It’s Time To Dump Banco Santander SA And Buy Barclays PLC As Eurozone Troubles Return

The Eurozone crisis is once again back on everyone’s mind, as the economies of Italy, Greece, France and even Germany start to slow. Unfortunately, this time around the European Central Bank has not been able to calm markets and the yields on Greek and French bonds have risen to levels not seen for months as investors jump ship.

What’s more, debt right across the European economic block remains at unsustainably high levels and frosty relations with Russia are not helping matters. It’s now expected that Europe will fall into recession once again — bad news for banks that operate within the region. 

A ESantanderuropean recession will hurt Santander (LSE: BNC). Despite the bank’s progress in cleaning up its balance sheet over the past five years, the group is still highly exposed to the region and is more than likely to feel the effects of any sustained economic contraction.

While Santander only generates around 26% of its income from Continental Europe, with Spain accounting for about 13% of group profits — not including Spanish non-performing loans — the state of the bank’s balance sheet is a concern. Even though management has made solid progress dealing with toxic assets since the financial crisis, risks remain.

Uncovering risk 

At the end of this month, on 26th October, the ECB will publish the results from its most rigorous set of stress tests yet. The tests, which are being carried out by the central bank’s regulator, the European Banking Authority, demand that banks must prove that they can withstand a simulated three-year period under stress.

DBarclaysuring this simulated three-year period, economic output will fall 2.1%, pushing unemployment to 13% and sending house prices down 20% on average. Additionally, the central bank is dredging through historic loans on the balance sheets of the banks under examination.

This process is intended to uncover any risky assets that have previously gone unnoticed. In total, it is estimated that over 160,000 credit files across the euro area will be examined by 6,000 auditors — this is not a small task. 

City analysts have already started to speculate about which banks will fail the tests and which will pass. Unfortunately, banks with equity tier 1 ratios of less than 10%, under the fully loaded Basel III rules, such as Santander and Barclays PLC (LSE :BARC), may be forced to raise fresh capital as a result of these tests. 

Moving quickly 

Barclays has sought to offset concerns that it will need to raise fresh capital by shedding assets. Specifically, the bank has set up a ‘bad bank’ to shift toxic assets off of its balance sheet. 

Barclays’ bad bank will eventually sell or run down £116bn of non-core operations, including £90bn of investment bank assets and of the group’s European retail banking operations. So far this year, a whole host of European banking assets have already been sold off. 

All in all then, after cleaning up its balance sheet Barclays looks to be a better investment than Santander.

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.