Santander Bank is thriving thanks to its overseas operations

Santander Bank is thriving thanks to its overseas operations

Spain's biggest banks are shrugging off the full impact of the weak domestic economy and the collapse in the country's property market, but the country's smaller savings institutions – the cajas – are not faring so well.

Investment banking? Never touch the stuff, Spanish bankers will tell you with glee. Only a few years ago, Deutsche Bank, UBS and the big US players with large investment banking arms might have sneered at Spain’s lower-margin, strictly retail operations. That was when the big hitters were earning huge fee income from mergers and acquisitions, derivatives and equity securities, to name but a few of the businesses at the high-risk end. In the wake of the 2008 meltdown, it seems that the likes of Santander and BBVA are having the last laugh.

“Spain’s big banks are able to compensate for the weak Spanish economy and the collapse of the property sector thanks to the diversification of their earnings in other countries,” says Carmen Muñoz, an analyst at Fitch Ratings in Barcelona. “In the case of those banks that are highly focused on Spain, such as Banco Popular or the leading savings bank La Caixa, their earnings are more correlated to the domestic economy.

"But even in the case of La Caixa, the group seems to be weathering the crisis quite well because of its national franchise and low-cost deposit base,” adds Ms Muñoz. “Popular has a higher exposure to the construction industry sector so it has had to set aside significant provisions. However, the bank draws much of its strength from a good franchise in the small and medium-sized enterprise sector in different parts of Spain.”

Government support

The government can be credited with taking a proactive role in shepherding the country's banks, and in particular the highly exposed savings bank sector, through the crisis. In January of this year, Spain’s finance minister, Elena Salgado, announced several measures on minimum core capital levels that will be required of Spanish financial institutions, as well as the timetable for compliance.

The new legislation requires all Spanish financial institutions, including banks, savings banks and credit co-operatives, to comply with a core capital ratio of 8% by the end of December 2011. The core capital ratio requirement of 8% will be higher for institutions that are not listed on the stock exchange or for those whose weight of wholesale funding is greater than 20% of total assets.

Institutions that fail to meet the 8% core capital ratio have to submit a plan to the Bank of Spain on how they expect to achieve the minimum requirement. If they are unable to raise capital on their own, the government will authorise a capital injection by the Fund for Orderly Bank Restructuring (FROB), available until October 2011. Savings banks that meet the minimum requirements will be allowed to maintain their legal status, while non‐compliant entities will be forced to convert into banks.

In addition to the €14bn paid out by the FROB and by the Deposit Guarantee Fund to date, Spain's government estimates that funds needed to bring institutions into line with the minimum capital should not exceed €20bn. “These measures,” says Ms Muñoz, “are a positive step in terms of maintaining financial stability and clarifying the government’s position on the legal status of cajas, although it is not clear whether the government will achieve its ultimate goal of restoring market confidence.”

Diversification key for Santander

As far as Santander’s chairman Emilio Botín is concerned, it has been business as usual throughout the credit crunch for the eurozone’s largest bank. “Banco Santander is the most diversified bank in the world,” he said in February.

“It is the only organisation with a significant presence in three G-10 economies and a critical mass in 10 markets, half of them mature and the other half emerging," he added. "This is unquestionably a major asset and one of the keys to the earnings we have achieved over three such difficult years. The lower contribution of the Spanish branch network to the income statement has been offset by the improvement in our results in other markets, particularly Brazil and the UK.”

Santander's first-quarter results for this year, which saw a 4.8% fall in net profit, clearly reflect the ongoing crisis in the Spanish economy, which ground to a halt with the collapse of its property sector. Santander’s domestic profit for the first three months of 2011 was down 47% compared with last year to €593m, while non-performing loans rose sharply to 4.57%, from 3.59% in the same period in 2010. However, the group managed to boost its core capital ratio to 9.66% at the end of the first quarter, which compares impressively with 7.23% at the end of 2008.

International diversification has clearly been the chief mitigating factor throughout the credit crunch. Santander began to expand abroad in earnest in the 1990s with a string of acquisitions in Latin American countries, including Brazil, Mexico, Chile and Argentina. In 2004, it acquired Abbey in the UK, and then in the recent financial crisis Alliance & Leicester and the deposits and branches of Bradford & Bingley, consolidating its position as the UK's second biggest bank in terms of mortgages and branch network.

In 2008, Santander also acquired Sovereign Bank in the US, and followed this last year with the purchase of Poland’s Bank Zachodni WBK, the German retail banking operations of Sweden’s SEB, and 318 branches from Royal Bank of Scotland in the UK. As a result, retail banking in Spain accounted for only 13% of the group's profit in the first quarter of 2011, down from 30% in 2007. Brazil and the UK now account for 25% and 17% of Santander's profit, respectively.

Financial reserves

As with other Spanish banks, Santander was shielded from the first wave of the crisis by the countercyclical reserves the Bank of Spain required it to set aside during the boom years. These helped smooth the profit cycle during the 2008-10 period. In Santander’s case, it was able to continue contributing to these reserves through certain capital gains, such as the sale of Antonveneta in Italy to Monti Paschi de Siena in 2008 and the float of 16% of the bank in Brazil in 2009. In the run-up to the crisis, Santander focused its property lending on first-residence mortgages rather than developers. Hence its exposure to property developers was about 8% of the system’s total, well below Santander’s 14% to 16% overall domestic market share. 

BBVA, Spain's second largest bank, is less internationally diversified, with significant foreign operations concentrated mainly in the US and Mexico. The bank posted a 7.3% drop in first-quarter net profit, with margins squeezed by high funding costs and a price war for deposits in the Spanish market. Like its rival Santander, BBVA's Latin American units, especially in Mexico, helped mitigate the slump in domestic profits. Spain accounts for more than one-third of BBVA's business, making it more exposed than Santander to the Spanish economy.

However, BBVA’s CEO Angel Cano has hinted that further international diversification is in the pipeline. “The weighting of emerging markets in group results will continue to rise," he says. Latin America, which has remained largely immune to the credit crunch, boosted BBVA’s lending in the region by 13.5% to €22bn last year.   

Santander and BBVA were fortunate to be able to fall back on foreign earnings, given the dark cloud hanging over their domestic operations. “Despite some apparent improvement in margins and credit quality in the first quarter of 2011, we remain concerned about the outlook for Spanish banks,” says Barclays Capital analyst Rohith Chandra-Rajan.

“We see margin headwinds arising from higher funding costs and believe first-quarter 2011 improvements in impairments to be largely seasonal or supported by one-off gains," adds Mr Chandra-Rajan. "Real-estate acquisitions were substantial in the quarter, which could add pressure to impairments. Of greater significance is early evidence of deleveraging with Spanish loan books contracting 2% in aggregate in the quarter. We believe that this marks the beginning of a substantial deleveraging process which will hamper earnings progression in the medium term.”

Banco Popular bucks trend

Thanks mainly to tight cost and risk management, as well as a healthy small and medium-sized enterprise franchise, Banco Popular, Spain’s third largest retail bank, has managed to buck the trend by holding domestic loan contraction to 1% in the first quarter of this year. This compares favourably with a 3% drop for Santander and 11% for BBVA.

Barclays Capital’s Mr Chandra-Rajan is looking for Banco Popular to achieve 19% growth in net income this year. “We remain of the opinion that Popular deserves a higher rating than its Spanish peers, with a 2% higher return on equity potential, but at the same time it cannot avoid the challenges affecting the whole of the industry. Strong competition for funding and the margin compression seen in 2010 make any recovery in revenue difficult to achieve.” 

María Cabanyes at Moody’s Investor Service in Madrid believes that Popular’s long-standing strategy of customer focus underpins a leading franchise in several retail market segments. “The bank has a strong commercial dynamism that has translated into market share gains and customer growth,” she says. Ms Cabanyes also says Popular has one of the most efficient branch-based retail banks globally and a more granular loan portfolio than its domestic peers. But Popular’s main challenge remains achieving sound earnings growth in a highly difficult operating environment of very weak credit trends, low interest rates and slow business growth.

Restructuring the cajas

Spain’s retail banks are enjoying a comparatively easy ride compared with their rivals in the savings bank sector, which suffered a 23% drop in profits in 2010 across the industry. “On balance, the systemically important banks are doing well and the issues are mainly concentrated in the savings banks sector, which is restructuring,” says Fitch Ratings’ Ms Muñoz.

The savings banks, known as cajas, have embarked on a radical consolidation and restructuring process, which most industry analysts consider long overdue. The number of cajas has been slashed from 45 banks at the beginning of 2010 to 15. The process has taken place in one year, compared with the previous round of mergers of the early 1990s, which saw their numbers reduced to 50 from 87 over a period of four years.

The cajas’ business model, however, with its enormous exposure to the hard-hit property sector, poses a major challenge to recovery and growth. “The restructuring is not going as quickly as everyone would like, but they are making headway in the consolidation process,” says Ms Muñoz.

 “They need to reduce capacity and there are too many institutions in the sector with too many branches. This is an urgent requirement because the outlook is for muted economic growth over the coming two to three years.”


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