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Western EuropeMay 2 2017

Buoyant Spanish banks finally look forward with optimism

As the Spanish economy ticks up, the country’s banks are feeling cautiously optimistic and confident enough to consider expansion, both at home and abroad, while ramping up their digital strategies. Jules Stewart reports.
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BBVA

Spanish bankers greeted 2017 with a sigh of relief. The general election in June 2016 ended the country’s year-long political deadlock, during which it was effectively without a government. The victory of the centre-right Popular party restored stability on the political front.

Last year also saw a material improvement in the asset quality of Spanish banks, largely on the back of 3.2% gross domestic product (GDP) growth, which made Spain one of the eurozone’s fastest growing economies. The country's property meltdown of 2008, which set off a near-decade-long recession, enjoyed a dramatic turnaround in 2016, with a 4.7% increase in house prices, the strongest performance in nearly a decade.

“This year things are looking better than what we had anticipated,” says José García Cantera, chief financial officer at Banco Santander. “We expected GDP growth of 3% in 2016, while the official figure was 3.2%. This year we were anticipating 2.5% to 2.7% growth, but it now looks like the final figure may be closer to 2.8%. The fundamentals are strong, with political stability, rising employment, solid consumer demand and a healthy balance of payments. Spain is in fact in a stronger position than countries such as France or Germany.”

Transition period

José Ignacio Goirigolzarri, chairman of Bankia, believes 2016 marked a period of transition, with costs and provisions for non-performing loans (NPLs) on the decline, but with margins remaining under pressure from low interest rates.

“Next year is likely to bring a rise in rates across Europe, though for now the banks are still finding it a challenge to achieve a satisfactory level of profitability,” he says. “The really positive impact of higher rates will most likely be seen in 2019. We are looking at the end of the crisis and the beginning of a new environment.”

Cristina de Parias, head of Spain at BBVA, agrees that last year’s improved scenario has continued into 2017. “There is increased appetite for investment, in Spain as well as in other countries,” she says. “Furthermore, the ultra-low interest rate scenario is encouraging business leaders to launch new initiatives. As a consequence, a positive sign is that new commercial lending was up by more than 8% in January, year on year, but we don’t know how this will evolve throughout the year.”

Similarly cautious optimism is expressed by Tomás Varela, chief financial officer at Banco Sabadell, which in 2015 acquired the UK's TSB for £1.7bn ($2.12bn). “Last year the banks began to put behind them some of the major problems that had been plaguing the market,” he says.

Mr Varela singles out greater clarity in legacy portfolios and regulatory requirements as two positive factors, and he says 2017 shows signs of providing an economic tailwind. “We are likely to see some inflation returning to the Spanish and European economies, which bodes well for a rise in interest rates,” he says. “We are also seeing a decrease in problem loan portfolios.”

Sabadell's UK plans

Elena Iparraguirre, director of bank ratings at S&P Global Ratings, says Sabadell took a bet on the UK market with TSB. “It has proven itself to be a professional manager and it could do a good job in migrating TSB to a new IT platform,” she says. “[Sabadell] needs to build up the franchise, but there are uncertainties ahead – mainly Brexit, and what it could mean for the UK economy.”

Ms Iparraguirre believes that because of its more limited size, TSB could be easier to manage and integrate than Santander’s acquisition of another UK financial institution, Abbey. “On the other hand, Santander had experience in operating outside Spain, buying banks and turning them around in Latin America, while Abbey was not under pressure to make its business grow,” she says.  

Sabadell expects to have completed the migration of TSB onto a new IT platform before the end of the year. Mr Varela says this will achieve operating autonomy and the ability to bring products to market quickly.

At group level, Sabadell will continue its programme of reducing non-performing assets (NPAs). “As stated in our recent strategic update, in 2018 to 2020 we intend to expand our small and medium-sized enterprise [SME] business in the UK market,” says Mr Varela. “While the UK SME business is different from the Spanish market, all SMEs require an integrated and efficient service and available credit, and we have experience in providing these.”

Sabadell began to expand in the retail market in the 1990s. Until then the bank had focused on SMEs and high net-worth customers. “We are not daunted by the challenge of expanding in SMEs as we have experience in dealing with this business, and we have a strong franchise in TSB,” says Mr Varela.

In general terms, Sabadell is pleased with the progress achieved since its takeover of TSB. “We knew what was on the table when we came to negotiate the merger,” says Mr Varela. “We found that TSB’s performance had exceeded our expectations and the integration is fully on track. We are going to launch a new digital app for our customers in the coming months, which is the first step in making this process more visible.”

There is speculation that Sabadell’s appetite for UK expansion may stretch beyond TSB. Market sources say the Spanish bank could launch a bid for the troubled Co-operative Bank, which is seen as a logical geographical fit, by adding the Co-op’s business in the north to that of TSB, whose main markets are in southern England and Scotland. Mr Varela says: “At the moment, we are not looking at markets beyond Spain, the UK and in Mexico, where in 2015 we launched corporate structured finance and SME activity and opened six business centres. We are currently 100% focused on integration and organic growth.”

A Popular target

Sabadell is not the only Spanish bank to find itself involved in takeover rumours. Instead of being on the acquiring side, Banco Popular’s poor performance in 2016 has sparked speculation that it could fall into the hands of one of its major competitors. As the market leader in SME lending, it would make a tempting morsel for one of the big three – Santander, BBVA and CaixaBank – trying to expand in this sector.

Banco Popular’s pre-tax results took a nosedive, from a €114.1m profit in 2015 to a €4.8bn loss last year. The bank raised €2.5bn in capital in May 2016, when it presented its updated strategic plan, under which part of the funds from the cash call would be earmarked for offering its large stock of problem assets to investors at a discount.

Analysts believe another rights issue may be unavoidable. The bank’s loss for the year exceeded market expectations by about €1.5bn, and also recognised €3.2bn in additional problem assets. There were several other unanticipated one-off impacts, including more than €300m in provisions for mortgage ‘floor clause’ claims that had been written into contracts by several banks, imposing a minimum interest rate on variable rate mortgages.

In December 2016, the European Court of Justice ordered lenders to hand back to clients the money they made on mortgage floor clauses. The floor clause is another source of pressure for the banks on the revenue side, but most analysts believe it does not pose a threat to the banking system’s profitability or capital position.

“Popular began lending large amounts to real estate and construction firms in 2005 to 2007, later than its peers,” says Pilar Pérez, associate director at Fitch Ratings. “In 2011, it acquired Banco Pastor, which had a larger-than-average exposure to the property sector.

“Popular’s exposure to problem assets remains well above the sector average. It is focused on the sale of property portfolios to institutional investors instead of retail buyers. This will enable it to get NPAs off its books at a faster rate. In 2016, it sold more than €2bn in property assets, mostly to retail buyers. The bank’s main underlying strength remains its highly competitive SME business. The business is quite profitable, but not enough to offset the losses incurred from the NPA portfolio."

Domestic business

Popular recently had a management shake-up, highlighted by the appointment of Emilio Saracho, formerly deputy CEO for Europe, the Middle East and Africa at JPMorgan as chairman. Mr Saracho’s appointment triggered speculation that he might try to avoid another rights issue by bringing in a large equity investor or, failing that, seek a merger with another bank. A Banco Popular spokesman declined to comment on market speculation.

With banks seeking to shed huge bad debt legacies of the past decade, while at the same time working to develop business strategies that will enable them to take advantage of Spain’s economic turnaround, the focus is likely to remain on building up the domestic franchise through organic growth.

Josu Fabo, director for financial institutions at Fitch Ratings, believes there could be some movement on the acquisition front in the next few years, but nothing like in 2012 to 2013, when there was a pressing need for consolidation. “There is pressure on the earnings side across the sector and this especially affects the smaller to medium-sized banks, which have a less diversified business model,” he says. “There could be incentives for them to seek partners, but we are not expecting to see a massive wave of mergers and acquisitions [M&As].”

The most eye-catching M&A operation in Spain in 2017 is Bankia’s forthcoming merger with Banco Mare Nostrum (BMN), a deal valued at €600m in terms of synergies to be derived from merging back-office operations, given the two banks’ complementary regional presence. Spain’s bailout fund, FROB, which owns 66% of Bankia and 65% of BMN, has given the green light to the merger, by which it hopes to recoup some of the money it spent on bailing out the banks in 2012, after they took massive hits from property investments.

Mr Goirigolzarri stresses that the bank will seek to derive profitability from its retail lending business. “We have put into place a unique business mix, with the emphasis on consumer and SME lending,” he says. “These are both high-growth markets. The emphasis is on selling high value-added products, and here we have brought out a number of unique initiatives. For instance, we have eliminated commissions on all products and services for customers who bank their pensions, salaries and the like with us.”

Consolidated market

When it comes to the M&A environment, Santander’s Mr Cantera points out that Spain has already seen a rapid shrinkage in the number of its financial institutions, from about 50 banks and cajas, or savings banks, when the financial crisis hit, to some 20 today. “It was difficult to predict this process and, going forward, I can say that we will look only at those opportunities that make strategic and economic sense," he says. “If something fits our requirements we might decide to make an offer, but our primary focus is on organic growth. We have 120 million customers worldwide and half of these are not multi-product clients. Only 30% identify Santander as their number one bank, so there is a lot of work to be done in this business.”

Santander also faces the challenge of dealing with Brexit and the uncertainty surrounding the knock-on effect for the financial sector of the UK pulling out of the EU. Santander derives 20% of its net attributable profit from its UK business. “The UK’s positive macroeconomic performance since the referendum has come as a welcome surprise,” says Mr Cantera. “There will inevitably be an impact at some point, but for now we can say: so far, so good.”  

BBVA’s Ms de Parias says the bank’s primary objective is organic growth. "Without acquisitions, we have increased our market share by about 35 basis points annually over the past five years,” she says. “But we also look at M&A opportunities as and when they arise in the Spanish market, keeping in mind at all times the potential to add value to the group. From a global perspective, BBVA has been an active M&A player, combining physical and digital opportunities.

“We will continue to focus on our geographical diversification. Currently two-thirds of our net attributable profit is derived from emerging market countries. Mexico, with 46% of the group total, is the main contributing country.” 

In the Americas...

In Mexico, BBVA has recently announced a $1.5bn, five-year investment plan aimed at leveraging its subsidiary Bancomer’s technology and developing solutions for its customers. The impact on BBVA’s Mexican business from political and economic uncertainty in the country remains to be seen. Bancomer enjoys wide margins, which explains its large contribution to group profits, and analysts don’t expect a significant change.

CaixaBank chairman Jordi Gual says there is still some excess capacity in the Spanish banking system after a deep restructuring, which saw a cut of about 30% in the number of branches and personnel across the board. “But the average return on equity is still at 5%, with the cost of capital running at 10%,” he says. “The smaller banks are the ones that face more demanding challenges, while large groups such as ours have the economies of scale needed to weather the difficult days and achieve sustainable profit rates.”

As for the low-interest-rate environment, Mr Gual points to the ‘Trump effect’ and the trend towards higher rates in the US that could signal the end of many years of depressed rates in Europe.

NPL worries

Spain’s banks are still not out of the woods with regard to their sizeable NPL portfolios. “We expect to see a continued focus on reducing NPAs, a process that regulators sound willing to push further as well by setting up specific targets for banks,” says S&P’s Ms Iparraguirre. “This could help boost profits, which are still affected by the level of NPAs. A large problem loan portfolio simply doesn’t generate earnings and needs to be funded and the workout managed, leading to a costly situation.”

Ms Iparraguirre says provisioning is declining but she estimates that in two years’ time, NPAs will still represent 11% of loans, compared with about 15% at the end of 2016. “The relatively slow pace of reduction compared with other markets could partly be because Spain lacks a deep, liquid market for NPLs,” she says. “There remains a gap between the price at which the banks are willing to sell and what buyers are prepared to pay.  

“The main problem is still how to make the banks’ business sustainably profitable. There is limited scope for growing earnings, though lower provisioning and a reduction in operating expenses will help. Nevertheless, we won’t see returns to match the banks’ cost of capital, a factor that is likely to keep competition intense."

Digital rollout

To combat this competitive challenge, a key step Spain’s banks have taken is an ambitious roll-out of digital programmes, aimed at bringing in more customers at reduced costs, while increasing efficiency.

“We are expanding our retail franchise,” says Bankia’s Mr Goirigolzarri, “while the launch of our digital platform in 2014 is bringing results. We are working hard to build up a digital and multi-channel approach and we expect to have the programme fully up and running by the summer. This will leave us well positioned for the next economic and business cycle.”

CaixaBank’s Mr Gual says its business model is that of a financial supermarket, composed of a full range of services and products, a concept he says is crucial in a low-interest-rate environment. “We distribute investment funds, pension plans, insurance and other products through a network of 5000 points of sale, and this has made us resilient,” he says. “Our competitive edge rests on three legs: the financial supermarket concept, a first-rate digital platform and a long-term relationship with our customers.”

More than half of CaixaBank’s customers now use its online banking platform, giving the bank a share of the Spanish digital market of more than 30%.

BBVA’s Ms de Parias says its competitive advantage lies in being customer focused rather than product focused. “We stand by our customers at all times and we put a lot of emphasis on customer relationship,” she says. “We are also moving ahead with our digital journey, a process that allows our customers to choose their channel of choice to interact with the bank. Last year, BBVA made significant progress [in] taking its clients through the digitalisation process, to the extent that digital transactions accounted for 17% of the total in 2016, compared with 8% in 2015.”

Ms de Parias says the bank now ranks first in Spain in digital transformation. “For instance, our customers can open an account in five minutes by sending a selfie on their smartphone,” she says.

“People tend to think that digital channels only work for millennials, but they attract every age bracket. More than 35% of our pension plans are arranged by mobile or internet,” she adds. “Therefore we are working on offering all business transactions conducted from a mobile. This whole strategy is based on the idea that digital transformation improves customer experience and satisfaction. In this regard, we have launched our Feel the Experience plan, to underpin our position as the most recommended bank."

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Read more about:  Regulations , Western Europe , Spain