change in liquidity may make it very difficult for them to make their regular payments, which in turn can lead to a “run on the bank” and the complete erosion of their company.

Business Resilience: While a lot of factors can negatively impact a bank’s performance, they are also well-established institutions that have a variety of ways of keeping their profitability in a stable range. By diversifying in a large number of countries, they are able to hedge their geographical risk and make sure one poor performing economy won’t sink the company. They also have been consistently improving their balance sheets and have significant capital reserves to weather any problems. Banks are also typically highly regulated, which means there are some safeguards against bad behavior in the industry, and they enjoy political support, meaning governments will always be prone to aid in case of any troubles. All in all, they’re a resilient business, but not immune to serious economic headwinds.

Understandability Assessment: 3 / 5 While banking is a fairly easy concept to grasp, the complexities in international financial services can make SAN’s financials pretty difficult to fully understand.

  • The business operations in themselves are not that complicated.
  • Their financials can sometimes seem complex because they are prone to accounting gimmicks and different ways of reporting their numbers.
  • The bank also carries complex derivatives and loan structures that have to be taken into account while analyzing the financials.
  • The fact that they are a multinational company makes their financials a little harder to follow. They deal in various different currencies, different economies and with lots of different tax regulations, all of which make the numbers less transparent.

Balance Sheet Health Assessment: 3 / 5 SAN has a reasonably healthy balance sheet but does face risks that can materially affect it.

  • The company has a significant amount of debt on its balance sheet, like all banks, but its leverage has been at stable levels. As of the latest report their total financial instruments are at 1.22 trillion EUR and the shareholders equity is at 106.6 billion EUR. This means their debt to equity ratio is around 11, meaning they have almost 11 EUR of debt for every EUR of equity, which is on the higher side but is normal for this industry.
  • The bank also holds assets of around 1.6 trillion EUR which seems sufficient to cover their liabilities, though, in a crisis situation, those asset values might drop.
  • Their cash reserves have been trending upward over the past years, however.
  • They have been consistently profitable and have a history of returning capital to investors, which is a good sign.
  • They have been subject to accounting scandals in the past, however, they have taken steps to reduce instances of such impropriety.
  • Their Tier-1 ratio (equity capital / risk-weighted assets) is reasonably good and within the regulations, which means they have a buffer to absorb losses. In their most recent quarterly report, management noted it is at 12.2%
  • Their liquidity has been improving year by year

Recent Controversies and Problems

  • The bank has been the subject of criticism for its lending practices in some emerging markets, which have increased their exposure to risk.
  • There are worries about rising inflation and interest rates eroding consumer spending which is a major pillar of their revenue.
  • The bank has been going through some restructuring and employee layoffs in several European markets, which has been seen as a negative sign by some.
  • Due to their international diversification, they are always exposed to geopolitical risk, and any adverse event in the regions they operate can have negative implications for their business.
  • The recent financial crisis that started in 2008, has brought many changes to the financial industry, including more regulations, and increased investor scrutiny. While SAN managed to survive this, its effects are still somewhat present, and this increases risk.

In Conclusion Banco Santander is a large, global bank with a wide portfolio of services and geographic diversification. While the company has a stable source of revenue, it doesn’t appear to have a “wide moat”, and is exposed to macroeconomic risks, regulatory risks, and the overall fragility of the banking industry. While it has taken some actions to build a resilient business, it might not be the safest of bets. The bank is easy enough to analyze to form a basic understanding, however a full picture of its performance is not that easy due to the complexity of their financials and operations, so a detailed understanding of the business is difficult to achieve. The bank’s financial position is moderately healthy, but is at risk due to high leverage and the possibility of unexpected events.