Santander: The most conservative – and profitable – bank in the world

I meant to post this a while back (or maybe I did and forgot), but a BusinessWeek post about overoptimism for Spanish banks reminded me about Banco Santander SA, which today received an “outperform” rating by Credit Suisse.

While we’ve been overwhelmed for months now by stories of banks engaging in risky behaviour in order to turn bigger-than-ever profits, Santander stands out as one that’s largely stuck to traditional products and still manages to satiate its stockholders. – Santander: The Most Boring Bank in the World

Spend an hour in Santander City and it’s easier to understand Banco Santander’s unlikely march during the last quarter century from sixth biggest bank in Spain to largest bank in the euro zone. Since Emilio Botín took over from his father in 1986, Santander has spent more than $60 billion buying banks in Spain, Latin America, Europe and, more recently, the U.S.

But it’s not just about being the biggest. By sticking to old-fashioned banking practices, while shrewdly employing the firm’s sophisticated banking software, Botín has also made Santander the most profitable bank in the world outside China, earning close to $25 billion in the last two years, even as the world’s economies teetered on the brink.

In Santander City the functional is exalted and the fancy eschewed. The bank runs the same way, thanks to Botín’s commitment to banking’s stodgiest virtues: conservatism, patience and the sort of loans that don’t need to be sliced and diced into nonsensical instruments like those that caused the meltdown on Wall Street.

Harry Kamen, retired chairman of Metropolitan Life and a former Santander board member, recalls learning of Santander’s risk-management committee in the mid-1990s. The independent committee reports directly to the Santander board and is charged with reining in managers overeager to drum up new business without looking hard enough at the pitfalls. “I asked who was doing this at MetLife and was told the actuaries were, but no one was looking at the whole picture,” says Kamen, who promptly instituted a similar structure at MetLife. “I learned a lot about risk by watching Emilio in action.”

Santander’s fixation with controlling risk is largely why it came through the recent banking crisis smelling like a Valencia orange. Going into the crisis, Santander had set aside funds to cover 151% of its expected loan losses, compared to 85% for its European peers. Nearly two years on, Santander’s so-called coverage ratio is 72%, compared to 58% for big European banks in general.

It didn’t hurt either that earlier banking crises had led the Bank of Spain to impose punishing restrictions on the kind of high-flying investments that crashed to earth at some U.S. and European banks. Santander expects profits in 2009 to stay roughly even with last year’s $12.8 billion, making it the third most profitable bank in the world. Little wonder Santander is now worth around $137 billion, more than double its market value in 2000.

The [Abbey National bank] turnaround came straight from the Santander playbook — and highlights the second key to the company’s incredible success: software. First step, in goes Santander’s proprietary Parthenon software, which organizes a bank’s business by customer instead of by product line, as had been the case at Abbey. “This is the kind of sophisticated information JPMorgan still didn’t have, and I saw it at a Santander branch in Chile,” says Davide Serra, head of the U.K.’s Algebris hedge fund.

The system facilitates cross-selling to existing customers while allowing Santander to cut back-office staff drastically (Santander never cuts the flesh pressers out front). In Abbey’s case, total employees dropped from 25,331 to 16,489, while costs have come down from 70% of income to around 40%, in line with Santander’s overall cost-to-income ratio. The average cost-to-income ratio in this sector of the U.K. banking business is 55%.

Those cost savings translate into lower lending rates, which has allowed Abbey to regain its share of the mortgage market and then some. It now makes 1 in 7 new mortgages in the U.K. and Abbey’s 1,300 branches will sport red Santander logos next year.

Santander would rather be profitable than interesting. Santander’s U.K. profits for the first half of 2009 were up 33% from the year before, if you don’t count acquisitions, and almost 63% if you do. It remains to be seen if Santander can work similar magic at Sovereign. Inciarte says cost-to-income at the U.S. bank has already fallen from 65% to 57%, but that getting down to 40% “will take us quite a while.”