Santiago In The Saddle

Chilean banking is in the middle of an historic realignment that will produce fewer, leaner and larger groups jockeying for enhanced shares of Latin America's most mature and fiercely competitive financial services market.

If 1996 marked an unprecedented year for high-profile mergers, the convergence of slower loan growth, narrower profit margins and mild asset quality deterioration will give fresh impetus to the industry's consolidation and restructuring this year.

The result will be a further reduction in the number of middle-sized and small banks capable of retaining their independence and establishing a profitable market niche.

But the overall banking sector should emerge financially strengthened as the survivors of the competition trim operating expenses, bolster capitalization and reap substantial economies of scale. A benign macro economic environment of stable growth, moderating inflation and gradually falling interest rates will minimise near-term adjustment pains of the bank restructuring process.

 

Landmark agreements over the past year have merged Banco Osorno into Banco Santander Chile and Banco O'Higgings into Banco de Santiago in the most sweeping restructuring of the industry since the financial crisis of the early 1980s.

Together with privately owned Banco de Chile and the state-controlled Banco del Estado, the restructured Santander and Santiago groups comprise the new big four of Chilean banking - the only financial institutions with sufficient capitalisation, market penetration and operational depth to compete nationwide as universal banks. Chile's four largest banks are also by far its most active lenders, with combined outstanding loans exceeding Ch$10 trillion (US$24.3 billion) at the end of January.

The momentum for banks restructuring is far from spent: Banco de Chile in particular is under considerable pressure to acquire or merge with a middle-tier institution whose niche strengths would bolster its defences against market-share inroads by Santander and Santiago.

A potentially attractive candidate for merger with Chile - or for expansion through acquisitions of its own - is Banco A. Edwards, a profitable middle-tier player with strong specialisations in consumer credit, medium sized corporate and high-income individual business.

Speculation also persists that Banco del Estado is a target for eventual privatisation, though the government's immediate focus this year will be on sell-offs of its sizeable minority shareholdings in several private sector financial groups - particularly Santiago, in which it currently holds a stake of around 30 per cent.

The government's shareholdings in the banking system increased significantly last year as the result of debt restructurings agreed with five financial institutions to retire a combined $4.3 billion in central bank subordinated loans. Settlement of this huge backlog in subordinated debt removes a heavy debt-service burden and a significant impediment to recapitalisation in the industry. Expected government action to sell off a portion of its equity stake in the industry should further broaden the funding base of the affected institutions, notably Santiago.

The Frei government has embraced intensified competition and accelerated consolidation in the banking sector as supportive of its broader strategy for sustaining a high-growth, low-inflation economy. Explosive growth in consumer lending, which reached an estimated 35 per cent pace in 1996, contributed heavily to a GDP surge of 6.7 per cent last year.

Heightened bank competition in trade and corporate finance, mortgage and consumer credit, deposit taking and other areas have driven down the cost of financial services and squeezed profitability, with net interest margins for the industry averaging well below 5 per cent of total assets.

In recent months, the central bank's rigorous monetary policy has produced an inverted yield curve that has made short-term funding more expensive than long-term lending. The central bank took a cautious first step toward monetary accommodation with a 25 basis point cut in the benchmark overnight rate to 7.25 per cent on 6 February, its first ease in more than a year.

But central bank President Carlos Massad has emphasised that monetary authorities will defer further rate cuts until they are satisfied that the downward momentum in consumer inflation has not stalled.

Economic trends should continue to support expansion of bank loan and deposit activity, if at a more moderate pace than in 1996. The consensus forecast among independent analyst anticipates a mild decline in GDP growth to a range of 5.5 per cent to 5.7 per cent in 1997, from 6.7 per cent last year and 8.2 per cent in 1995.

Against this backdrop of steady growth, moderate inflation and consistent fiscal and monetary restrain, banking sector performance will continue to be driven by the imperative of merger and consolidation, product innovation and aggressive marketing. These are the key industry trends to watch in 1997:

lLoan activity. Strong economic growth in recent years has accelerated the emergence of a broader pool of smaller to middle-sized corporate borrowers, which have become a prime target of credit marketing efforts. Even more dramatic has been the fierce competition in the rapidly grow in market for consumer credit, which expanded at more than double the overall rate of loan growth last year. But a significant deceleration in loan portfolio increases during the fourth quarter confirms that tight monetary policy and slower economic growth are beginning to rein in the lending boom. Analysts look for average loan growth in the industry to slow moderately from 10.4 per cent annualised in December to around 7 per cent to 8 per cent at year-end 1997.

lAsset quality. The extra ordinary quality of industry loan portfolios has provided a rock-solid base for aggressive expansion of credit commitments over the past year. Leading lenders such as Santander Chile and Edwards reported past-due loans at less than 1 per cent of overall portfolios at year end 1996, with provision coverage generally above 150 per cent in the industry.

Such a sterling performance will be difficult to improve on in 1997, and analysts see a significant risk of deterioration in loan performance following the surge in consumer and mortgage lending last year. But asset quality in the Chilean industry will remain among the strongest in Latin America, and competitive pressures will sustain moderate loan growth in real terms.

lCapitalisation and profitability. Weighted capitalisation ratios averaging around 10 per cent at year-end 1996 stand to improve now that many of the industry's largest institutions have settled outstanding subordinated debt obligations to the central bank. Profitability will continue to be squeezed by heightened competition for market share and near-term restructuring costs to absorb fresh acquisitions during 1997.

Net interest margins averaging less than 5 percent of average total assets will remain typical of industry performance this year.

But returns on equity have held up well at close to 20 per cent for the sector, and banks that aggressively pursue acquisitions should reap significant efficiency gains in the long haul.

Santander Chile realised a remarkable 21 per cent reduction in operating expenses in the fourth quarter of 1996 following the layoff of 900 employees and closure of 40 branches.

lConsolidation and diversification. Clearly the trend toward consolidation will continue during 1997, as Santander and Santiago complete post-merger restructuring and Banco de Chile weighs the potential advantages of merger with a strong middle-tier institution. The dominance of these three groups, plus state-owned Estado, in universal banking services will force middle-sized institutions to market niches such as fund management investment banking and smaller corporate loans.

For the industry as a whole product development and promotion are critical to enhanced profitability in 1997. Case in point: expanded mutual fund, credit card and ATM activity fuelled 19 per cent fee income growth at Santander in the fourth quarter, while Edwards generated 39 per cent jump in fee income on the strength of checking, credit line and corporate advisory charges.

But at least one potentially profitable area of expansion will likely remain off limits in 1997: current financial reform legislation before Congress would not lift the barrier to bank entry into the insurance business.

(The Banker)