Banco Santander. EPS Down, But Reputation Intact

A couple of years ago, earnings growth obsessed investors and banking analysts treated Banco Santander almost as an after-thought. For every mention of Banco Santander in the UK investment press there were 10 articles on each of the other big banks; Barclays, RBOS, LloydsTSB, HBOS and HSBC. Santander just wasn’t very exciting. Plus, the London investment community, deeply in love with its own Anglo Saxon model of capitalism was ever so slightly amused at the thought that our European cousins in the Mediterranean might articulate banking management skills equal, or god forbid superior, to those in London or Edinburgh.

Now, as the country continues its efforts to formally exit the worst financial crisis in living memory the enigma that is Banco Santander is better appreciated.

But in all logic the bank should be suffering a maelstrom of problems. Santander is domiciled in Spain, arguably the most vulnerable economy in Western Europe. The group also, in 2004, acquired one of the largest British banks, Abbey National, and it would be fair to expect Abbey to have a similar depth of exposure to struggling UK consumers and the housing market as the much maligned Northern Rock, RBOS, HBOS or LloydsTSB do, (the latter two now forming Lloyds Group). But Santander isn’t in a mess, nor was it on the verge of collapse like so many banks late in 2008. It didn’t dominate the headlines with news of government bail-outs or queues of panicking savers urgently trying to extract their cash. Quietly, professionally and with minimum fuss the Spanish bank has consolidated it position, strengthened its brand in the eyes of risk-averse consumers and built a reputation amongst banking sector observers for financial integrity and stability that most other Western banks can only dream of.

Santander’s strategy of geographical diversification and a commitment to building a relatively prudent book of loans and mortgages has protected its balance sheet from the worst excesses of the debt bubble, though obviously some additional bad debt provision has been necessary. The bank should be congratulated for having paid close attention to the Good Risk Management textbook, the book HBOS management left on the shelf, collecting dust, thinking it was a secret Martian code too complex to be deciphered.

Reviewing the financials from the latest quarterly report also reassures. The group’s attributable profit in Q2 has progressed to Euro 2,423m from Euro 2,096 in the prior quarter, whilst year on year performance is a modest 4% lower. The UK contributed 16% of profits, Latin America 34% and Continental Europe 50%. H1 2009 loan provisions rose 61% to Euro 4,626 from Euro 2,880 in H1 2008 causing a 19% descent in earnings per share which otherwise would have made strong progress. A proportion of the bad debt provision maybe ‘returned’ to the P&L if actual bad debts are less than the provision. Of course it is also possible that the provision is inadequate but with a diversified business model and exposure to the relatively healthy Latin America region, the future remains brighter for Banco Santander than many of its competitors.

The chart below highlights the growth in the bank’s NYSE listed ADR (Banco Santander Cent Hisp) which is deep in over-bought territory with a 14-day RSI of 77.38, so investors should add the firm to their watch list and reconsider the question of buying if better value returns.

Banco Santander STD to 29th July 2009

Banks: Always the Problem, Never the Solution

Imagine for just a few moments an economy with no debt. You have no ability to borrow or lend, nor does any other participant in the economy. There is also no mechanism to print money and therefore to create additional nominal paper wealth. The only assets you own were purchased with the fruits of your labour and enterprise. The only money you have is from the proceeds of assets you previously sold or income from labour and enterprise, yet unspent. Also in this fictional land, the nominal supply of money, coins and bank notes, exactly equals the true nominal and economic value of society’s wealth, This wealth consists of ready to use commodities (grown coffee, mined coal, etc) and real, not paper, assets. If the rate of saving increases, or the holding period between transactions lengthens, the velocity of money and real economic activity decreases. If through natural disaster or war, assets are destroyed, the nominal value of paper money would be greater than the economic value of real assets. In this environment of fixed money supply with no ability to lend, borrow or print money, society can only theoretically accumulate more assets in future periods, than it did in the past, by improving the efficiency of commodity growth and extraction or by inventing new products of economic value. But unless money supply is increased, or the circulation of money accelerates, the prices of assets and commodities would have to fall, due to the increased supply of commodities and assets relative to fixed paper money supply. Furthermore, you could not increase your personal real economic wealth by working longer hours unless another participant was willing to work less hours as your increased output would also create excess supply that the fixed monetary base could only purchase through deflation of asset prices.

Let’s build into this zero sum economic model, debt, the ability to lend and borrow. Again money supply is unchanged. The zero sum game is also unchanged. The flow of money is altered but no real economic growth is secured. The only change is the timing of consumption for each party. The borrower enjoys higher consumption now at the expense of future consumption. He is spending future income. The lender forsakes current consumption, preferring to consume later when the debt is repaid. The real economic asset base is unchanged. The borrower can purchase assets, employ more staff, pay higher wages but if the supply of money is unchanged every extra dollar he spends is directly offset by the decrease in economic activity of the lender.

So debt by itself, within a fixed money supply economy, is a financial transaction that creates no real economic growth. Progressing towards a more realistic scenario, closer to today’s economy let us introduce the concept of new and additional money supply. Not new economic wealth, just new paper money. The creator of this paper is seeking to stimulate the economy and decides to allocate a third each to Consumption, Lending and Investment. (By investment I am referring to the creation of new assets of economic value and the improvement of existing production efficiencies, not the purchase of assets already in circulation). Examining each of the three in isolation, if new money is added to an economy within a fixed asset base, purely to increase consumption, inflation is caused as demand increases whilst supply is constant. Nothing new of economic value has been created. Each unit of paper money is just worth less relative to the unchanged real economic asset base. Borrowing to purely consume creates inflation and has zero sustained economic benefits.

The second scenario relates to the share of printed money that is lent and borrowed. If the borrower uses his additional paper money to consume the economic impact is unchanged, as above. If the paper money is used to buy completed assets, again as discussed above, the only occurrence will be inflation in the price of assets. Debt used to increase consumption or purchase assets has zero sustained economic benefit, only the flow of money changes. There is no new real economic wealth, just inflation, or asset price bubbles, or both.

Therefore, only newly printed money that is invested into the process of building new assets of economic value has a positive impact on growth. Increases in consumption can only be sustained if it is the function of an enlarged asset base of economic value exactly matched by an increase in the supply of nominal paper wealth.

To achieve real economic growth, society must have a mechanism that increases money supply which both facilitates and mirrors real economic growth, (the increase in quantity of real assets). In the absence of this scenario when newly printed money is allocated to the purchase of completed assets, or consumption, rather than applied to investment in the production of new assets or invested to improve current output efficiencies, zero real economic growth occurs and asset price bubbles are created.

Applying this theory to the current stimulus policy and the new paper money printed by the Fed and other monetary authorities, every dollar spent on supporting consumption or used in the purchase of completed assets has zero true economic value and is today’s generation borrowing from the income of future generations. It’s fake growth, here-today-gone-tomorrow paper wealth. Therefore every dollar allocated to the balance sheets of failed banks, which is then lent to stimulate consumption or used in the acquisition of existing in-circulation assets represent transactions of no true economic value. Supporting financial institutions that profit from building fake wealth probably isn’t a great idea either.

In fact the stimulus package is quite successfully re-building the same myth of debt-fuelled economic growth and is deepening the embedded structural problems of a debt based society, which incorrectly allocates printed money to consumption and zero-sum financial transactions rather than into real economic investment.

If you persist with the same course of action, is it reasonable to expect a different outcome?

The UK Economy – 30th May 2009

In the UK, investors digested the Financial Services Authority stress test results for the banking sector. All the big banks; Barclays, RBS, Lloyds Group and HSBC passed the examination, though RBS and Lloyds would have failed were it not for the recent government bail-outs. The stress test was applied to ensure the banks were sufficiently financially robust to cope with a possible further deterioration in the UK economy and considered a scenario of a 6% fall in GDP, 12% unemployment, a 60% decline in commercial property prices and a 50% collapse in residential property prices. Observers quite rightly argued that the criteria could have been decided on the “back of an envelope” years ago and was hardly a doomsday scenario considering the falls in GDP and property prices already seen. Overall, welcome as stress-testing is, surely if it was that simple, it should have been done before the near collapse of the UK banking sector, not after. But politicians and bureaucrats are uber-skilled at closing the barn door after the horse has bolted whilst reciting cosy sound-bites, and at least they have their “back of the envelope” stress test in place for the next recession. Of course there is another side to the argument, maybe a practical one. The UK economy won’t collapse, thanks to monetary easing and government stimulus. If the stress test criteria was considerably more challenging and therefore some of the banks failed the test, the only party with deep enough pockets to fix the problem is the government (the tax-payer), who has already paid a heavy price. Maybe that’s why the exercise was less of a stress test, and more of a balance sheet tickling contest?

Let’s move on to a more positive note. UK house prices rose in May by 1.2% according to the Nationwide Building Society. The rise, the 2nd in 3 months, has eased the year-on-year decline in prices from -15% to -11.3%. Nationwide attributed the welcome price increase to weak supply, with home-owners reluctant to market their property at current depressed price levels. The data is the best monthly improvement year-to-date and follows: April -0.4%, March 0.9%, February -1.8% and January -1.3%.

In foreign exchange markets, Sterling moved higher against the Dollar over the week continuing the recent trend of USD depreciation in favour of perceived higher risk currencies. Traders also attributed the recent strengthening of Sterling to the gradual improvement in UK economic data, including higher mortgage approvals and a cautiously upbeat Confederation of British Industry survey which highlighted a probable stabilisation in consumer sentiment and a deceleration in the speed of economic contraction within the UK. Another equally feasible reason for Sterling’s good progress is that the pound, like equity prices, was previously over sold and is therefore in the process of returning to a ‘fair price’.

To close our look at the UK, equity prices mirrored the performance of the dominant US market and made slight progress over the week, though the FTSE 100 continues to trade in a 4,300 to 4,500 range as it has for most of May. This pause for breath, as discussed in the global section, is likely to end very soon.