Hot New Spanish Model… for Banking
by Tony D’Altorio, The Investment U Research Team
August 2009
There’s a hot new Spanish model that has everyone in Europe going ga-ga.
No, it’s not a runway or swimsuit model. It’s Spain’s banking model.
The Bank of Spain forced Spanish banks to follow a very conservative banking model using what they call “dynamic provisioning” requirements. These requirements forced Spanish banks to build reserves during the good times. This left the banks with capital to draw upon which is helping them survive the downturn.
The Bank of Spain also restricted local banks from piling into mortgage securities. And Spain has a small credit-card and commercial property market which limited risk exposure for the banks. But the banks did their part too. They focused on the retail market rather than risky investment banking, as did their American counterparts.
This new ‘hot’ model from Spain definitely offers profit opportunities for investors in the banking sector.
The Big Banks
So despite the collapse of the Spanish construction boom (a bubble), the country’s largest lenders – BBVA (NYSE:BBV) and Banco Santander (NYSE:STD) have so far proved resilient. They reported first half profits of 2.8 billion euro and 4.4 billion euro respectively.
A rise in bad loan provisions helped cause their earnings to slip 4 percent compared with 2008. Even then, Santander’s bad loans were 2.8% of its book and BBVA’s bad loans were 3.2% of its book. Both figures were well below their peers’ 4.6% average.
Both banks are well capitalized because of the “dynamic provisioning” requirements. They have written down or restructured their exposures to real estate developers, residential mortgages are well-capitalized, and both banks have a comfortable amount of provisions to fall back on.
It is no wonder that EU regulators are planning to adopt the “Spanish model” of banking throughout Europe. Investors who are looking to invest in the banking industry should look across the Atlantic and fall in love with a Spanish model.
A Globally Diversified Banking Leader
Banco Santander (NYSE:STD) is Europe’s largest bank by market capitalization and the third largest bank in the world in terms of profits. Santander has a banking empire with 14,000 branches in 40 countries, with an emphasis on three key geographic areas – Europe, the UK, and Latin America.
Profits for Santander have held up well as the bank has wisely steered clear of subprime or toxic assets and risky derivatives.
First half profits for the bank declined by over 4% year-on-year. However, this year-on-year comparison was distorted by a number of factors. The positive impact of Santander’s integration of their UK acquisitions – Alliance and Leicester, Bradford and Bingley – was offset by the drag from the consolidation of its U.S. acquisition – Sovereign Bancorp.
Santander also suffered losses in their Mexican operations. Mexico, of course, is in a deep downturn because of their close economic ties to the United States.
In most markets, Santander benefited greatly from a wide spread between the costs of deposits and the interest charged on loans. Therefore, net interest income for the six month was up about 25%.
Santander and Brazil
A major part of Santander’s corporate strategy is to buy and fix troubled banks. That was the plan when Santander bought the Brazilian bank two years ago from ABN Amro. Santander chairman, Emilio Botin, identified the Brazilian operations as a key piece in the bank’s overall strategy. Plans were revealed last year for it to become the most profitable listed bank in Brazil. Then Santander gave the bank its turnaround treatment.
Santander’s Brazilian arm is currently tied for third place with Bradesco for market share of domestic deposits. It also boasts a 14 percent market share in Brazil for loans. The unit, which contributed about a fifth of Santander’s first half profits, earns fat loan spreads of more than 16 percent.
Banco Santander has announced that they intend to offer a 15% share in the rapidly expanding Brazilian operation – Banco Santander Brasil – through an initial public offering (IPO) in Brazil.
Brazil’s two largest private banks – Bradesco and Itau Unibanco- trade on an average trailing price to tangible book multiple of 2.8 times. Therefore, most estimates for the valuation of the initial public offering of Santander’s Brazilian arm are in the $30 billion range.
Quite a nice payday for Santander!
The profitable payday from the upcoming IPO of their Brazilian arm is making Banco Santander even more attractive as an investment. And during this financial crisis, Santander is the most profitable bank in the world outside of China. The company’s net income will top the combined profits of the three largest U.S. banks last year.
Banco Santander is trading relatively cheaply at 1.9 times 2009 forecast book value and with a single-digit PE ratio. The stock also pays a decent dividend with a yield of about 4%.
So despite problems in the Spanish economy, Santander has been very successful by keeping their focus on a simple and conservative retail banking business strategy. And it is taking this cost-consciousness around the world. When the global economy recovers, Santander should continue to benefit from its geographic diversity and strong capital structure, and so will investors who bank on it.
Good investing,
Tony D’Altorio
Related Investment U Articles:
- Why You Should Bank on Banco Santander
- European Sovereign Debt Contagion Continues to Spread
- My Big Fat Greek Deficit
- Brazil Points to a New Sovereign Debt Story
- The Biggest Tech Trend in Brazil
2 Responses to “Hot New Spanish Model… for Banking”
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strange, a bit of a paradox, if Bank of Spain has such a great model, why is Spain in the worst recession of all of Europe?
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Great Story, glad to here Brazils Economy is doing so well and they were smart about their banking system. Great model for the rest of the world…
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