Consolidation in Chile’s banking sector – widely considered to be the best run in Latin America – has left six major players, and while not all mergers have gone smoothly, observers say the prospects for all are positive. Brian Caplen reports on the strategies adopted by the successful few.

BBVA

Chilean banking consolidation is moving towards a dramatic end game. With Canada’s Scotiabank buying the Chilean operations of Spain’s BBVA, there will be six players in the market that hold a combined 90% share, each with more than 10% individually.  

For some years, the big dilemma for universal banks that wished to stay competitive in Chile but had a market share of less than 10% was whether to buy or to sell. When Brazilian bank Itaú announced its merger with CorpBanca back in 2014, it created a fifth player with just over 10% and left only Scotiabank and BBVA in the 6% to 7% range of market share by loans. (A handful of smaller specialised banks have a few percent or less of market share, such as Security, BICE, Consorcio and Banco Internacional, as table 1 shows)  

Having missed out on CorpBanca with a 6.7% market share, BBVA was left facing the buy or sell conundrum. Then late in 2017 the Scotiabank/BBVA tie-up added Scotiabank’s 6.8% share to BBVA’s, to make 13.5%, and put the new entity on a par with Chile’s fourth largest bank, Banco de Crédito e Inversiones (BCI). In terms of bank acquisitions, BCI has been focused on buying overseas with the purchase of Total Bank in Florida, where it already has operations. At home, it is strengthening its domestic franchise by buying Wal-Mart Chile’s credit card business for $148m.

A lucky escape?

But for BBVA, the sale of its Chilean bank represents a retreat from a key Latin American market (Latin America including Mexico accounts for more than half of group profits), even though it retains its auto finance operation in the country. On the other hand, with hindsight its unsuccessful pursuit of CorpBanca may be seen as less of a missed opportunity than it appeared at the time, given that the challenges in combining Itaú with the Chilean bank is a main talking point in Santiago banking circles.

While analysts think that Scotiabank-BBVA has all the ingredients of a successful merger, they say Itaú CorpBanca has experienced a clash of cultures, with the product-led strategy of the Brazilian bank at odds with the more client-tailored approach of CorpBanca. There have also been IT problems and a large turnover among senior management.

“One possible explanation is the different cultures between the two banks,” says Mario Chamorro, the former CEO of CorpBanca who now runs Internacional. “As a Chilean bank, the CorpBanca management were used to taking their own decisions but when you work for an international bank, decisions are often taken by head office.”

And despite it making sense to use the same IT system as the headquarters, in the case of the merger in Chile it was like "putting the big bank into the small one”, says Mr Chamorro

But the worst may be over, with Chilean investment bank LarrainVial estimating net income for Itaú CorpBanca of $158m in 2018, $228m in 2019 and $282m in 2020, compared with $57m in 2017 and minus $24m in 2016. “Return on equity should start to improve gradually in coming quarters, mainly boosted by an improved cost structure management and a more active loan growth strategy,” says LarrainVial in a report.

High hopes

In general, the outlook for the major privately owned Chilean banks is positive. They increased earnings by 13.8% in 2017, casting aside the impact of slower economic growth in the country, while loans overdue by 90 days are only 2% of the total, with 1.5 times coverage. The banks achieved this by focusing on efficiency, risk management and, in the case of Santander – which has the largest share of the loan market at 19% – an attractive digital and lifestyle offering including the much-touted Work Café branches.

Now with a new pro-business government under president Sebastián Pinera and copper prices rebounding, banks should benefit from economic growth of an estimated 3% in 2018 and 2019 (compared with 1.7% in 2017 and 1.5% in 2016).

The good news is that in the past 20 years Chile, along with countries such as Peru and Colombia, has shown that the economy can grow even when commodity prices are low

Fernando Larrain

They also face proposed changes to the national banking law, however, which will bring the country in line with Basel III and require them, according to estimates by the regulator, to raise between $2.8bn and $4bn during the 2019 to 2024 phase-in period. The reform also places banking supervision under the newly created Financial Market Commission and gives the regulator scope to demand additional capital for systemically important banks as well as for smaller specialised banks, and to apply a countercyclical buffer. Previously, the regulator was constrained by what was set out in law.

The lion’s share of additional capital, about 50% or $2.3bn, will be required by state-owned Banco del Estado de Chile, and decisions will be required as to whether that capital is coming from the Treasury, from retained profits or by reducing the size of the bank. While Estado’s market share is less, at 15%, than both Santander’s and Banco de Chile’s at 18.2%, it has the largest branch network and covers locations the private banks do not. A large part of its balance sheet is comprised of long-term mortgages and loans to Chile’s biggest companies and, as with many state-owned banks, there is a bias towards agriculture and low-income households. This makes changing course difficult politically as well as commercially.

Analysts in Santiago say Itaú CorpBanca, Scotiabank-BBVA and BCI will likely need to raise between $500m and $700m each under the new rules but Santander and Banco de Chile will not need additional capital.

Reform debate

While some observers are unconvinced that Chile really needed to change the structure of regulation since the current system works well, the proposed banking law – which also strengthens the deposit guarantee scheme – has been broadly welcomed by the banking community. Fitch’s director of financial institutions in Santiago, Abraham Martínez, says: “The last banking reform was in 1997 when Chilean banks adopted Basel I. Twenty years with Basel I is quite enough; the system is stable and the banks are well prepared for the changes.”

Chile loans 0518

In fact, two key parts of Basel III – the liquidity coverage ratio and the net stable funding ratio – are not part of the new law as new measures in these areas have already been adopted and the large banks are all on track to comply.

Chile has long been regarded as one of the best-run countries in Latin America; government debt to gross domestic product (GDP) is a low 25%, while the budget deficit is just 2.8%. But investment has been put on hold in the past few years with copper prices languishing (copper accounts for 10% of GDP, 50% of exports and 10% of government revenues) and business confidence at a low in the face of controversial tax and labour reforms under the previous administration of Michelle Bachelet.

Now with the new government installed, confidence has returned, although Mr Pinera will be constrained in what he can achieve by the lack of a majority in Congress. Critics say Chile is too bureaucratic, and the licensing process is slow and deters investors, while bankers complain about inflexibility in changing products.

Fernando Larrain, CEO of LarrianVial, says: “The good news is that in the past 20 years Chile, along with countries such as Peru and Colombia, has shown that the economy can grow even when commodity prices are low. With assets under management of $400bn compared with a GDP of $270bn, we have a large pool of capital and we are becoming a capital exporter. But we still need to do a lot of micro reforms, such as improving governance standards in the civil services and making systems such as the toll roads function better to really make the country efficient.”

Segismundo Schulin-Zeuthen, president of the Chilean bankers’ association and a former CEO of Banco de Chile, says under the existing rules a bank wanting to change any aspect of a product or raise a fee has to get permission from each individual customer. “It makes it inefficient for both the bank and the client,” he says.

Santander's café culture

But sometimes in reacting to adverse circumstances a bank can carve out a winning strategy. Five years ago, Santander found that only 17% of its customers rated the bank highly. On top of that, in late 2013 the Chilean government passed a new formula for calculating maximum interest rates, reducing them from 54% to about 37%, which changed the viability of high-cost consumer lending – often to the unbanked – with high margins and high non-performing loans.

“With that business model you are not focused on the customers,” says Matías Sánchez, chief executive of Santander's commercial bank in Chile. “We lost our leadership in the market to Banco de Chile. We realised that Chile is no longer an emerging market and we needed a ‘supertanker transformation’ to a hi-tech, high-touch model. The new model is based on high income, low-cost and first-class experience.”

In 2017, several key initiatives were introduced in what Santander Chile describes as its ‘phygital' model combining digital with branches and contact centres. There was digital onboarding to enable non-customers to become customers and buy products in seconds without visiting a branch or calling the bank. In addition, Santander Life introduced a new generation of digital products that rewarded customers for good behaviour, such as paying on time.

Finally, the Work Café concept has transformed 20 conventional branches into places where customers and non-customers can buy coffee and work on their laptops in an informal environment as well as do banking. As there is no cash in the branch, there is no need for tight security and staff work in an open plan section with the emphasis on the front office. In a normal branch there might be four or five relationship managers but in a Work Cafe there are closer to 20 with fewer back-office staff.

The Work Café concept created in Chile has been given the seal of approval by Santander Group chair Ana Patricia Botín and is set to be trialled at branches in Spain, Brazil and the UK.

In becoming the leading bank in Chile (Santander Chile gained The Banker’s Bank of the Year award for Chile in 2017), Santander had to beat tough competition put up by Banco de Chile and BCI. All three banks have strong franchises, diversified business models, good profits and a solid deposit base. Banco de Chile has a large base of loyal retail depositors who just leave their money with the bank, giving it a funding cost edge; 28% of its liabilities are non-interest deposits compared with an industry average of 20%. It is also well known for fund raising and campaigning for disabled people. Both Santander and Banco de Chile had returns on equity of 19% in 2017.

Chile's top banks 0518

BCI looks to the US

As with banks elsewhere, Chilean banks have been ploughing huge sums into technology upgrades in a bid to stay competitive. In a report on BCI, Larrain Vial says: “After significant investment in technological development and the consequent deterioration in its efficiency ratio, the bank’s efficiency indicators should improve in 2018 [but] it will be challenging for BCI to return to historical efficiency levels and make this investment profitable given the current competition among its peers.” While Santander and Banco de Chile have efficiency ratios of about 45%, BCI’s is 54%.

The Wal-Mart deal will double BCI’s credit card franchise, but more crucial is the way the bank is developing in Florida, where it now has 23% of its assets following the Total Bank purchase for $528m. The seller was Santander Group, which acquired the bank in its purchase of Spain’s ill-fated Popular for a nominal €1. Popular had been negotiating the sale of Total with BCI prior to that deal.

BCI acquired City National Bank in south Florida in 2015 and analysts suggest it has been looking overseas because it considered banking assets in Chile too expensive. Florida has a large Spanish-speaking community, plus opportunities in real estate and the potential to grow fee income. The bank could eventually have 30% of assets overseas. (BCI declined to be interviewed for this article and failed to respond to questions.)

Starting off small

With the Itaú-Corpbanca and Scotiabank-BBVA mergers in place, the scope for domestic mergers and acquisitions is more limited. But if well-managed, smaller banks can grow dramatically from a small base. Financial and health services provider Inversiones La Construccion (ILC), which is 67% owned by the Chilean Construction Chamber, bought one of the country’s smallest banks, Internacional, with a 0.8% market share in 2015. ILC chief executive Pablo González describes it as “the last franchise available”.

ILC itself raised $468m when it became Chile’s largest ever flotation in 2012, in a deal led by Bank of America Merrill Lynch, IM Trust and JPMorgan, and so has plenty of firepower. ICL brought in Mr Chamorro to run Internacional with a focus on small and medium-sized enterprises and commercial loans where there is a gap in the market.

The bank has grown at a rate of 35% over the past two years and the aim is to get to a 1.5% market share over the next few years. New dynamics in the rest of the market should help in this. Mr González says: “Bank mergers give you room to grow. Every time there is a merger, the new entity loses a percentage or so of market share because they are over-concentrated in some clients and have to pull back, or because new opportunities of unserved customers arrives.”

Itaú's teething troubles

When Itaú first announced its acquisition of CorpBanca back in 2014, analysts saw it as transformational for the Brazilian bank’s desire to build a regional footprint. As well as becoming the fifth largest bank in Chile, it also gave Itaú a more significant Colombian presence.

The sellers of CorpBanca were the prominent Chilean business operators the Saieh family, who may have been prompted to sell by troubles in their supermarket chain SMU. A minority shareholder initially challenged the terms of the deal and it took two years to complete. Under the structure, Itaú Unibanco holds 35.71% and the Saieh family 31%, with Jorge André Saieh as chairman and Milton Maluhy (who has worked at Itaú for 15 years) as CEO.

Observers in Santiago say that while it was supposed to be a merger of equals, Itaú has taken control. The various problems mean the expected synergies have not so far come through two years after the deal completed.

Fitch does not rate Itaú CorpBanca but Mr Martínez says that prior to the merger, Itaú generated about $150m in profits and CorpBanca $350m. It closed 2016 with losses and in 2017 generated far less than would be expected for a bank of its size, he adds. “Itaú has a moderate risk appetite and CorpBanca a much larger risk appetite, leading Itaú to make provisions against many of the existing loans. In addition, the cost synergies have not come through as quickly as expected,” says Mr Martínez.

Market share boost

In 2017, Chilean regulator SBIF fined CorpBanca for exceeding its credit limits to three companies, including chemical company SQM. Itaú’s Mr Maluhy was unavailable for an interview but responded to the points raised in this article. In a written reply, he said: “The merger with CorpBanca allowed us to significantly increase our market share in Chile, with a larger base of customers, products and branches, which enables us to compete more efficiently.

“We know that bank mergers are complex from a technological point of view. Moreover, the merger of two medium-sized banks requires not only the integration of core banking systems, but also the scaling of processes and systems. On the other hand, we do not believe that our merger process has been different from that of other banks in the region. We have been fulfilling each of the stages of our integration process according to our original plan and schedule.

“To achieve our goals, we did some team building among the senior and middle management. Headcount reduction in this period has been aligned to our pre-merger announcements. In addition, we managed to attract market talents for key positions within the organisation.

“When we look back, economic activity after the merger was lower than what we did initially expect, especially in Chile. This translated into the lowest loan growth rates in the country for more than seven years. We do not see big cultural differences in the bank. The main concern is for customer satisfaction, which has always been and will always be the focus of Itaú. With a larger scale in Chile we are able to implement Itaú Unibanco's managerial and business model and strategy in the local operation.”

Analysts believe prospects for the Scotiabank-BBVA tie up are much better as there is a clear line of control and they are both global brands with similar risk cultures. In any case, Chilean banking has been radically changed by these two deals, making it very clear who the key players will be in the coming years.

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