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Why I Would Sell Barclays PLC But Buy Banco Santander SA

Last month, one City fund manager announced that Barclays (LSE: BARC) was uninvestable due to the sheer volume of legal issues facing the bank.

Only a few weeks later, the manager’s view was vindicated. Barclays was ordered to pay a settlement of £1.5bn after the bank was found guilty of manipulating the foreign exchange markets.

Unfortunately, this won’t be the last fine Barclays is going to be forced to pay.

And with this being the case, I’d argue it could be wise for investors to dump Barclays and buy Santander (LSE: BNC) instead.

Misbehaving

Barclays’ reputation has shot to shreds during the past five years, as lawsuit after lawsuit has been filed against the bank.

One such suit currently going through the courts is a demand from US regulators, who are seeking $488m in compensation from the bank following allegations that Barclays manipulated trades on electricity contracts across the US.

Further, some reports from City analysts suggest that Barclays could be facing another $1bn in fines related to the recent foreign exchange market manipulation case.

Additional provisions for mis-sold payment protection insurance could set the bank back another £600m, while miscellaneous legal costs have the potential to add another £800m to Barclays’ legal bill.

Overall, one set of analysts has estimated that Barclays could be facing an additional £3bn of conduct costs during the next two years.

Holding back growth

These rising legal costs are holding Barclays back. Including the estimates above, the bank will have paid out more than £15bn in fines settlements, and other charges, since 2009.

That’s around a third of Barclays’ current market cap. If the bank returned the same amount of cash to investors, shareholders would be in line to receive a one-off dividend payout of around 89p per share.

Additionally, investors need to consider the effect that Barclays’ “bad bank” is having on group profitability.

Barclays is using its bad bank to dump unwanted parts of its business including parts of its fixed income, commodities, and trading operations as well as retail banking units in Spain, Italy, France and Portugal.

However, as the bank sells off non-core assets, it is having to take some losses. Losses from Barclays’ bad bank division cost the group £1.2bn during 2014, around 22% of group pre-tax profit.

Brighter outlook

Santander is one of the few global banks that behaved itself in the run-up to the financial crisis. While the bank may have been forced to pay some small fines, on the whole Santander has avoided much of the regulators’ wrath directed at banks since 2009.

And without a wall of legal worries facing the bank and its management, Santander should outperform Barclays during the next few years.

First-quarter results are a great indicator of the two banks differing outlooks. 

Specifically, Santander’s first quarter 2015 profit jumped 32% year-on-year. While Barclays only managed to report adjusted pre-tax profit growth of 9% for the period, legal costs wiped out impressive growth at the bank’s UK retail and investment bank arms.

Primed for growth

While Barclays concentrates on its legal issues, Santander has been able to focus on its growth strategy. The bank recently raised €7.5bn through a share sale, some of which will be used for select acquisitions. It’s rumoured that Santander could be looking at HSBC‘s Brazilian business, too. Moreover, the bank is looking to increase its lending to customers by around 30% by the end of the decade.

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