Banco Santander: Don't worry about the pain in Spain.
Banco Santander, ADR (STD) is a multinational Spanish banking conglomerate, being the largest bank in the Eurozone, and one of the largest banks in the world in terms of market capitalization with close to 14,000 branches worldwide. It has lost about 22% of its value year to date; now bouncing around 5.5 dollars a share, a low that has not been tested since the height of the 2009 financial meltdown.
It certainly has some problems, as any bank in Spain does, but it is relatively well positioned when compared to its Spanish rivals. In fact, Groupo Santander posted a quarterly record for pre-provision profit of 6.280 million euro, or impressively $8.133 million. This alone suggests that STD is capable of producing revenue in a troubling environment. Unfortunately, Santander was forced to set aside a considerable chunk of pre provisions profit in expectation of future loans going sour, leaving Santander holders with earnings per share of only 22 cents, down from 31 cents the previous quarter. A significant portion of the provisions went to cover non-performing loans in Spain.
As can be seen below, Santander's earnings are well diversified. The largest contributor to group profits is Brazil, followed by Mexico and the United Kingdom. Spain alone is responsible for 12% of the group's profits as can be seen in the below graphic from Santander's most recent quarterly report.
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The diversification is all well and good, but the real question is whether or not Santander's stock price has fallen relative to its intrinsic value and farther than its peers. Santander's cousin, Banco Bilbao Vizcay Argentaria (BBVA) has fallen 32.72% from February 22nd, while Santander has fallen 32.93%. BBVA counts Spain as a major contributor to its profits, accounting for 25% of them, compared with 12% for Santander. Additionally, in the final quarter of 2011, BBVA had a Non Performing Asset Ratio of 4%. For every 100 loans the bank made, 4 defaulted. STD, on the other hand, had a non performing loan ratio of 3.98%.
Two basis points might not seem like a significant difference, but when your balance sheet is greater than a trillion euros that .02% ads up. Additionally, Santander has a lot of assets outside of the periphery and even outside of the Eurozone, which it could sell to raise cash if it ever needed. An interesting play would be to short BBVA or another Spanish bank while going long STD, expecting the spread between price performance to increase.
As can be seen below though, Santander's stock price has fallen drastically, even as the book value of the company has remained relatively stable, while revenue has risen. The intense provisioning for non-performing loans has essentially hidden the earnings power of Santander. Santander's loss provisions will likely continue in the near future as Spain's real estate market returns to a healthier, less inflated, equilibrium. At the height of Spain's property boom one in seven workers were directly tied to the housing sector.
Additionally, the Spanish economy was adding one new house per man woman and child that entered Spain. The expectation is that Santander will likely have to continue writing off loans until the Spanish real-estate market stops contracting. The precipitous decline of STD, relative to book value and revenue is astonishing, suggesting that the market has priced in even the worst of events for Santander. The below information is collated from Santander's past performance reports.
The euro area crisis has obviously depressed STD's stock recently, but it has provided the company with great opportunities for acquisitions. Allied Irish Bank (AIB) sold its 70% stake in a Poland's Bank Zachodni WBK to Santander for 3.1bn euros. AIB was short on capital, and now Santander has a majority stake in one of Europe's economic bright contributing to 4% of Santander's profits.
Additionally, within Spain, Santander is seen as a healthier institution, especially compared with the notorious Bankia. As depositors flee riskier banks, some of the deposits will flow into the healthier banks, bolstering their comparative advantage.
There is some risk for American holders of the ADR, as the euro might continue to devalue. One would expect that if the stock stays steady but the euro drops 10%, the value of the ADR will drop 10%, and so will all future dividends. This would be true for a company that was operating entirely in the Eurozone. Santander, as a global diversified bank, does not. Continental Europe, excluding Poland, makes up 21% of Santander's profits. The rest is well diversified across geographical regions, mitigating the exchange rate risk.
Additionally, there is worry about the health of Spain's central government. 10 year Spanish Bond yields rose briefly above 6.60% the other day, with the German/Spain spread reaching all-time highs. Through the European Central Bank's LTRO many European banks borrowed money from the ECB to purchase sovereign bonds, Santander among them. If Spanish yields continue to rise, Santander and other banks will be forced to take capital losses on the bonds they hold, further hurting earnings.
There is a real risk that yields will continue to rise, but they won't be rising too high. The ECB has stepped in multiple times throughout the crisis to suppress peripheral yields and would likely step in again. It is hard to imagine large multinational banks helping the ECB suppress yields without an implicit or explicit guarantee that bond yields would not be rising too high any time soon. It is likely we will see a continuation of the below cycle as illustrated by David Einhorn.
It is unlikely that there will be a massive and disorderly breakup of the Eurozone. A more likely scenario is a continuation of the "extend and pretend" while Germany slowly acquiesces to more ECB involvement as the peripheries continue down the road of structural adjustment. The ECB has much more room to get involved in the sovereign market. The Federal Reserve has bond holdings that equate to a little less than 16% of the USA's GDP, while the Bank of England holds bonds equivalent to 14% of the United Kingdom's GDP. The ECB holds bonds equivalent to 1% of GDP, though this does not include sovereign bonds pledged as LTRO collateral.
Disclosure: I am long STD.