Spain's banking sector is in rude health after a busy year in which its leading players have striven to put their Latin America-related problems behind them. Subordinated debt transactions that have improved capital ratios and strategic share sales have been the key techniques. Neil Day reports.
Reflecting on the release of Banesto's third quarter results in early October, fixed income analysts at Morgan Stanley could hardly contain their enthusiasm for the credit and the Spanish banking sector: "The Spanish banking system has in general proven to be more attractive than initially expected, with margins actually improving!"
Although more measured, Standard & Poor's painted a similar picture when it released its annual bank risk analysis for the country a week later. "The Spanish banking system stands among the healthiest in Europe," wrote the rating agency's analysts.
A year ago the outlook had been much less rosy, as Latin America cast a shadow over Spain's two largest commercial banks. Banco Bilbao Vizcaya Argentaria (BBVA) and Santander Central Hispano (SCH) had between them invested, according to S&P, more than $25bn in Latin America during the 1990s. With Argentina in crisis, fear of contagion high, and the election of the left wing Luiz Inácio Lula da Silva in Brazil in October 2002, their exposure to the region was worrying. Latin American subsidiaries represented 33% and 44% of SCH's assets and net attributable profits, respectively, at year-end 2002, and 29% and 25% of BBVA's.
With BBVA's exposure to the region lower than its peer's and concentrated in the relative calm of Mexico, SCH was the main victim of the circumstances.
One year on, both banks have ridden out the storm. SCH was downgraded by Moody's from Aa3 to A1, but is now on positive outlook with the rating agency and also at S&P, which rates the bank A. BBVA, meanwhile, succeeded in retaining its Aa2/AA- ratings throughout the past 12 months.
Credit analysts are quick to pay tribute to the banks, particularly the way in which SCH dealt with its problems rather than waiting for them to go away.
"SCH stands out in that it has done the most to improve its capital ratio," says January Streeter, a credit analyst at Dresdner Kleinwort Wasserstein in London. "This was a key area of concern following the bank's several acquisitions in recent years, but a number of initiatives including reducing equity holdings, has helped rectify the situation. A year ago core capital was around 4.5%, but now it is close to 6%."
Streeter says SCH is now well positioned to cope with any renewed Latin American crisis. "Sentiment towards Brazil has improved, but in my view the country is still vulnerable to further economic deterioration," she says. "At the moment Lula is trying to balance a lot of initiatives and although everything is fairly stable right now, that could always change. Overall, however, SCH is in a better position to absorb any losses than it was a year ago."
SCH's actions to remedy its problem were on two fronts: cutting its exposure to Latin America and strengthening its balance sheet. The former was most directly achieved through the sale of most of its holdings of Brazilian government securities, which had totalled over Eu15bn.
To strengthen its balance sheet, SCH last November sold a 12% stake in subsidiary Banesto, raising Eu730m, and a 3% stake in Royal Bank of Scotland for £1.3bn. The combined Eu2.6bn lifted the bank's core capital from 4.4% to 5.4%, just shy of its year end 2002 target of 5.5%.
|Spain's largest banks|
|Bank||Assets (Eu bn)||Tier 1 ratio||Ratings (M/S&P)|
|Source: Standard & Poor's, data from year end 2002|
"Our capital base has always been among the strongest in Europe," said a spokesperson for SCH at the time. "With these two deals, our core capital ratios are stronger than the likes of Deutsche Bank and UniCredito Italiano."
The improvement in SCH's capital strength has been reflected in its spreads. The bank's 6.375% 2010 BSCH Issuance Ltd subordinated paper had tightened from 187bp over Euribor in mid-October 2002 to 46bp over by mid-October this year.
Streeter expects SCH to be upgraded before the end of the year. "I believe the rating agencies are just waiting to see sustained earnings and to make sure that SCH has provisions under control," she says, "otherwise we should see an improvement in their ratings by the end of the year."
BBVA's bonds have enjoyed a similar rally. BBVA's 6.375% 2010 sub debt has rallied from 132bp over to 31bp over in the same period. José-Luis Dominguez de Posada, director of funding at BBVA, is pleased the bank's credit quality is being more properly reflected.
"The market is recognising our ratings," he says. "If you take you the ratings of the European banks, especially the continental ones, you will see that our Aa2/AA- ratings are not very common.
"The market had at one time certain doubts about our position in Latin America, but we were able to explain how our exposure to the region was concentrated in Mexico, and the proportion of this exposure to Mexico in comparison with our balance sheet."
BBVA took advantage of the improvement in sentiment in July by launching its first subordinated issue for two years. Barclays Capital, BBVA and HSBC priced the Eu600m 10 year non-call five lower tier two floater at 38bp over Euribor.
However, Dominguez feels that the bank is still being unfairly penalised for its Latin American risk. "We still suffer the consequences of our presence in Latin America," he says. "We have approached other banks with our ratings, but we are not yet fully in line."
Preparing for the future
Away from Latin America, the two main risks in the Spanish banking system are whether lending, particularly for real estate, can continue to grow at its recent rapid pace, and the large equity holdings of banks.
S&P's analysts, like others, believe Spanish banks are well positioned to cope with any economic slowdown and associated deterioration in their assets, but they nevertheless highlight the risks: "The ongoing increase in private sector leverage - despite the economy mildly slowing down - and the accelerating rises in residential property prices, are perceived by S&P as factors that increase the vulnerability of the Spanish financial institutions to potential increases in interest rates and/or unemployment, and to a sharp correction in housing market prices."
And while BBVA and SCH have been reducing their equity portfolios - the value of which had anyway been cut by the fall in equity markets - concerns remain about a rise in holdings elsewhere. "Despite the gradual reduction of these portfolios by the two largest Spanish banking groups over the past few years, the trend of increasing investments in permanent equity stakes by savings banks - notably the build-up of large portfolios relative to mid-size entities' capital - increases the overall risk of the Spanish banking industry."