SAN Banco Santander SA

By Jeannette Neumann 

MADRID-- Banco Santander SA, one of the world's largest retail banks, has for years relied on its profitable U.K. unit to offset turbulence on other fronts.

Now, the Brexit vote has plunged Santander's U.K. cash cow into uncertainty, leaving the bank facing headwinds in most of its main markets.

Santander, which has units throughout Latin America, is accustomed to coping with currency volatility, precarious economic outlooks and rapid-fire political resignations. But such turmoil is hitting the normally stable U.K., which generates around one-quarter of Santander's profit. The British currency has been pounded and the economy is expected to slow after voters supported a U.K. exit from the European Union.

Analysts have cut their expectations for the bank's future earnings. As a retail bank rather than an investment bank, Santander has the advantage of being less exposed to major revenue volatility when the market flops. But as a retail bank, analysts note, it is exposed to the risk of Brexit-triggered slowdowns in economies where it operates.

"The worse things go in the U.K., the worse it will be for Santander -- that's just inevitable," said Daragh Quinn, an analyst at Keefe, Bruyette & Woods in Madrid.

After Brexit, Mr. Quinn cut his estimates for Santander's earnings per share, a profitability measure, by 12% for the next two years.

A sustained decline in the pound would decrease Santander's U.K. earnings when the bank reports them in euros. And the economic slowdown that many expect in Britain is likely to hit the revenue the bank makes selling mortgages and other products.

Analysts are also worried that the post-Brexit uncertainty will force central bankers in Britain and the eurozone to keep their interest rates lower for longer, which squeezes the profit Santander and other lenders make on loans.

It isn't Brexit alone that has investors concerned about Executive Chairman Ana Botín's ability to boost profitability and the bank's share price.

She is scrambling to put out fires in several of the lender's most important markets at the same time, a testament to the challenges banks are facing world-wide. Santander is staring down a prolonged economic recession in Brazil; continued regulatory failings in the U.S.; and stubbornly sluggish loan growth and negative interest rates in its home market of Spain. Now, the repercussions of Brexit could put more of a damper on revenue growth in Spain.

Santander shares have fallen about 16% since voter support for Brexit was announced on Friday, June 24, frustrating Ms. Botín's nearly two-year bid to boost the bank's stock price.

Ms. Botín led the bank's U.K. unit before she took the helm of Santander when her father, the previous chairman, Emilio Botín, died in 2014. Since then, Santander's market value has declined by about half to around EUR50 billion ($55 billion).

Despite the hurdles to heightened profitability, Santander stood by its financial targets three days after the Brexit vote, assuring investors that it would be able to report a capital ratio of more than 11% by December 2018 under international regulations known as "fully loaded" Basel III criteria, up from 10.27% as of March 31, and said that earnings per share this year will be above those of last year.

"All commercial and financial targets for this year are reiterated," Santander said in a regulatory filing.

Several bankers and analysts in Madrid said they were surprised by the specificity of the announcement, given how uncertain the fallout from Brexit is on the U.K.'s currency and economy, and on other countries in the bloc.

Santander's chief financial officer says the bank's presence in ten main markets helps to stabilize earnings.

"Competitive conditions in the developed countries are very tough," finance chief José García Cantera said in an interview on Friday. "But we are compensating that by a good, or even a better-than-expected performance in emerging markets," he added, citing Brazil and Mexico.

Some analysts have pointed out that the contraction in Brazil's economy in the first quarter was less severe than expected and that political turmoil has eased somewhat. Still, Brazil's economy is in its fifth consecutive quarter of decline, the country's worst recession in recent history.

Sofie Peterzens, an analyst at J.P. Morgan Chase & Co., points out that Santander's focus on cost cutting, particularly in Spain where the bank is closing branches and laying off staff, will "help drive profitability."

The bank is also facing regulatory hurdles in the U.S.

Santander last month failed the Federal Reserve's annual stress test for a third year in a row, the only bank ever to do that, because of weaknesses in "internal controls, governance, and oversight functions" as well as problems measuring and monitoring risk, the Fed said.

An annual report published by Santander's U.S. consumer-loan unit at the end of March -- before the stress-test results were announced -- shows the bank has a lot of work to do to ensure it doesn't fail again next year.

The company said in the filing that its "CEO and CFO have concluded that as of December 31, 2015, we did not maintain effective disclosure controls and procedures," citing problems with how it estimates provisions for loan losses; ineffective oversight of the inputs and assumptions used in its models and a badly managed hiring process that left the company with poorly trained and ill-experienced financial staff.

"We are currently working to develop plans to remediate the material weaknesses," the company added in the March 31 filing.

Write to Jeannette Neumann at jeannette.neumann@wsj.com

(END) Dow Jones Newswires

July 11, 2016 17:13 ET (21:13 GMT)

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