Will Spanish banks continue to surprise the world? In the past decade, the bold initiatives and accomplished performance of the country’s financial institutions have repeatedly taken markets aback.
The surprises began in the 1990s with the sweeping consolidation of the six biggest groups from which Grupo Santander and Banco Bilbao Vizcaya Argentaria (BBVA) have emerged as kings of retail banking. Now, after building profitable empires in Latin America – where they have invested more than $26bn in the past decade – Spain’s dominant duo have set out to become audacious conquistadores in two of Europe’s most challenging markets.
Santander, the eurozone’s biggest bank by market capitalisation, last year launched a successful bid for Abbey National, the UK’s second biggest mortgage lender. Earlier this year, BBVA, also one of the eurozone’s top five, formalised an offer for Banca Nazionale del Lavoro (BNL), Italy’s sixth largest bank by assets.
Spanish outperformance
At the same time, almost all Spanish banks, including medium-sized, domestically focused groups such as Banco Popular, Banco Sabadell and Bankinter, have been outperforming their European peers in profitability, efficiency and growth.
The official figures paint a picture of consummate success: the Spanish financial services sector has the lowest average cost-to-income ratio in the world (56.8% in 2003). Risk quality is also unequalled in any other country, with non-performing loans representing only 1.1% of total loans. Average return on equity at 16.6% is bettered only in the UK (19%).
“This level of performance has put Spanish banks on a pedestal,” says Bruno Duarte, a London-based analyst at Fox-Pitt, Kelton. “Cost savings resulting from the mergers, exposure to Latin America and significant industrial holdings have made them unique in Europe.”
Spanish banks have been producing the kind of surprises that markets thrive on for so long that continuing high levels of profitability are virtually taken for granted. Their power to work further wonders now rests largely on the fate of the bids that the big two have launched in the UK and Italy – complex, mature markets where Spanish banks lack the cultural affinities they enjoy in Latin America.
“It’s a substantial challenge for Santander to be successful in a market like the UK where banks are sophisticated, the mortgage market is expected to decelerate and Abbey’s franchise has been severely diminished,” says Jesús Martínez, director at Standard & Poor’s in Madrid. “Santander has shown it can be a good manager in Spain and Latin America, but it has now made a big acquisition in a market where it will not be easy to grow.”
He sees BBVA’s bid for BNL as a less ambitious move that will produce only gradual benefits. “If BBVA is successful, it is not going to make a big, short-term change in the BNL franchise. The revenues and cross-synergies it has proposed are relatively conservative and achievable. It is being realistic and any success it has will be modest. The proposed consolidation would not significantly diminish the overall profitability of the group.”
Bold moves
The bold moves that Spanish banks are making into big European markets and the accomplished performance of the sector as a whole would have been unimaginable only two decades ago. Juan María Nin, managing director of Barcelona-based Banco Sabadell, Spain’s fourth biggest financial group, says that Spanish banks owe their success to a “magic combination” of market liberalisation and “first-class regulation”.
“Liberalising the financial system and opening it up to foreign banks in the 1980s provided a tremendous stimulus for healthy competition,” says Mr Nin. “At the same time, the sector has benefited from excellent regulators, who have always been tough, prudent, professional and coherent. This has been very positive. The more demanding the system is, the fitter you have to be.”
Banco de España (Spain’s central bank), the Comisión Nacional del Mercado de Valores (CNMV), the securities market watchdog, and the insurance regulator all win top plaudits from bankers. “The central bank has played an important role in the development of the sector by being forward-looking in terms of market liberalisation but very conservative in regard to provisions and risk management,” says Alejandra Kindelán, chief economist at the Santander group.
Exposure risks
However, although Spanish banks have more than adequate solvency levels in terms of regulated capital – an average ratio of 12.6% of risk-weighted assets in 2003 – S&P’s Mr Martínez says that regulatory ratios do not reflect risks such as exposure to Latin America or industrial shareholdings. Spanish banks also use a good deal of subordinated debt that rating agencies do not consider as core capital, he says.
Spain’s buoyant economy has created a fertile market for the growth of financial services. According to Jaime Caruana, governor of the central bank: “Spain is experiencing one of the longest uninterrupted waves of economic expansion in its history.” The upswing has already lasted for a decade and is forecast to continue at a similar pace in the medium term.
After GDP growth of 2.7% last year, the centre-left Socialist government of prime minister José Luis Rodríguez Zapatero, which took office in April 2004, is forecasting 2.9% growth this year, inching up to 3% in 2006 and 2007. This will keep Spain growing significantly faster than the EU as a whole, as it has been doing since 1997.
Expansion is being driven by a booming construction sector, buoyed up by both housing and public works, and strong growth in consumer spending. In recent years, Spain has been building more than 650,000 new homes a year, accounting for more than half of new housing in the EU.
House purchases and robust consumer spending partly reflect a sharp fall in interest rates from levels approaching 20% in the 1980s to about 2% today. Because of the eurozone’s “one-size-fits-all” monetary policy, Spain is enjoying low rates. And these are unlikely to move significantly upwards until the German economy recovers, despite Spain’s own high growth rate and inflation about one percentage point above the EU average.
Strong growth in job creation is another important factor. Santander’s Ms Kindelán says Spain has accounted for 30% to 40% of all new jobs created in the EU in the past few years, most of them in construction and services.
According to an adviser to the secretary of state for economic affairs, unemployment growth, which is already the highest in Europe, is unlikely to fall below 2% or 3% for the next three to four years. The jobless rate, at 10.2%, is still above the EU average, but less than half the level that it was a decade ago. More women have been joining the workforce, although the level of female employment is still comparatively low, and the number of people working in the clandestine economy but registered as unemployed has significantly diminished.
Strong employment growth has attracted and helped to absorb a big influx of immigrants. Almost four million immigrants, representing a population increase of almost 10%, are estimated to have entered the country since 1999, of which more than one million are thought to have joined the workforce, says Ms Kindelán. Consumer confidence indicators, although beginning to fall, also remain substantially above the EU average.
Debt on the rise
Since the beginning of the real estate boom in 1997, household indebtedness has tripled, growing 17.5% in 2004 to a record total of €595bn, representing 75% of GDP against 45% eight years ago. Average house prices have increased 150% over the same period.
For the first time, the level of family indebtedness is now greater than disposable income. However, this is seen as a natural catching-up with economies such as the UK and the US rather than an alarm signal.
“Things would have to change a lot for the housing market to collapse,” says a government adviser. “Although the level of indebtedness is high, the average Spanish family needs to spend only 15% of disposable income to service its debts.”
In the first quarter of 2004, mortgage lending rose 24% on the same period last year. That is a clear indication that the dynamic housing market, which has contributed so much to the growth of Spanish banks, remains as lively as ever.