As so many banks implode as the credit crisis rolls on, few have held up as well as Banco Santander. Headquartered outside Madrid in its Santander City campus, the bank has led a bit of a charmed life through the turmoil; it has major shares in the Spanish and Latin American markets, and a has executed a significant growth strategy in the 2000s through acquisitions in the U.S. and Europe. The bank trades at a 30% premium to its peers--but it may have issues as a result of the Madoff crisis, which has allegedly left customers with over $3 billion in losses.  Why is Santander holding so well, and what’s in store for the future?  

On February 5, Santander reported $8.8 billion in profits, up 9.4% from 2007.  The profits came through despite over half a billion euros worth of losses from the Madoff fraud (Santander reserved over $650 million for it) as well as a further €6.14 billion in bad loan provisions, up 73% from the year before. 

Santander did take €3.57 billion in extraordinary capital gains in 2008, after its ABN AMRO takeover with Royal Bank of Scotland and Fortis. But unlike its deal partners, Santander remains independent, has needed no bailout funding, and is fiercely positive on its outlook. The company says it expects to earn roughly €2.2 billion per quarter. 

How come?

One big advantage Santander has over other banks has to do with Spanish regulators. They force banks to keep strong provisions and capital bases through good times as well as bad.  In 2000, Spain's central bank introduced dynamic provisioning, which forces banks to build up reserves against future, hypothetical losses. This is a model now likely to be copied by many other regulators to dampen the effect of cyclicality. 

At the time, Spanish banks fiercely resisted the regulation, as they thought it would put them at a disadvantage to non-Spanish banks. Instead, the rule has helped them better ride out the crisis. Santander’s core capital base rose by 98 basis points between 2007 and 2008, to 7.23%.

This is a critical point, therefore: Santander has a strong capital base.  However, it did need a €7.2 billion rights issue to reinforce capital in November, possibly because of rising bad loans.  They jumped by over 100 basis points in 2008, to 2.04% of the portfolio, possibly reflecting deterioration in the domestic and UK markets. 

In Spain, bad loans rose to 2.58%, which cost the bank €3.6 billion. Problem loans should keep rising as Spanish unemployment, the worst in Europe, increases.  Add to this the collapse of the Spanish property market, and loan defaults, along with corporate impairments, are likely to increase this year.

Notably, BBVA overtook Santander in Spain last year to become the country’s largest asset manager. Total assets industrywide assets under management in Spain contracted by almost 30% in 2008, following net redemptions of nearly €58 billion. 

Santander’s assets under management fell by 36% last year to €32.95 billion, compared to an 18% fall for BBVA Gestión to €33.2 billion. Some of Santander’s decline is attributable to the Bernie Madoff debacle.

Santander will give its Madoff investors €1.38 billion of preference shares in recompense for their losses.  These shares will pay a 2% annual dividend, and cost the bank €500 million.  Santander’s customers lost around €2.3 billion in the alleged Ponzi scheme, through the bank’s Optimal private banking arm. 

In the UK, Santander acquired Abbey, formerly a UK building society, in July 2004.  Abbey was one of the UK’s largest mortgage banks, and had thrived until poor management lost direction and profitability fell.  Santander has since acquired the savings business and branches of Bradford & Bingley in September 2008, as well as Alliance & Leicester, as a result of the 2008 banking crisis.

In total, this gives Santander a major share of the UK mortgage market. The company says its share of the UK mortgage market has grown to 30% in the last year.  

In 2008, Abbey increased its net mortgage lending by 28% to £11.1 billion, while profits jumped 21% to £991 million.  This brings Abbey’s mortgage balance to £121.5 billion, which rises to £159 billion when added to the mortgages from Alliance & Leicester.

Santander also now seems to also be targeting the U.S. with the acquisition this month of Sovereign Bancorp for around $1.6 billion.  This is Santander’s first entry into the U.S. markets and, as with its approach with Abbey, the bank is likely to leverage a prime mortgage book and branch network to build a base for growth. 

Overall, the outlook should be positive if Grupo Santander can manage the risks of its strategy.  The risks are that the Spanish market downturn might worsen, the UK mortgage market might deteriorate, and the bank’s Madoff investors might not accept the preference shares as a settlement.

What do you think? Let me know! 

Related:

German Bankers: Covering Up Their Own Black Swans?

The View From Europe: The Rise and Fall of RBS 

Chris Skinner is an independent commentator on the financial markets. He is the author of several books, including The Future of Banking, The Future of Finance after SEPA, andThe Future of Investing after MiFID. His daily blog can be found at www.theFinanSer.co.uk.