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Western EuropeApril 6 2008

Walking a crisis tightrope

Spanish banks appear to have survived the credit crunch relatively unscathed. However, as Jules Stewart reports, the country’s current account deficit and reliance on foreign markets is causing concern among some commentators.
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Spanish banks are confronted with the same market turbulence and uncertainty as their European peers in the wake of the global liquidity crunch that hit last summer – with a few notable differences. Enrique Casanueva, country manager at JPMorgan Chase in Madrid, says the Spanish banks are, overall, in better shape than those in other countries, such as Germany, France or the UK, as they have no direct exposure to the subprime crisis.

“Spanish banks enjoy excellent asset quality and have had conservative lending and provisioning policies over the past few years, which provide a substantial cushion for the expected increase in non-performing loans, particularly in construction and real estate,” he says. However, there is concern over the outlook for some of the smaller banks. “Investors are cautious about some of the smaller institutions, particularly those with a more limited range of businesses and products, if they also have a high exposure to the construction industry,” he says.

“Some of these have been growing by opening many branches, which can sometimes take a considerable amount of time to turn a profit.” Competition will also become tougher. “There is increasing competition for customer deposits, and those institutions with higher liquidity needs will have to make an extra effort to secure their funding,” says Mr Casanueva.

The virtual shutdown

Marisa Mazo, strategy director at broker Ahorro Corporación, points out a distinguishing feature in the situation of growth and credit demand. “Spain was growing quickly with a high trade deficit and therefore needed access to foreign capital,” she says. “The virtual shutdown of the capital markets meant that bank lenders, which in the past had little difficulty raising capital through covered bond issuance and other securitisation instruments, now find these markets closed to them.”

One upshot of this loss of access to the wholesale capital markets, says Ms Mazo, is that Spanish banks’ share of the European Central Bank’s (ECB) weekly funding auctions has soared from about 4% a few months ago to 10% now.

Deposit focus

“The interbank market is as dead in Spain as elsewhere and Spanish banks are falling over one another to raise liquidity through deposits,” says David Burns, country head of Schroders Investment Management in Madrid. “They are offering deposits up and down the high street of 5.5% to 7%. The financial sector spent something in the order of €35m in 2007 to push its deposit products. Banks are re-negotiating their credit lines and loans. However, the big Spanish banks are very diversified and they can fall back on Latin America, eastern Europe and other businesses segments.”

Spanish banks are starting from a position of strength, as the most efficient in Europe with a cost:income ratio of 48%, compared with the 60% EU average. This high level of efficiency is largely the result of a major cost-cutting drive involving the introduction of new technology. The two largest banks, BBVA and Banco Santander, are waging a desperate war for domestic deposits.

Both are aware of the risks posed by their international franchises and potential problems outside Spain, although their biggest exposure is to Latin America, which for the moment is mostly a strong performer. However, there are concerns over Santander’s business in Brazil, which accounts for 23% of group earnings. “What was seen as a big positive for Santander in 2007 has turned somewhat negative, with newsflow from Brazil pretty poor in recent months,” says UBS analyst Gert Van Rooyen.

Big two uncertainty

Another 13% of the bank’s business comes through its Abbey subsidiary and the outlook for the UK consumer, particularly in the mortgage market, remains clouded with uncertainty. BBVA, on the other hand, has a 32% exposure to Mexico, which is yet to feel the impact of the downturn in the US economy. Mr Van Rooyen has lowered his 2008 earnings estimate for BBVA by 4% in 2008 and 5% in 2009, and that of Santander by 5% and 7% in the same period.

Despite recent assurances from finance minister Pedro Solbes that the Spanish banking system enjoys an excellent state of health, market observers outside and inside Spain express more scepticism over the banks’ ability to come through the crisis unscathed. This also applies to the unique system of 45 savings banks, known as cajas, which account for more than 50% of Spain’s financial system.

In fact, the rise of the cajas, two of which – La Caixa and Caja Madrid – rank among the country’s top four financial institutions, are largely responsible for making the Spanish banking system one of the most competitive in the world.

During the 1990s, when BBVA and Banco Santander were involved in the separate complex merger processes that created the country’s two largest banks, the cajas moved in and began aggressively building their branch networks. Once the dust had settled on the mergers, Santander and BBVA found that they had closed too many branches and were being upstaged by the cajas.

La Caixa and Caja Madrid have a huge presence in the Spanish market and enjoy ratings on a par with the soundest of international banks. La Caixa, for instance, is rated AA- by S&P, whose Spanish analyst Elena Iparraguirre highlights the bank’s robust retail banking franchise, strong management, successful strategy, sound capitalisation and financial flexibility.

“La Caixa’s transformation since the mid-1990s has been amazing,” she says. The bank’s growth strategy has enabled it to become “an indisputable leading nationwide player, holding a 10% market share”. La Caixa’s chairman, Isidro Fainé is, on record, forecasting profit growth of 10% to 15% this year despite market uncertainties.

Schroders’ Mr Burns expresses some concerns over the sector. “What we still don’t know is what is happening in the savings banks sector, which is very opaque,” he says. “There is speculation that the cajas loaned a lot of money to the property sector and there could be a few surprises on that front.”

Macroeconomic picture

For Luis de Guindos Jurado, executive chairman of Lehman Brothers for Spain and Portugal, the bank story is closely linked to the macroeconomic picture. “There has been a convergence of three imbalances in the economy,” he says.

“We have seen inflated property prices, a loss of competitiveness due to the inflation differential and, worst of all, a spike in the level of personal and corporate indebtedness. Household debt is roughly 150% of income and corporate debt is well above net income.

“Spain’s current account deficit, at 10% of GDP, is the highest in the developed world, while the net debt is 70% of GDP. Hence Spain has had to borrow the equivalent of about 20% of GDP in the international capital markets every year to finance growth and repay debt. These funds were mainly provided by the banks, but given the low savings ratio of the Spanish economy, almost 30% of the banks’ funding was obtained in the international capital markets.

“Given the recent shutdown of these markets, Spanish banks have been forced to reduce retail lending drastically. Loan growth was about 25% a year during the past four to five years. This is likely to fall to 5% or 10% now, and it is going to have an impact on the bottom line of financial institutions.” Spanish banks outperformed their European competitors by 12% last year. However, this slipped dramatically to 4% underperformance in the first two months of 2008, a trend that some analysts believe could worsen as the year progresses and the market starts to focus on the challenging conditions that lie ahead in 2009.

Concerns grow

“Fundamental concerns with regard to the Spanish banks are now greater than ever before,” says Mr Van Rooyen. The banks are facing declining volumes, margin pressure and a sharp rise in non-performing loans, all of which will have a negative impact on bank earnings. “These issues combined form a toxic cocktail that the Spanish banks will have to swallow in 2009,” he adds.

These negative factors have yet to flow through to the bottom line and for now, the banks are talking optimistically about coming through the crisis unscathed, some more convincingly than others. BBVA, the country’s second largest bank, is confident that its E60bn-plus war chest, reputedly the most sizeable in the eurozone, will see it through the lean times ahead. Other banks are building up significant assets to use as collateral to access ECB credit over the coming months.

“There is a sense that a new deck of cards has been dealt and that we’ve been given a pretty good hand,” says Ignacio Muñoz-Alonso, BBVA’s head of corporate and investment banking, Europe, the Middle East and Africa.

“The banking community is going to exit this crisis in a very different way from the way it entered. BBVA has an opportunity to exit the turmoil in better shape than our competitors. Our capital base is almost untouched and we are one of the few net lenders in the interbank market. We were fully funded for months ahead from last April to the end of 2009 and there is no sense in the bank of tension or cash constraints.”

No subprime impact

Carmen Muñoz, an analyst at Fitch Ratings, points out that there is no direct or indirect impact on the Spanish banks from the subprime crisis. “No losses have been reported as they have no SIVs or conduits,” she says. “A side effect could be Santander’s need to write down $1bn for its US bank, Sovereign, but this is more a stock market-related issue. However, year-on-year loan growth across the board has halved to 10% so the banks need to review their growth plans. They are trying to re-focus towards the small to medium enterprise (SME) sector.”

Mr Muñoz-Alonso says that BBVA is putting strategies in place to enable the bank to deliver strong growth through to 2010, despite the current turbulent conditions. One leg of this strategy is geographical expansion in areas that play a natural hedge vis-à-vis the downturn, namely the Middle East and Australasia. “We are planning an aggressive expansion in these regions in key products such as project finance, corporate finance, some forms of sophisticated structured finance and derivatives,” he says.

BBVA raised €32bn in the capital markets in the first half of last year through securitisations and the issue of covered bonds, senior debt and regulatory capital. The operations were highly praised by sell-side and buy-side analysts. BBVA’s relative financial strength was recently acknowledged by Standard & Poor’s, which upgraded the group from AA- to AA, putting in on a par with its larger arch-rival, Banco Santander.

Relative strength

S&P justified its upgrade on BBVA’s “more robust performance than that of its European peers for strong local franchises, increased diversification, resilient asset quality, prudent management and reduced exposure to equity holdings”. The agency expects BBVA will continue to outperform, particularly in its two main geographic exposures, Spain and Mexico.

Foreign banks still find Spain a highly attractive market with strong growth potential. The economy will suffer this year but it will be coming off from a very high level and still show robust growth well above the EU average. “We haven’t made any changes to our expansion plans for this year,” says Carlos Martínez de Campos, president of Barclays España, which has the largest foreign presence in Spain.

“In retail banking it is quite important to maintain continuity and not get caught in a stop-go situation. We are now Spain’s sixth largest bank with 500 branch offices and we have no intention of slowing down our growth. We are using other products to take up the slack from the slowdown in residential mortgages.”

Branch opening

Leo Salom, Barclays’ CEO of global retail and investment banking for western Europe, says that the bank is rapidly increasing its distribution footprint in the Spanish market. He acknowledges a coming slowdown in consumer activity but says the bank remains committed to opening almost 100 sites in Spain this year.

“Our ambition transcends being in the middle-tier category,” says Mr Salom. “The focus is on segments such as the affluent client and our card business, as well as building a stronger franchise in the SME sector.

“There will be a slowdown in the mortgage business, which means there will also be a greater strategic focus on traditional investment and deposit products, as well as on certain insurance products. The biggest concern is the confidence factor. Spain is now suffering its first confidence crisis for 15 years and banks, as well as industry, need to provide ideas and solutions.”

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