Banco Santander (NYSE:SAN) may be the largest international bank that no one really talks about. With a branch network nearly three times larger than Bank of America, and about $1.5 trillion in assets in geographies that include Spain, the U.K., and Latin America, it's undoubtedly one of the world's most-complex retail-banking institutions. 

A full transcript follows the video.

This podcast was recorded on Jul. 18, 2016.

Gaby Lapera: Hello, everyone! Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. You are listening to the financials edition filmed today on Monday, July 18th, 2016. My name is Gaby Lapera, and joining me on the phone is Jordan Wathen, one of our excellent analysts here at The Motley Fool. How's it going, Jordan?  

Jordan Wathen: Pretty good. How are you?  

Lapera: Really great, thank you. I'm really excited to talk about our topic today, which is Banco Santander -- or just Santander, as we're going to call it today. Why don't we just dive in? I was looking at this bank online, and Capital IQ -- and through their investor relations website -- and the thing that struck me was the complexity of this bank.  

Wathen: Right. Banco Santander. It's the largest bank in Spain, and it's definitely one of the largest banks around the world. At the end of the most-recent quarter, I think they had about a trillion-and-a-half of assets, which would put it among, say, our big four here in the United States. It's mostly a retail bank, so they're basically in the business of taking deposits and making loans. They do that from about 14,000 branches, so it's operationally huge. Bank of America, for instance, has something like 5,000 branches, just to put that in perspective.  

It's historically earned respect for being very efficient and very operationally lean, because it has, at least historically, spent less than 50% of its income on operating expenses, whereas its peers are about 62% operating expenses as a percentage of income.  

Lapera: This is really interesting to me, because I know that, recently, they've been having a lot of trouble. Right now, Santander is ranked as the third-largest eurozone bank by market cap, sitting around $58 billion U.S. dollars -- which I just want to remind you, we should put everything in U.S. dollars if we can, so it's easier for our mostly U.S.-based listeners to understand what's going on. I know that we have some international listeners -- shout out to you all right now. Since 2014, the bank has lost about 50% of its market value. It was around $100 billion U.S. dollars two years ago, which is crazy.  

Wathen: Right. It's really a huge bank. It ran into some issues, of course, and some have been long-term issues. For instance, the fact that it's in Spain has been a bit of a problem because, since the financial crisis, Spanish property dropped in value and basically never recovered. If you look at its Spanish loan book, 6% of its loans are non-performing, which is, compared to the American banks, how their real-estate loans are faring; it's pretty poor performance.  

Lapera: Not just that, but Spain has incredibly low interest rates, and has for a while.  

Wathen: Right, that certainly doesn't help.  

Lapera: Spain hasn't been performing that well, so that's a longer-term issue. In the more short term, they've also had some issues with stuff in Europe and in Latin America, right?  

Wathen: Right. One of the big problems -- we'll just get this out of the way, because this is a problem that's really unfortunate in the timing -- just the way it works. The bank reports its earnings in euros, the euro is much stronger against the Mexican peso, against the pound, for example, than it was six or 12 months ago. When it translates those earnings back into its home currency, so to speak, whatever it earns overseas is automatically lower.  

Lapera: Yeah, so it looks like they earned less. It basically is that they earned less than you would have had if those loans had been made in euros. One of the things that's really been affecting this, actually, is Brexit. I don't know if you've caught onto this -- with what Jordan was talking about -- but Santander has a really big presence in Latin America, South America, especially in Brazil, Argentina, Chile. There's a lot of volatility in South America; I don't know if people know that. I don't know if they think about South America as a place to invest in very frequently, but South America is a very interesting place, full of a lot of opportunities, but very risky opportunities. I think Santander is feeling that right now, in particular.  

Wathen: Right. It's hard to imagine how Brexit, and then Latin America, could be related, but really, when you think about Santander, if you look at its 2015 profits, about 23% of it came from the U.K., give or take. That's expected to be its core earning space, where you expect some stability. Of course, Brexit throws that out the window. It's very hard to make money in the U.K. right now as a lender. Recently, in 2015, Santander earned about 1.8% net interest margin on its loans. The difference between its deposit or funding costs, and what it was earning on its loans that it was making, which is a very thin margin.  

Lapera: That's so low.  

Wathen: Most people expect that to come down even further, because yields are down considerably in the U.K.. The 10-year yield in the U.K. was 1.6% in January, and now it's down to 0.8%, so you have a 50% reduction right there.  

Lapera: Right. The U.K. was being used to smooth out the volatility that you're seeing in Latin America. One of its most-important markets, like I said, was Brazil -- or is Brazil -- in Latin America. Brazil's in the middle of the worst recession that they've ever experienced right now.  

Wathen: Brazil's having a bit of trouble. The IMF expects now that Brazil's economy will shrink by about 3.8%. Argentina's also expected to shrink by about 1%, and then even among growing countries in Latin America -- like Chile is expected to grow 1.5%, Mexico to grow 2.4%. Santander operates in all these countries. As Latin America, as a whole, is expected to shrink by 0.5% this year, in 2016, which would be the second negative-growth year in a row, or the second year of contraction in a row.  

Lapera: Right. When you take the contraction that we're seeing in Latin America, and then you pair it with the contraction that you're going to probably see post-Brexit, you get bad news for Santander, because Santander was relying on the U.K. to smooth out any volatility that it would have in its South American markets. One of the reasons that Santander expanded to South America -- besides the fact that they're originally Spanish and it made sense for them to go to Latin America -- it just makes sense in terms of language and all of those good things, is because there's a lot more opportunity in terms of interest rates in nations that are in economic growth periods and political development periods versus the Western world, where interest rates are very, very low right now.  

Wathen: Right. Basically, the U.K. is supposed to be the anchor, and it's supposed to provide the consistency, and then Latin America's where you can really get some fat loan yields. You can put your money to work, and earn a very good spread. The Brazilian 10-year rate, for instance, government bonds in Brazil yield 12%. In Mexico, they yield 6%. In Chile, they yield 4.4%. That's really a basis to understand ... In the United States, for example, you're not going to earn much on deposits because you're going to pay, at a minimum, 0% for them, and hope to lend them at 3% or 4%. In Brazil, where the government bond yield is 12%, there's obviously much more room to carve out a margin between what you're lending at, and what you're paying on your deposits.  

Lapera: For everyone who was wondering how Brexit and Latin America are intertwined for this bank, this is why. Just to add to the complexity, Santander has also been trying to build up its consumer-financing branches over here in the United States, as well. That has gone interestingly for them. I don't know if your mother ever told you this, Jordan, but my mom always says, "If you don't have anything nice to say, don't say anything at all." Barring that, just say that it's interesting.

For the U.S., the U.S. division of Santander, they're having a little bit of trouble. Announced, I think yesterday, was that Santander has ... The Consumer Financial Protection Bureau, which I'm going to shorten to CFPB because it's too much of a mouthful to say, has ordered Santander to pay about $10 million in fines for hiring a telemarketer that engaged in deceptive tactics in order to get bank customers to sign up for an overdraft protection program.  

Wathen: Right. It wouldn't be another day if there weren't another bank in the news for being fined by the Consumer Financial Protection Bureau. This unit is called Santander USA Holdings (NYSE:SC), and it's what owns Santander Bank here in the United States. That bank previously operated as Sovereign Bank. They bought it in, I want to say 2006, but don't quote me on that. The $10 million, as far as financial results goes, is pretty immaterial, probably about less than 2% of allocated profits last year; but it really does, on top of other issues, which I think we'll get to, really shows the problems they're having operationally. Santander got in trouble, basically, with the CFPB because they basically told people to sign up for an overdraft protection program, which would charge them fees every time they made an overdraft on their account.  

Lapera: The reason the CFPB cares so much is that, typically, these overdraft charges, they hurt low-income consumers disproportionately more. They're more likely to overdraft their account, and then the fees that they get charged are going to hurt them a lot more than someone who has a big paycheck coming in every month.  

Wathen: Right. Once someone signed up for this, what could potentially happen is, they go to the grocery store and overdraft buying something there. They go to a gas station and swipe their card for a tank of gas, and make another overdraft, and those fees just add on top of each other every single time.  

Lapera: For the most part, a lot of the overdraft problems -- stuff that banks had built up as a way to boost their fee income -- had been controlled post-financial crisis. Especially, Bank of America was infamous for the fees that it would charge its unsuspecting customers, but they really cut back on that. This is a relic of that era. Still, there's a service -- Moebs Services estimates that U.S. banks made approximately $32.5 billion from overdraft revenue alone in 2015, which is not an insignificant amount of money.  

Wathen: No, it's not insignificant at all, especially when you consider it's basically cost-less. It doesn't cost the bank anything, really, to charge someone an overdraft fee. That almost flows entirely to the bottom line.  

Lapera: Yeah. It should be pointed out that Santander has severed relations with the vendor of its own volition, and the CFPB has mandated that it contact everyone who is enrolled in the program to make sure that they actually understand what they have signed up for. It's more of a hit to their reputation more than anything else. Speaking of their reputation, Santander has failed the Fed's stress test three years in a row, making it the first bank to ever do that.  

Wathen: Right. That's a huge thing. One of the problems -- especially as you talk about Santander -- is last year, the United States really only made up about 8% of its allocated profit. It's a small part of the overall bank, and if you ran the entire institution, obviously your concerns are probably more aptly directed to the United Kingdom or Spain, for example. The U.S. holdings unit hasn't done well on stress testing. It's done well quantitatively, but not qualitatively. Basically, the Fed's worried about their ability to manage their risks, and allocate capital effectively.  

Lapera: I think that the direct quote from the Fed is that they cited problems with Santander's ability to implement good internal controls, oversight, and governance. Interestingly, they passed on the Fed's capital requirements. Their Common Equity Tier 1 ratio was around 12%, and I think the Fed's minimum requirement -- or I know the Fed's minimum requirement -- is 4.5%. Monetarily, they passed, but it sounds like their internal controls around risk are not great.  

Wathen: Right. It's an unfortunate consequence for the people -- we'll get into this -- but the people who invest in Santander Consumer USA, which is their consumer bank. It's a non-bank, sorry. It's a non-bank financier of cars. Their Santander Consumer USA unit can't pay a dividend until that holding company, which owns about 60% of Santander Consumer USA, gets the rubber stamp from the Fed.  

Lapera: Attached potentially to why the Fed has so many problems with their risk oversight is the fact that, what Santander's really known for, at least in the U.S., is subprime auto lending.  

Wathen: Their subprime auto lending unit is the Santander Consumer USA unit, which is publicly traded under the ticker SC here in the United States. They are basically in the business of financing cars for people who have, generally speaking, will probably have problems paying it back. I was looking at their financial filings earlier, and about 27% of their borrowers have, at one period or another, asked for an extension on their car loan. These are not at all very prime borrowers. In fact, the prime auto loans that they actually originate, they typically sell off. It's almost a subprime pure-play, so to speak.  

Lapera: Just in case you're wondering, subprime is credit scores -- FICO scores -- below 640.  

Wathen: Right, below 640. These are loans that are very high risk. Basically, the way you make money in this business is to have scale. You have to be willing to deal with borrowers who are going to call you up and say, "Hey, I can't pay this month," or, "I need to defer my payment." In a lot of cases, it's very high touch. You're going to have to repossess a lot of cars.  

Lapera: The other way that you make good money is, because a lot of subprime borrowers don't have a lot of resources to borrow money, it means you can charge them much higher interest rates.  

Wathen: Right. In 2015, and I'll look at the actual number. I believe... let's see... their loan yields were 16.9% on their subprime borrowers, who had an average FICO of 584.  

Lapera: Holy... I can't say that word on here.  

Wathen: Very high interest rates on borrowers who, at least in terms of their FICO score, aren't generally good borrowers.  

Lapera: Attached to the subprime auto lending, Santander in the U.S. is facing a class-action lawsuit again. Not again, but in relation to the CFPB investigation. They're facing a class-action lawsuit alleging that they pressured consumers into making payments online or on the phone, and then charged them illegal convenience fees, and this is for the subprime auto loans. It's kind of like the same thing that the CFPB went after. This is a class-action lawsuit, so it's not being brought by a government agency, I don't believe. Unfortunately, for Santander, on July 13th, they lost their motion to dismiss. It looks like the case is going to continue for the time being, so it's kind of a mess.  

Wathen: That's the thing about subprime lending -- it's just a really ugly business. Actually the ex-CEO of the consumer unit here in the United States, Tom Dundon, he always tried to avoid the media and avoid any attention, because it's not a pretty business. It's not fun to say, "Yeah, I made $1 billion lending money to people who can't exactly afford a car." It's not a fun way to get rich. It's not fun to knock on doors and try to recoup $500 from, say, a single mother who earns minimum wage because she wanted to buy a car to get to work. That's just not a fun business. It's not something someone wants to be known for.  

Lapera: Like you said, it can be profitable if you get it up to scale, but it's, I don't know. One of the things that I was looking at when I was looking at the Santander investor relations site was that they break out all of their investor presentations by geographic area, and then they have one overarching one; but the overarching one doesn't have nearly enough detail, and then you have to make this conglomerate of all these other ones. We're actually talking about a fairly small portion of Santander's business, when you think about it overall with the U.S. It's a very, very complicated bank, and while it doesn't make all of its money from subprime auto lending, that's most of the money it makes in the U.S., right?  

Wathen: Right. In the U.S., at least, yeah. Understanding the structure of the bank just in the United States is hard enough. Santander, the giant $1.5 billion [Editor's note: Billion should be trillion.] bank, owns Santander Holdings in the United States, which owns the retail bank, and owns the non-bank car company. Then, United States, you have Santander Consumer USA, which is wholly auto loans.  

Lapera: It doesn't get any better, I feel like, in any of the other countries that it operates in. It's equally complicated in all of its business units. For me, anyway, I would have a really hard time investing in Santander, just because it's so complicated in a way that even JP Morgan is not, even though JP Morgan is a universal bank that does investing, as well as retail stuff. Santander is just so, for a retail bank, is incredibly complicated.  

Wathen: It almost feels like it's by design. It's really what happens when you go around the world and you basically buy banks. That's Santander's growth story, is they went around the world and they acquired banks. That's how they built this business globally.  

Lapera: On top of that, they're dealing with a lot of regulatory things that, say, a Wells Fargo is not, because they have a much-more limited market, Wells Fargo does, so that they can be a lot simpler. As a retail bank, they function very efficiently in the United States because they have a very clear, or at least for investors, they have a very clear business model.  

Wathen: I think most investors would prefer to have a pure-play, I think. When you think about investing in a bank in the United States, I would say a lot of investors prefer the simplicity of Wells Fargo, for example, because you know it's basically an American bank. What happens in the American economy affects Wells Fargo. If you look at, say, Citi, for example, you know you have worldwide exposure. Frankly, I don't have that much insight into how Latin America's going to look five years from now. I just don't. I don't live there, I don't see it day to day; but I know what America looks like. From an investor standpoint, I think being a global bank is something that will always, to some extent, negatively affect its valuation.  

Lapera: Right. It's just interesting because this is a retail bank that has the complexity of a universal bank, which is a very unexpected thing to find, I think. Overall, what do you think of Santander after our conversation today?  

Wathen: Santander Consumer is very interesting to me. I think the subprime auto business, in general, is very interesting because I think there's a lot of money to be made, and I think there's a lot of, probably, concern that might potentially be overblown. I don't know if I could add more qualifiers to that. Santander Consumer has been warning for a long time, well not for a long time, but especially recently, that auto loans aren't going to perform as well as they were. Yields are down, and also their expectations for losses are way up. I think there's a point at which this gets really interesting for me to buy. I don't know if its five times last year's earnings, which it basically trades for right now. I'm still not quite comfortable with what losses will look like in the future, but it's definitely one that's on my watch list as something to potentially buy as just a value play.  

Lapera: That's interesting. It's definitely not on my watch list at all.  

Wathen: It's one of those things where, there's a price at which something's so cheap that it's worth a flyer. If you look at the valuation of Santander Consumer USA, it's really just a call option because it's just priced so inexpensively. If things work out the way they're projecting, it'll do just fine. They'll print money. It might not ever get the valuation they want, but I think it could potentially be a good investment as long as they don't lose it all on subprime over the next couple of years.  

Lapera: For me, the risks that are happening internationally, which is confusing, because they also trade on different tickers everywhere. Its enough to be very off-putting to me, especially their exposure to Latin America.  

Wathen: Right. Banco Santander, the whole, giant $1.5 billion- or trillion-dollar institution isn't really that interesting to me, just because I feel like it's one of those things where once something goes right in one locale, you end up having a problem pop up elsewhere. The return on brain damage for something like that's a little too low, I would think.  

Lapera: Awesome. This was a very complete conversation, at least from my perspective. If listeners have any questions, feel free to write in. As usual, I want to remind you that people on the program may have interests in the stocks they talk about, and The Motley Fool may have recommendations for or against, so don't buy or sell stocks based solely on what you hear. Contact us at IndustryFocus@fool.com, or by tweeting us @MFIndustry Focus. Thank you to Austin Morgan, today's totally awesome producer, and thank you to y'all. I hope everyone has a great week!

Gaby Lapera has no position in any stocks mentioned. Jordan Wathen has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Wells Fargo. The Motley Fool recommends Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.