With one of the highest exposures to the real estate sector and a large proportion of wholesale funding derived from the securitisation market, Spain is being hard hit by the credit crisis. However its largest banks look well set to weather the storm. William Thornhill reports.
The Spanish economy has ground to a halt. After a 13 year stretch of continuous growth, second quarter GDP slowed to a paltry 0.1% quarter on quarter (QoQ), led by the construction sector, which contracted by an eye-watering 2.4% QoQ.
With the worst yet to come, banks will be looking to batten down the hatches. Domestically, the emphasis is on what areas to invest in, rather than prioritising which business lines should be cut, and by how much. "Right now we are playing very defensively" said Carlos Stillianopoulos, head of origination at Caja Madrid. It is hard to imagine any bank, Spanish or international, acting differently.
Nonetheless, those that have a global reach, like Santander, have been very active over the past year. Since the onset of the crisis it has acquired Banco Real in Brazil for €11bn, sold Antoveneta in Italy for €9bn and acquired consumer finance assets like GE and RBS. It has also launched a recommended offer to buy the UK mortgage lender Alliance & Leicester.
Besides its acquisitions, the bank has also intensified credit monitoring procedures, said the global head of credit at Santander, Ignacio Domínguez. Because the amount its Spanish clients can borrow is now more limited, "in some respect we are a global bank and our clients in Latin America (Brazil and Mexico) and Europe (Italy and France) have compensated,” he said.
Yet Santander’s modus operandi has not changed that dramatically. "We do deals with the names we know well and in that respect there is little need to shed risks, as the ones we have are the ones we want to keep," Domínguez added.
In fact, with its massive balance sheet, Santander is now well placed to capitalise on the less crowded competitive landscape. “18-months ago global corporate lending was much more competitive," Dominguez said. "Now many of our competitors have disappeared, so this crisis has presented [us] with an opportunity to gain ground."
Santander is playing a senior role in some major loan syndications with its bigger clients, including Gas Natural, BHP Billiton and Inbev. It also has two to three other large deals in the pipeline that are likely to be announced over the course of this year.
Funding sorted
Yet this is not the main problem: "The main issue we, and all other international financial institutions are having right now, is funding," said Stillianopoulos.
After setting up an MTN programme for the first time, Caja Madrid has issued close to €2bn in private placements this year, along with several senior unsecured deals amounting to nearly €3bn. "All in all we have done close to 80% of our funding this year, it hasn’t been easy, but we can still raise money," Stillianopoulos added.
Caja Madrid is a net lender in the interbank market, to the tune of €4bn. It has €10bn deposited with the Bank of Spain, available to be pledged as ECB repo collateral in case of emergency. Since its funding need for the next 18 months is €12bn, it has secured its requisite near-term foreseeable liquidity needs.
Caja Madrid also has a formidable retail funding platform, something that has done much to support its Double A ratings. "Liquidity is mainly supported by a stable retail deposit base, which accounted for 54% of total lending," Fitch said, recently. Like many banks across Europe, Spanish institutions have sought to expand their retail franchises, something that Santander – Spain's largest bank – had started to do well before the crisis broke out.
Its efforts have been most noteworthy in Spain, particularly through its “we want to be your bank” programme, which provides free banking services to linked customers. But the Santander Group has also embarked on many comparable projects elsewhere, to bring new participants – both individuals and SMEs – into the banking system for the first time.
Moreover, the firm has raised €18bn in medium and long-term debt during the first half of 2008, according its CFO, Jose Antonio Alvarez, putting the bank “on track” in terms of its funding for the year. Santander has between €35-50bn in high-grade asset-backed instruments and other debt that can be used as collateral for discounting at the ECB, he said, although it has not used this facility, since it can finance itself more cheaply in the market.
In July this year Santander increased the size of its CP programme to €25bn – an increase of €10bn. It is negotiating the sale of its Banco de Venezuela unit in Venezuela, and has said it is exploring options for the sale of its asset management and insurance units.
Santander remains a hugely profitable bank: in marked contrast to US investment banks, it recorded a stunning 22% year-on-year rise in first half 2008 profits to €4.73bn, excluding capital gains. European profits stood at €2.4bn, while LatAm profits reached US$2.2bn.
NPLs soar from low base
These stunning results came against a background of sharply rising non performing loans (NPL), which rose to 1.34% in the first half of 2008, from 0.83% in the first half 2007.
According to Ahorro Corporación Financiera (ACF) equity research, the rise in NPL's across the Spanish banking sector is a major issue; it identified an average increase in the NPL ratio of almost 50% in the second quarter versus the first. Loans to real estate developers comprise 16% of banks' lending portfolios, ACF said, with as many as a quarter of these estimated to be at risk. The Spanish savings bank association (CECA) believe NPLs will rise to 3% this year and 4% next year. Yet, despite the expectation of a sharp rise, that is well below the 6.35% average across Europe.
Caja Madrid also reported a steep rise in its NPL ratio in the second quarter to 1.89% from 0.52% a year earlier. Yet the bank remains sanguine: "We have come up from a very low level and whilst this is likely to increase, it's not a major worry for us," Stillianopoulos said.
The rating agencies seem to see it differently. Fitch and S&P put the outlook for firm's Long Term Issuer Default rating to Negative from Stable. Fitch cited "challenges faced by Caja Madrid to manage high risk concentration in the construction and real estate sectors, particularly in individual names, in a significantly slower economic environment and housing sector in Spain."
The headline grabbing, major, individual name Spanish failure this year was the insolvency of real estate firm Martinsa Fedesa, to which Caja Madrid had a €1bn exposure. It has provisioned €250m against it. Stillianopoulos conceded that this firm proved "one of the most difficult to refinance," but added that, since other important deals have already been refinanced, another failure of this size was not expected. Nonetheless, he said smaller developers are likely to encounter problems.
On a positive note, Caja Madrid's underlying profitability ratios remain sound, underpinned by "good levels of SME and corporate lending, supported by its solid retail franchise, particularly in Madrid, and active management of its net interest margin," Fitch said. At 51% for 2007, its cost/income ratio is good, Fitch added.
The banks with the greatest capacity to meet higher provisioning requirements resulting from the increase in NPL ratios are BBVA, Santander and Popular, said ACF equity research. These banks have operating margins over loans ratios that are far higher than other Spanish banks.
Being the second largest Spanish bank, BBVA is also diversified and large enough to weather the storm. Alongside Santander, it has been one of the few Iberian players not to have been put on analysts sell recommendations. "BBVA offers an attractive combination of higher-than-average growth and undemanding earnings multiples," said equity analysts at Fox-Pitt. The firm is particularly well positioned to capitalise on its 27% market share in Mexico, where GDP is almost the same as Spain, but where growth potential is significantly greater.
Overall BBVA recorded a near 5% rise in profits year on year in the second quarter 2008 at €1.486bn, largely driven by a 20% rise in trading. NPLs rose 40% from the first quarter and were more than double the previous year.
BBVA Group delinquencies rose 14% in the second quarter from the previous, and rose 44% from a year earlier to give a NPL ratio of 1.15%. But NPL coverage fell more sharply than expected, from 185% to 142%, which the bank said was due to its retail lending franchise, as opposed to SME exposure.
Despite this evidence of deterioration, the major Spanish banks would seem to be well capitalised to weather the ongoing credit crisis, which Domínguez predicted will prove quite long-lasting. “I don’t believe the consequences of the credit crisis will be transitory,” he warned. “The market will take 3-5 years to adapt to the new environment."
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