The current banking environment in Spain is an accumulation of positive news, coming hard on the heels of three years of solid economic growth. The country’s banks have been steadily reducing their stock of non-performing assets (NPAs) – though for most, this task still remains a challenge.
“[Banks] will need to accelerate divestment of these NPAs more aggressively, and not just through organic reduction,” says Elena Iparraguirre, director of bank ratings at Standard & Poor's. “They are transferring their NPA portfolios to institutional investors, as is the case of Santander with Popular, while BBVA has reduced by 80% its stock of foreclosed assets. We would expect to see others following this trend, especially in view of regulatory pressures from the European Central Bank [ECB].”
Ms Iparraguirre says that after significant deleveraging, the banks’ funding risks have eased and their profiles are much more balanced. This means that customer deposits now finance the bulk of lending activities and the banks’ access to the markets has been restored. Moreover, their sovereign creditworthiness has been improving and this could eventually bring funding support mechanisms for the banks, if needed. Meanwhile, as the property market recovers, there is likely to be greater willingness on the part of institutional investors to play a role in this market.
After the tsunami
José María Roldán, chairman of the Spanish Banking Association (AEB), believes the banks are breathing freer in the aftermath of what he terms a “regulatory tsunami” and that the challenge now is to implement wider reforms, such as the completion of the European Deposit Insurance Scheme.
However, Mr Roldán, who also serves as vice-president of the European Banking Federation, notes that Spanish banks are still facing challenges to achieve a sustainable level of profitability.
“There has been a clear-out over the past decade in which the number of financial institutions has fallen from 45 to 13,” he says. “This cutback, however, has not brought a reduction in competition, which is in the DNA of Spanish banks.
“The banking crisis has intensified competition in the battle to gain market share. A distinguishing factor is the banks’ model of one-stop shopping, which they are applying to other countries in which they operate. They are finding this a more profitable business than engaging in cross-border mergers.”
Strong momentum
There is a consensus among Spanish bankers that the economy’s substantial momentum, since the reforms of 2011 to 2015 were put in place, has translated into a major boost to business. “This has surprised observers and we are witnessing a continual revision of gross domestic product [GDP] growth, which some put at 2.9% for this year,” says Jordi Gual, chairman of CaixaBank. “Our own estimate is for 2.8% growth, which is good news for the banking industry. Spain has been creating 500,000 new jobs per year and this has provided consumers with a sense of security.”
At the same time, CaixaBank has been reducing its NPA portfolio. “The property market is showing positive growth as well, with sales up 6% to 7% per year, allowing us to sell more non-performing assets,” says Mr Gual. “There has been a boom in external investors in this sector, mainly private equity firms from the US and UK, who are buying portfolios and putting them back in the market.”
Mr Gual says low interest rates are not a major problem for CaixaBank, given that a substantial part of the business is in managing assets such as insurance, pensions and investment funds. “We benefit from this and can survive in a low interest rate environment,” he says. “We have definitely detected customer appetite for these products. The Spanish financial markets in these products are underdeveloped relative to GDP, so we see this as a major opportunity.
“We are not under pressure to reduce costs to boost profitability. What we can offer is good professionals to provide value-added services.”
Profit problems
Increasing profitability remains a challenge for the banks, especially those with a more regional focus and less diversification than the large banks with national coverage. “Given the likelihood of continued low interest rates,” says Ms Iparraguirre, “we can expect to see greater efforts to cut costs by reducing their branch networks and cutting back on staff. It will be tough to boost their volume growth or do anything drastic on the cost-management side, given the high outlay required for restructuring.
“Likewise, all the banks are targeting roughly the same customer base,” she says, adding that there is a chance of a rate cut in the second half of 2019, following some positive signals from the ECB – although inflation remains far below ECB targets.
The cutback in Spain’s branch network is an ongoing process. Since the 2008 financial crisis, the number of branch offices has shrunk from more than 46,000 to the current level of just over 28,000. The objective, as outlined in the sector’s strategic plans, is to reduce this number to a maximum of 10,000 offices in the medium term, in line with International Monetary Fund recommendations.
Bullish on growth
Cristina Torrella, senior director at Fitch Ratings, takes the view that in terms of the Spanish banking sector, the economic growth witnessed in the past few years is likely to carry on into 2019, despite the likelihood of a modest slowdown. “Another matter is how this benign economy will filter through to loan activity,” she says. “The message for now seems to be that the deleveraging process on banks’ overall loan books appears to be entering its final stages, despite the different growth dynamics by loan segment.”
Growth in profitability will perhaps decelerate slightly in 2018, but it will be higher next year
Another crucial factor is the recovery of the property market, she adds. “There is still a debate over this issue and how it is spread across all locations, but in broad terms, this market is in a much stronger position than in the past,” she says. “This has been a major feature in the clean-up of the banks’ problem assets portfolios, especially foreclosed real estate assets.”
Competition remains intense and banks are struggling to achieve a level of returns above their cost of capital. Banco Sabadell, which in 2016 acquired UK bank TSB for €1.7bn, is confident its new two-year strategy plan will enable the lender to achieve a two-fold increase in profitability to €1.4bn by 2020, and move up from fifth to fourth position in the Spanish ranking.
Sabadell chairman Josep Oliu forecasts return on tangible capital to reach 13% by 2020, compared with 7.27% in 2017. “Growth in profitability will perhaps decelerate slightly in 2018, but it will be higher next year and a good deal stronger by 2020,” he says. “We expect to achieve 5% annual growth in income over the next three years, with a rise of more than 4% per year in net interest income in the same period.”
A Popular move
In 2018, the Spanish banking industry has (so far) not suffered any unsuspected shockwaves. In 2017, on the other hand, Spain’s financial markets were shaken when EU authorities declared Banco Popular “failing or likely to fail”.
Following the Spanish banking regulator’s decision to resolve the Popular crisis and find a buyer through an auction process, Banco Santander was selected the successful bidder for the symbolic price of €1 and a €7bn capital increase, which Santander injected one month after announcing the acquisition, to rebuild the balance sheet of Popular, which was saddled with €37bn in toxic real estate loans.
“We are moving ahead of schedule in the integration, with the legal merger taking place earlier than expected,” says José García Cantera, Santander's chief financial officer. “We’re now working on integrating Popular’s technology platform, which was in a precarious state when we acquired the bank. Our plan is to have Popular legally integrated into Santander in September. The branch integration will follow and the Popular brand will eventually disappear, with all branches in Spain rebranded as Santander at the end of the process.”
Mr Cantera says Popular, which was the leader in the Spanish small and medium-sized enterprise market, makes a perfect fit with Santander’s business. “Popular was specialised in small to medium-sized corporate clients, while our focus is more on the larger segment of this business,” he says. “There is therefore no overlap between the two banks.”
The acquisition of Popular strengthens Santander’s position as Spain’s largest universal bank – however, Mr Cantera stresses that size is not the primary objective for growing the business. “Our priority is profitability and customer service,” he says. “Satisfaction increases loyalty, which in turn enhances profitability. In this respect, we see digitisation as an opportunity, both on the cost and the revenue side. It is one of the ways we can increase our market share, by reaching out to new customer segments at a lower cost.”
One source of concern is the UK’s vote for Brexit and the impact this may have on Santander’s UK business. The bank is adopting a more cautious position in the UK market, although Mr Cantera says the country’s growth rate indicates so far the economy is doing well.
“There are, however, signs of a slowing growth rate and we are seeing a contradictory trend in a higher employment rate in the context of lower GDP growth,” he says. “The fact is that the UK is one of 10 countries in which Santander has a significant presence. In spite of what may happen in the UK, we are doing very well in countries such as Mexico and Brazil. Diversification is one of our business model’s key strengths. When some markets lag, others take the lead, thereby maintaining the group’s profitability.”
Bankia's BMN boost
The other major news on the acquisition front is Bankia’s takeover and integration of Banco Mare Nostrum (BMN), a partly state-owned grouping of three savings banks that were merged in 2010. Bankia, in which the Spanish government still holds a stake of about 60% following the bank’s multi-billion-euro bailout in 2012, was granted permission to acquire BMN in late 2017 and the deal was completed in January 2018.
“It was important to finalise this deal without delay in order to begin the implementation of the restructuring plan,” says Bankia chairman José Ignacio Goirigolzarri. “Our two banks make a perfect fit, as BMN fills in the gaps where we lacked a significant presence – for instance in the region of Murcia, the eastern region of Andalusia and the Balearics. The plan for this year is to ensure all systems are working smoothly, and from there it will be business as usual.”
The new group expects to generate cost synergies of €190m by 2020. Mr Goirigolzarri says the takeover will have no impact on Bankia’s new three-year strategic plan. “Six years on from the time the original plan was put into place, we can say with confidence that it has achieved its objectives,” he says. “We fully expect to nearly double attributable profit to €1.3bn by 2020, after reporting €816bn in earnings last year.”
Bankia is making a significant effort to broaden its digital reach to customers and has fully digitised its systems over the past three years. The lender is spending €1bn on new technology over the next three years.
Spain has been creating 500,000 new jobs per year and this has provided consumers with a sense of security
“As of now, two out of every three of our customers uses mobile banking,” says Mr Goirigolzarri. “Moreover, 21% of those who have purchased our products in the first quarter of this year have done so online. This is one of the ways we expect to double our digital customer base to 4 million by 2020.”
Bankia’s three engines of growth, according to Mr Goirigolzarri, are its merger with BMN, the business areas the bank was not allowed to undertake during the restructuring plan, and its new positioning in the market, which has restored consumer confidence. “You only have to look at our growth record over the past six years to appreciate how the mood has changed,” he says. “This is true of our customer base as well as our staff. People are now happy to work with Bankia.”
Political risk
The sensitivity of banks to the domestic political environment was demonstrated in a dramatic fashion this year in Catalonia, following the region’s illegal referendum on secession from Spain. In the wake of the vote, nearly 2000 companies shifted their headquarters to other parts of Spain. This included CaixaBank and Sabadell, which moved their legal base to Valencia and Alicante, respectively. The impact of this initiative remains to be seen, though for the moment it has not caused any major disruption to the two banks’ national operations.
“The fact that CaixaBank and Sabadell have shifted their headquarters out of Catalonia is not likely to have an impact on their business, which is nationwide,” says Josu Fabo, director financial institutions at Fitch Ratings. “A look at their 2017 numbers shows deposits remained broadly stable and there is no evidence that they are more exposed to risk.”
However, S&P’s Ms Iparraguirre believes the two banks are facing a potential risk factor. “The impact on the franchises of CaixaBank and Sabadell remains to be seen,” she says. “They are more vulnerable than other banks, though so far, the Catalan economy has proved resilient. Only in the longer term will we see the damage that may have been inflicted on the regional economy by the transfer of many large corporates out of the region.”
Mr Gual at CaixaBank says: “In spite of our decision to move our headquarters out of Catalonia, we have seen an increase in customer funds and we have posted our best set of results since CaixaBank's flotation in 2011. Last year our return on tangible equity rose to 8.4% and we believe it will be between 9% and 11% in 2018.”
Digital drive
Cristina de Parias, who heads BBVA Spain, says the bank’s emphasis is firmly on transforming its digital business, which is reflected in the fact that in the past 12 months the bank has already made 92% of its products and services available in its application and on its website. “Thanks to that, 42% of all units sold were through digital channels,” she says. “Last year these same channels accounted for more than one-quarter of all sales.”
The strategy is to offer a multi-channel service composed of digital, remote and physical services. The branch network will have fewer and larger points of sale, in order to provide a more segmented service for each customer’s needs. “BBVA is basically applying its digital strategy for Spain to other countries where the bank has a presence,” says Ms De Parias.
“The financial sector is going through major changes and it is becoming more focused on efficiency and [on] providing a better experience for customers. The idea is to empower our customers and provide value-added products to help them to make better decisions,” she adds.
Like its rivals, BBVA suffered from exposure to Spain’s property sector meltdown during the financial crisis. The bank recently announced a joint venture with Cerberus Capital Management to sell an 80% stake in its non-core property assets to a subsidiary of the US private equity firm for about €4bn. “Thanks to this deal, BBVA will be one of the banks with the lowest exposure to the property sector [in Spain],” says Ms De Parias. “This will enable us to focus on our core business and achieve double-digit profitability in Spain.”
She adds that BBVA’s first-quarter results for 2018 reflect the strength of the bank’s diversification strategy. “We’ve got the right mix in the countries where we operate, with a good balance between developed and emerging markets,” she says. “In Mexico, BBVA has a leadership position and now accounts for 35% of group profits, 10 percentage points ahead of its domestic business, with the rest distributed in South America (13%), Turkey (12%), the US (12%) and 3% for the rest of Europe.
“Our objective is to grow the business organically in Spain at home and abroad.”
Consolidation a possibility
While the banks claim to be concentrating their efforts on achieving market share and profitability through organic growth, they have not ruled out the possibility of future consolidation. Analysts believe some Spanish banks might be looking at consolidation, a move more likely to involve smaller entities with an asset base in the range of €50bn. Some of the potential takeover candidates mentioned are savings banks (cajas), such as Kutxabank, Liberbank or Ibercaja, while the benefits of large players acquiring smaller competitors are thought to be less obvious.
“Consolidation in the banking sector is an ongoing debate,” says Fitch’s Ms Torrella. “In the medium term, we will probably see some activity, driven by pressure on profitability and capital pressures in the context of a stricter regulatory environment. To that must be added a natural resistance to the expense involved in a merger or acquisition process.”
All in all, the overall outlook for the sector remains positive. According to the AEB’s Mr Roldán, Spanish banks will be able to continue reducing their NPAs in 2019 thanks to the current benign environment – something the regulators should be happy to hear.
