Improbable as it may seem to some, the Spanish economy is out of the emergency ward and on the mend. That should be good news for the country’s biggest bank, Santander (LSE: BNC) (NYSE: SAN.US).
Of course, we’re not talking about a miracle resurrection — the patient has not ripped off his oxygen mask and hot-footed it out of the hospital to do 50 laps in the local swimming pool.
He is, however, brightening up, eating solid foods again, and taking short walks in the garden. Metaphorically speaking!
Why investors are looking to Spain
In short, there’s enough green shoots to tentatively vindicate those of us who argued 18 months ago that — barring a full-on collapse of the Euro — things probably wouldn’t get much worse and might actually get better.
After a long recession, the country turned the corner in the third quarter of 2013 with positive GDP growth that some dismissed as a blip. Fourth-quarter GDP growth of 0.2% showed it wasn’t, however, and just this week Spain’s economy minister said the government expects the next quarterly GDP figures to be “at least the same”.
Three quarters of growing GDP is a trend in my book. And I think there’s every reason to think the strength could continue, as I believe growing confidence should see more of Spain’s massive black economy go legitimate, bringing much needed revenue to the country’s tax coffers as well as boosting the official statistics.
There are positive signs in the crucial housing market, too. While there’s no firm data yet pointing to a solid upturn, anecdotal reports from estate agents and the like suggest things are at least not getting much worse. Prices are down at least 40% since 2007, so you’d hope so!
One sign that this isn’t just self-interested propaganda from people with proper to sell is that foreign investors are starting to put money to work in the sector. Renowned hedge fund managers John Paulson and George Soros have backed Hispania, a soon-to-be-listed Spanish property fund that’s expected to raise 500 million euros. Soros has also joined his fellow billionaire Bill Gates in FCC, a survivor of Spain’s troubled construction sector that should do well if Spain continues to recover.
Spain is a sleeping giant for Santander
All this positivity could be very good news for banking giant Santander.
The bank has had to take massive charges in recent years against its Spanish assets, which crushed its earnings. Pre-tax profits fell from €12 billion in 2010 to just €3.5 billion in 2012, before recovering to €7.3 billion in 2013. In total, the bank set aside €65 billion against its global asset base and in boosting its capital buffers over the five years of the crisis.
If Spain truly is recovering, however, then not only could the rot in Spain have stopped – it could start to reverse.
Spanish loans account for 24% of all Banco Santander’s net loans to customers, and the percentage of non-performing Spanish loans has been steadily rising. Huge provisions were made against Santander’s domestic asset base.
This hasn’t just dented the value of those assets – it has also fuelled that profit collapse I cited early.
Even in 2013, a better year for the bank, Spain generated just 7% of Santander’s attributable profit. That compares to 17% of total profit coming from its UK operations – more than twice the share as that from Spain, even though UK loans at 34% of Santander’s total are only a third or so more valuable on its books.
If the Spanish loans stopped deteriorating and became as profitable as those UK loans, shareholders would enjoy a double whammy of rising profits from the Spanish assets, and also eventually writebacks that increased the carrying value of its Spanish loans.
Costa comeback
Looking to Spain for good news for Santander from here would be quite a reversal.
For the past few years you’ve had to look at its global operations to understand the bank was not a one-way bet on the troubled peripheral country. Now a recovery in that country could augment profits from elsewhere – or even to offset any further weakness in Santander’s enormous Latin American operations.
With the shares still boasting a dividend yield of around 9%, I think it is well worth considering Banco Santander as a short-term play on Spain continuing to get better, as well as for the company’s longer term attractions as a global banking behemoth.
