Property: the Spanish are coming

Spain's property market collapse makes the UK housing sector look positively swinging. So how are the country's banks able to even consider bids for our mortgage lenders? By Sean Farrell
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The Independent Online

Spain's biggest banks are riding high amid the credit turmoil. Not only has Santander agreed a cut-price deal to buy Alliance & Leicester, but a rumour that Banco Bilbao Vizcaya Argentaria was mulling a bid for HBOS helped to send shares of Britain's biggest mortgage lender up nearly 17 per cent yesterday.

Analysts said a BBVA bid for the parent of Halifax and Bank of Scotland was unlikely. One analyst said the only reason for Spain's second-biggest bank to do such a deal would be to enter a "medieval duel" with Santander, which wants to add A&L to Abbey National, which it bought in 2004.

But the incident was an illustration of the perceived strength of Spanish banks in the midst of the financial turmoil after avoiding the massive writedowns on credit products that have hit their European rivals.

Spain's big two banks have won praise for diversifying their businesses into high-growth Latin American markets, which so far have remained buoyant as the US and Europe head into a slowdown. Santander makes about 35 per cent of its income from its home market, while BBVA gets about 39 per cent of revenue from Spain and Portugal. They also resisted the urge to expand in investment banking as the debt markets boomed, sticking to their roots in retail banking.

Mamoun Tazi, banking analyst at MF Global, said: "They [Santander and BBVA] have some very good franchises in South America and they have a decent business in Spain, though Spanish housebuilders are going through a terrible recession. They seem to have not stepped on landmines both in terms of Spanish real estate and US sub-prime. That is why they are confident."

The Bank of Spain has also helped out by requiring the banks to make old-fashioned general provisions – supposedly outlawed under IFRS accounting – so that they have been building up reserves against future bad debts instead of waiting for loans to turn sour. The central bank also deterred its banks from running structured investment vehicles and other such exotic funds by saying that they would have to capitalise them on their balance sheets.

Santander and BBVA have not been shy about broadcasting their relative success, dishing out lectures on prudent banking and declaring themselves virtually immune from the maelstrom around them.

The night before his bid for A&L, Emilio Botin, Santander's 73-year-old chairman, dispensed words of wisdom at the Euromoney awards. "If you don't fully understand an instrument, don't buy it. If you would not buy a specific product for yourself, don't try to sell it. If you do not know your customers very well, don't lend them any money. If you do these three things, you will be a better banker, my son."

Francisco Gonzalez, BBVA's chairman, has made withering comments about US banks, saying in January that they acted "immorally" by encouraging people to take out loans they couldn't afford.

Marco Troiano, a banking analyst at Standard & Poor's Equity Research, says: "Santander take great pride in the way that they have come out of the credit crunch and they are right to feel proud. The main reason for that is their legacy as a retail bank, and the Bank of Spain's rules were more prudent than for other countries.

"Now, of course, they are facing another kind of problem, which is the cyclical slowdown at home. It is possible that real estate prices could fall in absolute terms and that presents challenges for Santander."

Mr Botin's speech to the Euromoney awards was said to have been tongue- in-cheek, but a source at one British bank said the triumphalism of the Spanish bank bosses was "bewildering", given the condition of the Spanish economy and the difficulties the banks could face from the bursting of the country's 10-year housing bubble.

Evidence of the potential troubles ahead came to light earlier this month when Banesto, a domestic lender that is 88 per cent owned by Santander, reported second-quarter results. Defaults surged to 0.79 per cent of total loans from 0.59 per cent in the previous quarter and non-performing loans more than doubled to €693m (£546m).

Net profit at the bank, which is run by Mr Botin's daughter Ana Patricia Botin, rose 14 per cent on higher lending revenue; but, with the economy slowing, loan growth is likely to slow down sharply. Analysts will watch the domestic operator Banco Popular Español's results today for further signs of trouble ahead.

Santander bank has forecast profit for 2008 at more than €10bn, a record, as growth in Brazil and elsewhere in Latin America makes up for the slowdown in Spain. It has doubled its presence in Brazil with the acquisition of ABN's business there, but still makes about half its profit in Spain and the UK, where property bubbles have burst and the economic outlook is bleak.

As well as the slowdown in their home market, Santander and BBVA may not be able to rely on a continuing boom in their Latin American operations. Markets such as Chile and Argentina are suffering from high inflation and their central banks are raising interest rates, while Mexico may suffer from its close economic ties with the US. Even Brazil, the great success story of Latin America, is having to raise interest rates to combat inflation.

A banking analyst who declined to be named says: "Latin America has been one of the positives of these two banks, but this is going to change this year because the macro economy is not as positive as it used to be."

Mr Botin has built a reputation as a shrewd, opportunistic, deal-maker as he has built Santander into one of the world's top 10 banks. That reputation was enhanced last year when he bought ABN Amro's prized Brazilian operation for a bargain price in the three-way break-up bid for the Dutch bank and then immediately sold ABN's Italian business for a profit of £1.7bn.

Abbey's performance was unspectacular in the first three years after Santander's purchase, but the bank has started flexing its muscles this year to take market share from rivals. It is also expanding in business banking, a plan that will be accelerated by the A&L deal.

But question marks still hang over the initial deal. MF Global says the takeover was a mistake by Santander, because investing in the mature UK market diluted the Spanish bank's returns. The A&L deal is a necessary second step to boost returns through cost cuts, MF Global says.

Muted forecasts for growth

The Spanish economy has basked in a decade-long boom, outperforming its neighbours right up to last year when it grew 3.8 per cent compared with an average of 2.7 per cent across the Eurozone. Yet a sharp decline in the country's property market last year has slowed growth sharply, and caused experts to downgrade their estimates on just how bad the country's economic slowdown will be.

Last quarter, real gross domestic product hit levels not seen since the early 1990s, as it grew just 2 per cent in the three months to the end of June. This was flat compared with the first start of the year, predominantly caused by the fall in property, as housebuilding makes up 10 per cent of the economy. This compares with 7 per cent in the US at the peak of the market. Fears continued to rise over the sector last week as one of the country's biggest property companies Martinsa-Fadesa filed for creditor protection owing €5bn (£4bn). This has had a knock-on effect on domestic banks where profits have suffered from rising provisions from bad loans.

As the economy has weakened, consumer demand has slowed, manufacturing orders have fallen and employment has soared, rising by 425,000 in the past 12 months to hit 9.9 per cent. Experts are muted over the country's future growth prospects, with economists at Standard & Poor's economists forecasting 1.5 per cent GDP growth this year followed by 1.6 per cent in 2009.