Spanish banking finds itself in a privileged position. Following the financial storm that shook the foundations of the great global banks last year, Spanish banks have shown resilience — thanks in part to a reserve system which, since 2000, has forced banks to put aside extra money to offset loan default risks. It appears that the crisis may already be history – or soon will be — for parts of the Spanish commercial banking sector, and perhaps for many of the world’s key economies, too. In early October, the International Monetary Fund raised its forecasts for world growth in 2010 by six tenths of a percentage point to 3.1%, noting that the end of the worldwide recession is in sight because of the strong economic performance in Asia and positive economic signals in many other parts of the world.
Still, the IMF has warned in its report, “Global Economic Perspectives,” that the recovery will be slow and that some countries – including Spain — will continue in recession during the coming year. The recession in Spain results largely from the abrupt end of the construction boom. Credit institutions, especially savings banks more exposed to the real estate sector, have suffered most during the crisis, leading them to reduce capacity through mergers, layoffs and office closings.
Nevertheless, Spain’s two largest banks, Santander and BBVA, have shown new strength with profits of €4.4 billion and €2.8 billion, respectively, during the first half of the year. The relatively good performance by these institutions during the crisis has enabled them to continue their policy of overseas consolidation, explains Mauro F. Guillén, director of Wharton’s Lauder Institute. “This is not the right time for big deals, but it is right for isolated, specific moves.”
Proof of that comes in the recent announcement by Santander that it will launch an initial public offering (IPO) for its Brazilian subsidiary, Santander Brasil. Those shares were to begin being quoted on the market on October 7 in New York and on October 8 in the Brazilian market. Santander Brasil, the result of the merger of Santander Banespa and Banco Real (acquired from ABN Amro in 2007) will open 600 new branches, about a third more than it now operates. The offering will involve selling about 16.21% of the shares of Santander Brasil.
According to Ignacio Galán Zazo, director of the Ibero-american management and corporate social responsibility department at the University of Salamanca in Spain, there is no doubt that the right time for expansion through foreign development opened up a year ago, when the fall of Lehman Brothers took place. “That was when the markets plummeted. The markets lost confidence, and the bearish strategists brought down stock prices around the world. Santander knew how to use this opening to enter the U.S. [it bought the 75% of Sovereign Bank that it did not control], and the United Kingdom [Bradford & Bingley, Alliance & Leicester] at the opportune time.”
When the markets recovered, those investments were worth triple the price they paid for them a year ago, he notes. Now, the best way to expand is through internal development. “In Brazil, an IPO is a very intelligent way to raise cash and obtain liquidity at a time when the markets have almost recovered their historic highs. In addition, it will enable [Santander] to get stronger and finance its growth in Brazil.”
This public offering also highlights the importance that Santander gives to the oil-rich market in Brazil, which has a flourishing middle class that still views loans as something of a novelty. The country is one of the most stable in Latin America, both politically and economically. At present it contributes 18% of the group’s global profits. Brazil is on the rise, Guillén says, “and Santander benefits from that.” The IPO also permits the bank to send the message “that everything is going well.” At a time when the Spanish market is not at its best, geographical diversification provides the best recipe for riding out the crisis, he adds.
Santander and BBVA now face a period of global growth and expansion through mergers and the strengthening of their foreign investments, continuing a policy of increasing globalization that began during the 1990s, and led them, first, toward Latin America and, more recently, toward Europe, the U.S., and other parts of the world.
Last August, BBVA acquired Guaranty Financial, a Texas bank that was suffering serious financial problems and undergoing intervention by government authorities. The purchase of Guaranty, completed in 2007, through its subsidiary Compass, strengthens the positioning of BBVA in the U.S. south. Headed by Francisco González, BBVA already owns Valley Bank, having integrated its Mexican subsidiary Bancomer as well as Laredo National, Texas Regional and State National. The last three of these banks are active in Texas and New Mexico. BBVA’s biggest acquisition was completed in 2007, when it paid €6.655 billion for Compass Bancshares. This enabled BBVA to enter the list of the top 20 banks in the U.S.
BBVA completed its latest purchase, involving Guaranty Financial, after a struggle for the U.S. institution, which has 150 branches divided between Texas and California. The purchase took place with support from the Federal Deposit Insurance Corp. (FDIC), which was managing the Guaranty Financial. The FDIC will assume a high percentage of the losses generated by the bank. With this deal, BBVA becomes the fourth-largest bank in Texas, displacing Wells Fargo, and the 15th largest bank in the U.S., ranked by deposit volume.
Although BBVA views the post-crisis period with optimism, Jesús Palau, executive director of the finance program at ESADE, warns that “the crisis is not ending; it’s just that conditions are not as bad. And it will take time to end.” While Palau recognizes that “this is a good time to buy cheaply,” he does not agree with the large bank’s strategies. “Spanish banks have to look within themselves a great deal before going abroad, by using internal controls.” In his view, “Although Spanish banking has not been so affected by the financial crisis, it was affected by the bursting of the real estate bubble, to the extent that the banks became the main bidders for real estate in Spain, which led to an accumulation of a great deal of assets on their balance sheets.” He thus advocates cleansing internal balance sheets more than more than looking for international diversification.
Despite the optimism of the two largest Spanish Banks, Palau recommends caution. “They are becoming too large.” He adds, “When a bank expands and increases its size, it makes more [money], but it also spends more: Growth doesn’t necessarily guarantee higher profits, since the profitability of your own resources remains the same.” This is the strategy of growing by growing. Palau recommends that a portion of those profits be allocated to reserves in order to improve capital ratios to deal with the possible deterioration of the economic situation in the future, and to improve the circulation of credit. Nevertheless, he recognizes that banks must not lose the opportunity to grow “if it winds up being cheap, and if they can use their own funds to do so.”
Manuel Romera, who heads the finance department at the IE Business School, notes that the deals Santander is undertaking take into account that the crisis has not entirely ended, and they are less risky because Santander is focused on granting loans for corporations and retail banking. Galán agrees, noting that Santander is focused on traditional [retail banking] activities, not on investment banking. Santander’s risks are well-managed and diversified, he adds. So it makes sense for it to engage in deals in various markets that are in different phases of the economic cycle and development.
For Romera, “Money has to be invested, since it loses value as cash because of the impact of inflation and the opportunity cost. That’s the reason that institutions take risks.” BBVA offers a good example of the kinds of risks some institutions will take on with the viability problems of Guaranty. It suffered losses estimated at US$440 million in 2008, but they could reach as much as US$2.2 billion overall now that the bank has filed for bankruptcy. Nevertheless, Francisco Gonzalez, BBVA’s president, told the press recently that the risk is minimal because the potential losses of the institution are limited in the U.S. The FDIC signed an agreement with BBVA, stipulating that in case the loans assumed by BBVA were to fail, the FDIC would assume 80% of the US$2.2 billion in losses, and as much as 95% of further losses, up to a maximum figure of US$11.5 billion.
Areas of Expansion
According to Romera, the Spanish banking market is saturated, with excess capacity of 30%, and needs to be reconfigured. That’s another reason for Spanish banks to consider expanding overseas. “There are good opportunities for diversification, including beyond Latin America.” He adds that that Spanish Banks are in a favorable position because they traditionally focus on retail banking activity. “This banking model is growing in countries like Brazil and the U.S., so they are becoming markets in which Spanish institutions have great opportunities.” Guillén warns, however, that banks will have to anticipate cyclical changes.
Galán thinks Santander will have to continue to get stronger in those markets where it already has a presence. In his view, “In the short and medium term, the U.S. has been a very attractive market starting from the purchase of Sovereign in 2006.” Galán said this gives Santander a chance to “bring its business model into the U.S., and supplant inefficient American banks. One of the lessons that this financial crisis has taught us is that banks don’t know how to do commercial banking in the U.S. I believe that Santander is a model for banking in the U.S., in its relationships with customers, employees, shareholders and society.”
Last June Alfredo Sáenz, chief executive of Banco Santander, told Expansion, the economic daily, that over the next five years, his bank will undertake additional acquisitions in the U.S. market. As early as 2006, Santander bought a 25% stake in Sovereign, at a price of US$25 a share. Following that, last year “we had the opportunity to buy the rest [of Sovereign] at a cheaper price, three dollars a share.” Sáenz identified Massachusetts, New York and Pennsylvania as three states that offer important growth opportunities.
He added that the bank will replicate in the U.S. the same bank integration strategy that it carried out in the United Kingdom. After Santander bought Abbey in 2004, “We were obliged to achieve better profitability,” he said. “Last year, we had the chance to help the British government solve part of the crisis by buying B&B and Alliance & Leicester.” As a result of this strategy, he noted, “Santander is stronger in the United Kingdom now.”
Over the medium and long term, Galán believes that there are two key countries it can target – Russia and China. “Both are big markets, although each has its peculiarities. Obviously, business models must be adapted to local circumstances and entry procedures, and expansion plans must be specific for each market. The traditional methods for internal and external development don’t work for these markets. Instead, they require innovative mixtures of new ways. It is a question of time; of risk management; and of finding entry methods that are appropriate for these markets.”
Romera adds that Spanish banks have only a nominal presence in growth markets like China. The differences, he says, “aren’t just cultural, but involve the way they understand banking; in this case, in a Communist country, it becomes very difficult to quickly expand Spanish banks and savings banks.”
Romera notes that Santander’s activities outside Spain now represent about 50% of the institution’s entire business, “depending on how you measure it, since part of that activity, although carried out outside Spain, depends directly on the Spanish market.” Nevertheless, he forecasts that in eight to 10 years, corresponding figures will read: 25% Spain, 75% foreign countries. Midsize Spanish banks, such as Banco Popular, are not planning a comprehensive global expansion, even though they have a presence in markets such as the U.S., particularly in of Florida where the deals have concentrated in recent years, including with the purchase of Mellon United by Banco Sabadell; the acquisition of Total Bank by Banco Popular; and the presence of Caja Madrid, which acquired 83% of City National Bank last year.
Galán praises this commitment by big Spanish banks to external growth. “In a global world like we have today, only the big firms survive, and the bigger you are, the better. The ones that survive are the ones that simultaneously figure out how to obtain economies of scale, economies of reach, and economies of experience that have a global scope.” He warns that this process is not easy to accomplish, since “you need to design organizations that are so advanced, so flexible, and so agile that you can reduce bureaucracy and functional duplication. And it means innovating both coordination mechanisms and incentive systems. The key to the globalized world of today is a global dimension equipped with an Organizational Design that permits it to adapt and responsive.”