Are Spanish banks' growth strategies hiding problems at home?
Aug 26th 2009 8:00AM
Updated Dec 4th 2009 12:39PM
Just as speculation about the health of the banking system in the U.S. seems to be quieting down, there's reason to believe that foreign banks -- particularly two Spanish institutions -- are about to go under the microscope, even as the pair snaps up assets in foreign countries.
Banco Santander (STD) and Banco Bilbao (BBV), with a combined market capitalization of $200 billion, must deal with double-digit unemployment in Spain and a bursting property bubble that threatens to wipe out shareholders, according to a research report from Variant Perception (via FT Alphaville). These two are also working on integrating disparate acquisitions.
Variant Perception argues that Spanish banks are taking advantage of latitude in loan accounting to hide losses, making them look healthier than they appear. Unemployment is already at 17 percent and rising, and over-building (loans to developers and construction companies comprise 50 percent of GDP), led to Spain having as much unsold housing as the United States, but with one-seventh the population.
Nonetheless, shares of Santander and Banco Bilbao have tripled from their lows this year, although short interest in Santander -- the number of shares sold short with the intention of buying them back at a lower price for profit -- has quietly crept up 50 percent as the stock has rallied.
The FT's Felix Salmon correctly notes, the situation in Spain is basically the same as what happened stateside: Real estate became a cash cow for speculators in beachfront building, until the party stopped.
I'd say that the important difference, however, is that Spain is tied to the Euro and can't take the same steps the re-appointed Ben Bernanke could with printing presses at his disposal. That will lead to a different kind of correction with more visible pain, as opposed to the U.S. path of subsidizing and trying to reinflate asset prices, which better hides the true costs. And, since the magnitude of the price increase in Spanish property was more than double that of the U.S. between 2000 and 2008, there's going to be plenty of pain.
Variant Perception adds that the correction in prices has been only a 10 percent decline from the peak, and that banks are aggressively extending credit to borrowers in an attempt to prop up demand. By offering loan terms like 100% loan-to-value ratio and a 40-year term, or shelving repossessed property at a subsidiary, the losses can be hidden for a time.
But if something can't go on forever, it won't, or so the saying goes. And Spain's two largest banks seem to be running from the problem rather than buckling down to face the storm brewing at home.
Santander, for instance, has been buying back its hybrid equity at a discount and refinancing at much higher interest rates. This results in a one-time, up-front gain, but at the cost of higher interest expense in the future, since the new coupon rate offered is 10.5 percent. That's not exactly a sustainable strategy, or cost of financing.
Although Santander is an internationally diversified bank and its future is tied to more than the Spanish economy, it is leveraged at 27 times its tangible equity. If you exclude deferred tax assets, the leverage ratio approaches 55 times. The 11 billion Euro (19.9 percent) increase in shareholder's equity in the last twelve months is more than offset by the growth of intangibles (10.3 billion Euros) and deferred tax assts (+7.2 billion Euros).
In other words, as Santander has expanded the asset side of its balance sheet 25 percent in the last year, it has become more levered and the quality of the underlying equity has decreased.
A similar plotline has been seen before with American banks, and the rescue kit available to them is not in the hands of the Bank of Spain. If the Spanish banks were to run aground, it could be a test of strength for the Euro's durability, and demonstrate the value in maintaining the dollar's position as the global reserve currency.
James Cullen edits and writes at CollegeAnalysts.com. He has no personal position in the stocks mentioned above.