Chile’s financial industry has developed significantly over the last 20 years, achieving a high level of consolidation. However, when focusing on some of its members, for example banks, pension fund administrators, brokers dealers and asset managers, one may observe very unalike contexts. These significant differences generate different opportunities for such industry players.
On the one hand, the banks and the pension fund administrators (AFP) have been subjected to stringent regulations and fiscal supervision: the Superintendence of Banks and Financial Institutions (SBIF) currently monitors the banks and the Superintendence of Pensions (SP) now oversees the AFPs. High regulatory barriers have deterred new entries into the industry. Thus, during the last decades, these industries have undergone multiple merger processes, resulting in significant industry concentration.
Additionally, the banks and the AFPs have experienced high-growth periods which have led to increased business volumes. This has encouraged banks to assume considerable scales, encompassing increased operating efficiency. But, such scales have a price. The high organisational complexity reached by these players has brought about new challenges regarding their ability to capitalise the broad array of clients and products that they now enjoy.
In this context, these organisations have left interstices that allow the entry of new competitors with niche strategies, such as retail banks and investment banks with leaner organisational structures that enable them to move about more expeditiously.
On the other hand are broker dealers and asset managers; both of them governed by the Superintendence of Securities and Insurance Companies (SVS). These players have had a lesser degree of regulation, allowing for a large number of incumbents.
All things considered, the fact remains that the size of the two industries is relatively small – reason why their current high level of fragmentation is not sustainable. Furthermore, during the last few years, Chile’s capital market regulations have deepened, thereby increasing their operational costs.
In conclusion, the size of these industries, their high level of fragmentation, and the new regulatory environment – which is likely to continue to increasing player costs – should logically be followed by a process of consolidation and intensive M&A activity (see Fig. 1).
Immunity to the banking crisis
The economic and financial crisis experienced in Chile in 1982 was one of the worst in the country’s recorded history. Numerous banks were seized, some of them nationalised and others dissolved. GDP fell by 13.6 percent; the sharpest drop since the 1929 worldwide recession, consequently shooting unemployment rates over the 20 percent threshold, where they remained for several years.
One of the lessons of this crisis was the need to strengthen our banking regulations; which then led to important amendments to the General Banking Law during the 1980s and part of the 1990s. The main objective was fully achieved. Therefore, currently, the Chilean banking system is one of the strongest in the world; a circumstance that was put to the test during 2008’s financial crisis and from which the country’s banking system emerged virtually unscathed.
Currently, the Chilean banking industry has reached a significant size resulting from two decades of continuous growth: explained, both by its own strength as well as by the country’s economic success throughout this period. Thus, bank loans went from $46.5bn in 2003 to $230.8bn in 2013, a compound annual growth rate (CAGR) of 17.4 percent (see Fig 2). In just five years, banks earnings doubled, going from $1.9bn in 2008 to $3.9bn in 2013. This important financial stability, however, generated a greater concentration in the system. Stringent regulations and controls raised banking costs, forcing mergers in order to increase operating efficiency. Today’s Banco Santander, for example, is the product of 10 years of mergers (1993-2002) between seven different banking institutions. Moreover, a merger process between Corpbanca and Itaú is currently underway; which, in turn, will further concentrate this industry.
At the same time, the high cost of incorporating and operating a bank has generated significant industry entry barriers. Consequently, the creation of new banks since has been minimal. This is how, despite the strong growth of the industry, the number of players decreased from 29 banks in 1998 to only 23 in 2013 (22 if we consider the current merger process between Corpbanca and Itaú). As a result of this, the average amount of loans per bank grew by more than five times in the last 10 years, from $1.8bn in 2003 to $10bn in 2013.
The consolidation of services
The vast majority of Chilean banks have become highly-efficient major corporations spanning across all market segments and covering all sorts of products. But the scale has come at a cost. In order to cover all commercial segments with a diverse range of products nationwide, they understandably became more complex organisations.
Moreover, in order to be able to delegate organisation-wide decision-making, they have had to develop policies and processes that are more standardised and rigid. This has inevitably led to greater bureaucracy, stiffness and slowness. In addition, 48 percent of all banks are now subsidiaries of foreign banks; which, in turn, face additional complexities and challenges of their own.
Retail banks were the first ‘niche banks’ to capitalise on the opportunities generated by the concentration of banking. This explains the creation of Banco Falabella in 1998, a subsidiary of one of the major national retailers, already running an important consumer loan business for its retail department stores. This strategy was followed a few years later by other major Chilean retailers: in 2002 by Banco Ripley, owned by the Ripley Corp., and in 2004 by Banco Paris, owned by Cencosud. As of December 2013, these three banks had already increased their market share to over 10 percent of all bank consumer lending. Also, in June of this year, Scotiabank Chile announced an agreement with Cencosud, the parent company of Banco Paris to acquire the credit business of the latter.
In 2004 a process similar to that occurring within the retail segment began with the creation of Banco Penta: Chile’s first investment bank. Banco Penta focused exclusively on three types of clients: high-net-worth-individuals, financial institutions and corporate clients: the bank’s products are asset management, brokerage, corporate finance, financing and sales and trading.
Later on in 2011, BTG Pactual acquired Celfin Capital, a local broker dealer and asset manager, in order to create a second investment bank. A year later, Banco de Crédito del Perú (BCP) followed a similar strategy upon acquiring IM Trust, another local broker dealer and asset manager. However, BCP did not incorporate a bank in Chile in favour of continuing to use its Peruvian bank for businesses requiring balance sheet.
Banks lead traditional players
Despite the small amount of revenue generated by Chile’s professional Asset Management (AM) industry, its number of players is relatively high. With only $586m in revenue in 2013, the total number of firms amounted to 36, with a modest $16m average income per institution. Upon disaggregating the industry into AM banking subsidiaries and ‘pure’ AMs, we observe an important dispersal.
Banks’ AMs represent only one third of all AMs (12); they generate 67 percent of all industry revenues, with an average income of $33m. Contrariwise, ‘pure’ AMs (24) only generate $194m, with an average player income of only $8m. Something similar occurs with broker dealers (BD). During 2013 the 48 players in this industry generated only $476m in revenues; a mere $10m average of revenue per player. Just as in the AM industry, the BD banking subsidiaries lead the business. With less than one-third of players (15), in 2013 they generated 57 percent of all revenues ($273m). On the other hand, the 33 ‘pure’ BDs generated only $202m, which is equivalent to an average income per player of just $6m.
Both businesses are human capital and IT intensive; clearly difficult to sustain with low average incomes. Consequently, in the coming years, both of these sub-industries should see important M&A activity; something that has already begun with the purchase of Celfin by BTG Pactual in 2011; of Cruz del Sur’s acquisition by Banco Security; and, of IM Trust’s acquisition by Banco de Crédito del Perú (BCP) in 2013.
Pensions in transition
In November 1980, through a complete overhaul of the welfare system, Chile created a new pension system consisting of a fully-funded individual capitalisation system managed by private-sector Pension Fund Administrators (AFP). The regulatory framework governing AFPs prevents banks from entering this industry: 12 AFPs were created in 1981 and others were created throughout the 1980s.
Between 1990 and 2010, however, the industry consolidated through multiple AFP mergers. Thus, by 2010 the number of AFPs had dropped to only five. Subsequently, and in order to increase competition by encouraging the entry of new players, a process was created permitting existing AFPs or new ones to submit their bids in a bi-annual bidding contest, on the basis of commissions, for all the new members of the system for a two-year period.
In 2010 a new AFP, AFP Modelo, won that year’s bidding process becoming the newest and sixth AFP in the system.
By 2013 the AFP industry had $163bn in AUM; equivalent to 62.4 percent of Chile’s GDP. The revenue generated by the industry in 2013 totalled just over $1.1bn; equivalent to an average income per player of $188m.
In recent years, two major M&A transactions were executed. The first was the sale of AFP Cuprum, owned by Grupo Penta, to Principal Financial Group in 2012 for $1.5bn. The second was the sale of AFP Provida, owned by the BBVA Group, to Metlife for $2bn.
Furthermore, it should also be noted that Chile’s new government has just submitted a draft bill to create the country’s first state-owned AFP, aimed at injecting more competitiveness and broader coverage into the system. It is not yet clear, however, what the actual impact of a such new scenario might be; because, the bill is still being debated in congress.