Tough times for British arm of Spanish banking giant Santander

29 January 2020, 16:43 | Updated: 30 January 2020, 06:06

These are not easy times to be running a bank in the UK.

Ultra-low interest rates hammer profits because they lead to what is called "margin compression" in the jargon - reducing the spread between what banks charge borrowers and pay savers.

In addition, there is the need to close branches as more customers switch to digital banking and away from using cash, while trying not to alienate older customers.

They also have to invest in technology to maintain creaking IT systems and to see off the threat of digital-only challengers.

There were also regulatory changes with which to grapple, such as "ring-fencing", which obliged lenders to separate their deposit-taking activities from supposedly riskier activities such as investment banking.

And, on top of that, there has been ferocious competition in the mortgage market.

All of which explains why, in September last year, the Spanish banking giant Banco Santander wrote €1.5bn (£1.3bn) from the value of its UK arm.

The impact of that decision, which at the time was also blamed on uncertainty surrounding Brexit, was felt in Wednesday's results from the Madrid-based lender.

The eurozone's second-biggest bank by stock market value reported a 17% drop in full-year net profits, to €6.5bn (£5.4bn), representing its first drop in annual earnings since 2012.

That was due largely to some €1.74bn (£1.45bn) worth of impairments, most of which related to the UK business.

In the UK itself, Santander UK - the country's third-biggest mortgage lender after Lloyds-owned Halifax and the Nationwide building society - suffered a 37% drop in full year pre-tax profits to £981m.

That partly reflected the cost of a branch network reorganisation, announced this time last year, in which Santander set out plans to close around one in five branches or 140 in total.

The bank also had to set aside a further £169m to compensate customers mis-sold payment protection insurance following a last-minute rush in claims ahead of the deadline last August.

And, of course, there was fierce competition in mortgages.

It is probably the most difficult time in this country for the lender since, in 2004, Santander rolled into Britain, firstly snapping up the then-struggling Abbey National for £9bn and then, in the aftermath of the financial crisis, buying Alliance & Leicester and the branch network and deposit book of Bradford & Bingley.

It made the bank a bona fide contender to compete with the "big four" of RBS, HSBC, Lloyds and Barclays and this was accentuated when it made a big push into business banking.

The lender also proved a feisty competitor to the four with the launch in 2012 of its much-vaunted 123 current account, advertised by racing driver Lewis Hamilton, Olympic gold medallist Jessica Ennis-Hill and golf star Rory McIlroy, which offered cashback and a market-beating rate of interest.

The account attracted 1.1 million customers in its first year and, since launch, deposits with Santander have risen almost six-fold due to its popularity.

However, these initiatives have soured, with Santander struggling to crack the entrenched power of the established lenders in the business banking market.

Then earlier this month, the bank announced it was cutting the interest rate and cashback benefits available on the 123 account, winning it plenty of adverse comments in the influential personal finance pages of the newspapers.

It has all led to speculation that Santander - which still has more than 1.3 million British shareholders - might seek to cut its UK business adrift.

Of the eight countries in which the bank operates, Santander's UK arm was by far the worst-performing, while it is now way behind Spain and Brazil in terms of its contribution to group profits - with Mexico closing on it.

Nathan Bostock, chief executive of Santander UK, admitted today that the current environment remained tough due to intense completion and a "demanding" regulatory agenda.

But he insisted: "We have taken decisive steps in 2019 to progress our strategic priorities and our focus on cost efficiency is starting to deliver tangible benefits.

"We are confident in our ability to succeed by providing our customers with an experience that is second to none and through a relentless focus on improving our efficiency and competitiveness.

"We are embedding sustainability across our business and in everything we do and we remain well-placed to meet our medium-term goals."

He said he expected the bank to carry on growing mortgage lending in line with the overall home loans market and said the cost of running the bank would fall this year.

That may not be enough, though, to turn around the bank's UK performance in the short term.

John Cronin, UK financials analyst at Dublin-based stockbroker Goodbody, told clients today: "The cost transformation programme is starting to show results, though this is against the backdrop of lower fee income.

"This all points to the UK operation continuing to underperform the rest of the group in the medium-term, making us wonder if there are part of the UK's operation which the group views as non-core in a longer-term context."

The lacklustre performance in the UK, where profits have now fallen for three years, was a blemish on an otherwise creditable set of numbers from Santander.

Overall results came in slightly better than expected, with stronger growth in Latin America and the US helping make up for sluggishness in Europe, while there were also soothing comments on the bank's capital position.

Any decision on whether or not to remain in the UK will ultimately rest with Ana Botín, Santander's executive chair, who used to run the bank's UK arm before taking the top job in the group.

She told CNBC, sister channel to Sky News, today: "In the UK we're focused on profitability, but it will take a couple of years.

"The UK is one of the countries where we are expecting more improvement in 2021. But it takes time."

Ms Botín, who succeeded her father Emilio in 2014, knows all about playing the long game.

She is the fifth generation of her family to run the bank and, while she has sought to overhaul the working culture at the bank, she has shown patience in running it.

But with Santander's shares unloved by investors, relative to their peers, that patience will not be unlimited when it comes to the UK.