When Banco Santander sneezes, Europe catches cold. So when, last November, the eurozone’s largest bank, announced a €7.2bn rights issue, only days after saying it was not considering a capital increase, the markets braced themselves for the worst. But unlike several casualties of the European rights issue jamboree, Santander’s swift, albeit unexpected, action helped ensure the success of its capital raising. “This demonstrates Banco Santander’s ability to act quickly, strengthening its core capital to approximately 7%, which is especially important in the current economic scenario,” says chairman Emilio Botín.
Capital dilution
The rights issue came in response to investor concern about capital dilution after a recent string of acquisitions, including UK mortgage lenders Alliance & Leicester and Bradford & Bingley, as well as bidding for the remaining 75% it does not already own in US bank Sovereign. A high-ranking Santander executive explains further: “The injections of government equity into 17 of the world’s top 20 banks distorted the level playing field. Santander was determined to remain among the strongest banks. It is worth noting that this was the first capital raising through a rights issue successfully completed since the fall of Lehman Brothers last September.”
The executive also points out that rivals such as HBOS flagged their capital raising plans weeks in advance of the offering, thereby sending the share price into a tailspin. HBOS’s £4bn (€4.4bn) rights issue, for instance, left underwriters Morgan Stanley and Dresdner Kleinwort saddled with £800m of unsold shares on their books, the largest value of unsold stock this decade. The offer continued for more than 11 weeks, during which the bank’s shares dropped by a huge 43%.
Santander was determined to act swiftly to avoid being taken advantage of by short sellers, but the bank is aware that it is not immune from the global liquidity crunch. Simultaneously to the rights issue announcement, Santander indicated that it had postponed planned asset sales due to poor market conditions. The bank is seeking to dispose of its 31% stake in Spanish oil refiner Cepsa as well as its Banco Venezuela subsidiary.
The bank aims to drive profitability through measures such as cost cutting and integration of its foreign businesses. “We have 14,000 branches worldwide, with opportunities to reduce costs by integrating IT systems,” says a senior bank executive. “We are also moving ahead with the integration of Bradford & Bingley and Alliance & Leicester with Abbey in the UK. Costs are growing at slightly more than half the level of inflation so we still have some flexibility.”
Property price plunge
The Santander rights issue comes as storm clouds darken over the Spanish economic landscape. Property prices, the driver of Spain’s extraordinary growth during the past few years, fell by at least 15% in 2008, according to housing minister Beatriz Corredor. “It is a reality that we cannot deny,” she says. The government is facing an even grimmer performance this year, with analysts forecasting as much as a further 35% drop in real estate prices.
The knock-on effect is already making itself felt: registered unemployment was up 170,000 as of last November, nudging the three million jobless mark, the highest level since 1996. In the first 10 months of 2008, Spain had an €8.5bn budget deficit compared to a €27.8bn surplus in the same period the previous year. “Recent macro indicators paint a picture of an economic contraction gathering speed,” says Citi analyst Mike Pinkney, adding that variables which affect construction activity are suffering particularly. He says that other areas of the economy, such as the services sector, are also taking a hit.
Serious situation
The situation is serious enough for Spanish prime minister José Luis Zapatero to have summoned the heads of Santander, BBVA and the country’s leading savings bank (cajas) lenders to an emergency meeting in December to frame a response to the crisis. Two of the government’s measures were to raise the minimum deposit guarantee to €100,000 from €20,000 and to set up a Financial Assistance Fund to acquire asset-backed securitisation products and repos from financial institutions. In December, the Treasury launched a €100bn programme to guarantee bank bonds for as long as five years, to encourage lending.
“We have tried to act in co-ordination with the rest of Europe to deal with the crisis,” says the Treasury’s director-general Soledad Nuñez. “Under the terms of the 2008 programme, banks that have issued senior debt in the past five years will be able to issue bonds to July 2009.”
The Treasury programme is a welcome move,” says María José Lockerbie, an analyst at Fitch Ratings. “Spanish banks had been growing their loan books rapidly over the past few years due largely to their ability to issue debt in the capital markets at low spreads. With the markets now closed, I wouldn’t be surprised to see most Spanish banks applying for the programme.”
The Treasury’s Ms Nuñez explains that Spanish banks have avoided exposure to the subprime crisis mainly due to Bank of Spain’s policy that specifically discouraged any involvement in these products. “There was no outright ban on acquiring subprime mortgages, but to do so, the banks would have to increase their provisions and this acted as a strong deterrent,” she says.
Ignacio Muñoz-Alonso, head of corporate and investment banking at BBVA, Spain’s second largest bank, sees the mandatory provisioning policy set down by the Bank of Spain and its on-balance sheet treatment of special investment vehicles as major factors that kept Spanish banks at a safe distance from the toxic products responsible for bringing down other institutions.
Stabilisation ahead
“When the dust settles, we estimate that the banks’ non-performing loan ratios should stabilise in mid-2009,” says Mr Muñoz-Alonso. “A lot has been done on the fiscal and monetary policy fronts, and the key is to have an idea of how much damage banks will suffer in this downturn. We, at BBVA, are quite comfortable with a 6.8% Tier 1 capital position. In fact, difficult times may offer good opportunities. For instance, companies need special help for re-financing and re-structuring, and in today’s market there is less competition around.”
Spain’s third largest retail bank, Banco Popular, differs from its rivals in its focus on the small and medium enterprise (SME) sector of the economy. With this highly profitable segment as its main profit source, Popular expanded its loan book by more than 8% in 2008. There is uncertainty about future growth as Spain’s vast small business market is being affected by the credit crunch, although the bank is confident of keeping its capital ratio at about 7% in 2009.
“We can still aspire to inflation-type growth in 2009, while we have undertaken an aggressive campaign to gather deposits,” says Juan Echanojáuregui, the bank’s deputy-director. He agrees that a crucial move to cushion the crisis was the €100bn Treasury programme. “This was one of the keys to unlock the bond issuance markets,” he says. “We have €4bn of bonds maturing in 2009 and with a 5% share of the bond market, we are able to access €5bn in guarantees. Given the level of medium-terms notes maturing this year, Banco Popular is in a position to issue about €1bn a quarter.”
Popular, with a cost-to-income ratio below 40%, has historically been more profitable than Santander and BBVA. “However, if there is going to be a severe recession, SMEs are going to suffer badly and this will have an impact on Popular’s profits,” says Fitch’s Ms Lockerbie. “This happened in the recession of the early 1990s when Popular’s profitability took a hit, even though at the time it remained higher than the sector average.”
