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WorldJuly 1 2016

Spanish banks focus on domestic market for slow but steady recovery

With the property market going up and unemployment coming down, Spain’s banks are hoping a renewed focus on their core customers and domestic market will spur a slow but steady recovery as the country emerges from recession. Jules Stewart reports.
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Spain’s banks look set to face a year of patchy but steady recovery on the back of the country’s emergence from eight years of recession. “The situation of the Spanish banking sector is improving at a gradual pace, in line with our expectations,” says Elena Iparraguirre, director of bank ratings at S&P Global Ratings.

“This is helped by the macroeconomic environment, with positive gross domestic product [GDP] growth forecast for the current year, along with a drop in unemployment. These factors are facilitating a reduction in the stock of problematic assets and a marginal increase in property transactions and prices, enabling the banks to reduce their stock of property assets, which they are no longer selling at losses,” she adds.

Property boost

Meanwhile, Spain’s property market – the collapse of which plunged the country into its deepest recession for decades in 2008 – is finally starting to show signs of recovery. According to Spain's National Statistics Institute, property transactions were up 16.8% in the first quarter of 2016 compared with the same period the previous year. Perhaps most encouraging of all, for the banks as well as for the country as a whole, is the downward trend in unemployment. Spain’s jobless rate, at 20% the second highest in the EU after Greece, is estimated to fall to 17% to 18% in 2017 with up to 1 million new jobs forecast to be created in the next two years. More people back in work translates into higher consumer spending and an opportunity to sell banking products and services to a broader customer base.

As for overall economic output, Spanish government and European Commission statistics roughly coincide in their estimates for GDP growth of 2.6% to 2.7% this year and 2.4-2.5% in 2017. However, the outlook for bank profitability is challenging. The years of massive losses are a thing of the past, but with interest rates at such a low level in the US and Europe, it will be difficult to improve revenue streams.

“We actually see banks’ net interest income contracting this year,” says Ms Iparraguirre. “The banks will try to offset this with higher transactional fees, such as ATM charges. They are also rethinking cost savings in general. There are plans to cut branch networks and staff numbers in order to operate more efficiently, yet it will be difficult this year as well as in 2017 to boost return on equity [ROE] above the 5% to 6% level."

She points out that a key segment of Spanish banks’ business lies in managing deposits, which is their main funding base. “Here they are not making money,” says Ms Iparraguirre. “One of the structural challenges is the possibility of rates remaining low for several years. The banks’ ROE is far below the cost of capital [that] investors are seeking.” 

Restructuring pays off

On the more positive side, there is general agreement that the restructuring carried out during the recession in Spain has largely worked. The savings bank sector has gone through a period of consolidation, in which many institutions have been taken over by larger entities or bailed out by the government, and this has led to a more rational structure of the banking sector. There has also been a steady improvement in the fundamentals of Spanish banks, especially in terms of asset quality and capital. During the recession years the banks made a significant effort to rebalance their funding structures and for the most part they have built up sound liquidity levels.

“They are also still facing revenue challenges as these remain under pressure from low interest rates, muted loan volumes and a highly competitive environment,” says Cristina Torrella, senior director at Fitch Ratings. “That said, the banks continue to reduce costs by downsizing their branch networks and staff.”

One of the main drivers of profitability is the improved picture for provisioning for non-performing loans (NPLs), aided by the economic outlook, which is forecast to remain positive. Exports are holding up well, along with domestic demand, and there have been helpful external factors such as lower oil prices.

Spanish bankers, in the face of several adverse and to some extent unexpected events, are making plans to cope with a demanding and highly competitive environment.

“There have been significant changes in perspectives for the banking system and environment over the past year,” says José García Cantera, chief financial officer at Banco Santander. “We believed emerging market countries were going to recover quickly from the financial crisis and that US interest rates would rise, the political uncertainty in Spain didn’t exist and Brexit was not an issue. But the outlook for 2016 is not what we expected and the assumptions proved to be wrong. We are still in a low interest rate environment and now we see that we’ll have to live with lower rates for longer. This is not likely to change before 2018. The regulatory picture is also uncertain, which makes it difficult for banks to implement long-range plans.”

Keeping the faith

Santander has the broadest international footprint of Spanish banks, with Brazil alone accounting for roughly half of the group's profits. “Economic growth is patchy in our global markets. Spain is doing well and the UK is making reasonable strides, however the situation in Brazil is worse than anticipated,” says Mr Cantera. “Nevertheless, we remain committed to our strategy of operating as a full-service retail bank in all our markets.” Political chaos, along with falling oil and commodity prices, have taken a devastating toll on Brazil’s economy. Its GDP contracted by 3.8% in 2015 and a further shrinkage is expected this year.

BBVA is the only other Spanish bank with a major international presence. Chief financial officer Jaime Sáenz de Tejada believes Spain will provide the largest increase in profitability for the group’s global balance sheet. “We expect CatalunyaCaixa, which we acquired for €1.1bn in 2014, to contribute €300m to annual group profits by 2018,” he says. “As for our international business, we anticipate Mexico will remain our principal foreign market. In 2015, Mexico accounted for €2bn of profits.”

The clear signs of recovery in Spain have focused bankers’ attention on the domestic market rather than acquisition opportunities abroad. The last big international operation to be launched from Spain was Banco Sabadell’s £1.7bn ($2.49bn) takeover of the UK’s TSB in 2015. Tomás Varela, Banco Sabadell’s chief financial officer and TSB board member, says geographically, Sabadell is now content with the reach of its business in Spain, the UK and the US. “The latter centralises smaller investments in other American countries,” he says. “They all offer organic growth opportunities and we feel there is no need to look further afield at this stage.” 

Mr Varela says Sabadell is acquainted with the main dynamics of other countries and regions with regard to their banking sector's profitability. “We find that among the handful of countries where it could make sense for us to invest in Europe and [the Americas], the UK and Mexico are undoubtedly the most interesting and profitable for a retail banking franchise.” 

For the moment, Sabadell is focusing its business lines on the UK market. The bank aims to develop a new small and medium-sized enterprise (SME) initiative to take advantage of the fact that it has gained broad experience in this market. “We are designing this for British SMEs, which require a different approach altogether, even if the background might be similar,” says Mr Varela. “The project with TSB is, in the first instance, one of putting two cultures to work together with a single common target, which is the migration of TSB’s systems onto Sabadell's Proteo4UK platform. Our team is moving the project forward with impeccable timing. So far, all milestones are going according to plan.” 

As for the Spanish bank’s plans for TSB, in the short term these are the ones TSB already had in place. “Post migration, with TSB having full independence to control its products’ time-to-market and other commercial capabilities, it should become a fully flexed retail bank with a broader range of products,” says Mr Varela. “Separately, we will work on the SME initiative in order to be in a position to launch shortly after the migration takes place.” 

Domestic focus

Spanish banks are focusing their efforts on expanding business at home rather than launching acquisitions in the international market. CaixaBank, which has the largest domestic franchise, has limited its foreign ambitions to acquiring full ownership of Portugal’s BPI. CaixaBank’s bid values BPI at €1.62bn. The Spanish lender said its offer was conditional upon reaching at least a 50% ownership stake, up from the 44.5% it currently owns. The offer is also contingent on BPI lifting a 20% voting rights cap that has frustrated the Spanish bank’s ambition to exercise more control over BPI.

CaixaBank’s previous attempt to take over BPI was thwarted by Isabel dos Santos, the bank’s second largest shareholder with 18.6%, and the daughter of Angolan president Jose Eduardo dos Santos. “We are looking at launching the bid in the third quarter of this year,” says CaixaBank chairman Isidro Fainé.

Elsewhere, CaixaBank is gradually expanding its Latin American venture with Mexican billionaire Carlos Slim, and the bank has also increased its stake in Austria’s Erste Group Bank to 9.9% in order to gain access to markets in central and eastern Europe. CaixaBank’s only Asian venture is a 17% shareholding in Hong Kong’s Bank of East Asia. “For the moment we are determined to grow our business in the Spanish market,” says Mr Fainé.

Faced with the difficulties of a low-rate environment, which most bankers expect to continue in the short term, CaixaBank has been working to improve efficiency by cutting its branch network and staff, while reducing the number of staff in central services. This has now been cut to 6% of total staff, compared with up to 30% for some of its competitors.

M&A stays at home

Whatever merger and acquisition (M&A) activity is to take place in the near term will almost certainly revolve around domestic banks. “It would be difficult to see the banks embark on a programme of major international expansion like BBVA and Santander have done,” says Fitch’s Ms Torrella. “There is some scope in Spain for consolidation, as the capacity for organic growth remains limited.” BBVA’s Mr Sáenz de Tejada says he can foresee another round of consolidation taking place in the Spanish banking sector, perhaps in three years’ time. “It is a logical step for achieving cost synergies and coping with low rates,” he says.

Sabadell’s Mr Varela says: “As for the Spanish financial sector map outlook, a good rule of thumb is that any proposed transaction should create a bigger and better institution. There is no other possible or valid design currently to execute M&A in our opinion, and options are limited once you weigh in these restrictions.” 

One of the most eye-catching deals on the horizon is the possible merger of Bankia and Banco Mare Nostrum (BMN), two banks created from the merger of several cajas, or savings banks, which were undercapitalised and suffered from a high exposure to the property market. The cajas specialised in mortgage and real estate lending, hence Bankia and BMN were badly hit when the property bubble burst. Bankia required a government bailout to the tune of €22.4bn and has to date repaid €1.6bn through a 7.5% share offering. BMN received €1.6bn in government aid, which it has yet to repay.

“Bankia and BMN complement one another in their geographical presence,” says Bankia chairman José Ignacio Goirigolzarrri. “This operation would make sense for Bankia if the merger creates value for all shareholders. In such a scenario, it would allow the integrated group to gain greater efficiency and create more value, helping Bankia and BMN to repay the government the bailout funds they received during the crisis.” Barring legislative changes, Bankia is not allowed to embark on any mergers or takeovers before completion of its restructuring plan, scheduled for June 2017.

Mr Goirigolzarri says Bankia has fulfilled all the objectives of its 2012-2015 strategic turnaround plan, with profits more than doubling from €408m to €1.04bn in that period. “We have exceeded our target for market quota,” he says. "The bank’s ROE stood at 10.6% in 2015, compared with our 10% objective, and we generated €6.8bn in capital, €1.4bn more than anticipated.”

Gaining confidence

Whether or not the Spanish banks embark on another round of consolidation, the strategy for the next few years is likely to focus squarely on seeking ways to grow in a difficult environment and regaining public confidence. Bankers have acknowledged there is no business without satisfied customers and all efforts are centred on offering more competitive products to the retail market.

"We are a customer [bank] more than a products bank,” says Banco Popular’s chief financial officer Francisco Sancha. “We have deployed a consistent strategy for the past 50 years and today we are market leaders in the SME sector, which is our core business. Each of our branches is a small shop, with its own profit and loss account, and every branch manager fulfils the role similar to shopkeeper. This motivates staff to offer our SME and retail customers a high level of service.’

Banco Popular accounts for 17% of the Spanish banking system’s SME business and this represents some 60% of group profits. “The model has proved successful,” says Mr Sancha, “and this is reflected in our 12% core ROE on the pure banking business. Moreover, we have not required state aid of any kind during the recession.” At the same time, Popular has been selling off legacy NPL assets, which are provisioned at 40%. “We have been working on this since 2013, when we sold €700m-worth of assets. Last year the amount was €2.3bn and we expect to exceed this in 2016,” adds Mr Sancha.

In line with the banks’ focus on customer service, Santander has instituted a shift in culture with the objective of bringing the bank closer to its customers to ensure a deeper and longer lasting relationship. “We have detected the need for a change in the traditional model of a bank as a lending institution, as this is not presently a profitable business in the current low rate environment,” says Mr Cantera.

Santander has 115 million customers worldwide, half of whom operate actively with the bank. Of the latter, about 14 million consider Santander their primary bank. “We see a huge potential to increase our footprint and intensify our relationship with our existing customers, particularly in Spain, which provided 15% of group profits in the first quarter of 2016,” he adds.

Rethinking strategies

Santander considers the current level of bank profitability more of a reflection of the financial crisis legacy than the potential for growth. To this end, last year the bank launched its 1-2-3 Account, which has since signed up 1.1 million personal and SME customers, of whom one-third are new to Santander. The account pays cash back on selected household bills and interest on a customer’s balance. “We launched this account understanding that consumer demand for credit is not sufficient in itself to offset the decline in lending. The 1-2-3 Account is bringing in higher levels of commissions, while we are cutting costs through a reduction in our branch network,” says Mr Cantera. “We are not yet leaders in the SME sector, but this initiative has enabled us to boost our market share in this business area.”

Bankia’s Mr Goirigolzarri says his bank’s basic objective is to offer customers value and high-quality service at competitive prices. “We are also striving to maintain our leadership in profitability and efficiency,” he says. “We are basically committed to two lines of operation. As regards our customers, we remain focused on the issue of commissions. Our intention is to do away with commissions for direct debit retail and corporate customers. This sets us radically apart from our competitors and makes Bankia a more transparent institution. Second, we plan to extend this innovation to self-employed customers, so that our entire customer base can work with us on a close, straightforward and transparent basis.”

Like its competitors, Bankia is developing an extensive programme of digital banking, which Mr Goirigolzarri considers a means to an end. “This will allow Bankia to improve its customer service, a crucial factor in future success,” he says. “We also want to modernise our distribution network. Currently, about one-third of our business is done with virtual customers. Each of these will have a relationship manager. By the end of 2016, we anticipate having a portfolio of 250,000 remote customers. There are great efficiency gains to be achieved with this system, which allows us to double the number of customers for every manager.”

New challenges

Mr Goirigolzarri agrees that banks face a number of big challenges from the new regulations and low rates that are having an impact on the business model, and putting pressure on the capital base. “The task is to prove to the market that we are a strong bank, capable of making a contribution to the country’s economic growth,” he says. “Our aim is to bring the bank closer to its customers and persuade them to believe in us.” 

BBVA has now signed up 15.5 million digital clients out of a total of 66 million. “We are committed to growing our digital sales and increasing our customer base through new channels and cross-selling,” says Mr Sáenza de Tejada. “We are working to design products that can be delivered to clients digitally. We must also work on our ability to integrate new business models and develop new core competences into our overall banking business. It is essential to have a first-class workforce and attract talented people in new areas such as data analytics and digital sales.”

Sabadell’s Mr Varela says the difficult years of the crisis have taught bankers many lessons. “We have seen the consequences of a real estate bubble that burst and we have learnt that product spreads should not be structurally sacrificed, as was the case with offering mortgages at very low rates for the entire life of the product,” he says.

“The Spanish banking system is now getting acquainted with the idea that we do not need to unnecessarily subdue pricing in a context where our returns are growing at an acceptable level for our shareholders in terms of return on equity. There has been a lot of indiscriminate pressure on the banks by public opinion, but thankfully things seem to get better, albeit slowly. I’d say we are still not out of the woods, but the good news is that those who provide a superior standard of service in an efficient manner will still be able to achieve a sustainable level of profitability.”

   

 

 

 

 

 

   

   

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