Santander’s Spanish dilemma

July 28, 2011

By Fiona Maharg-Bravo and George Hay
The authors are Reuters Breakingviews columnists. The opinions expressed are their own.

Banco Santander, Spain’s biggest bank, may have passed the European-wide bank stress tests easily, but its first-half results were less of a breeze. Profit at the $85 billion institution fell short of expectations thanks to a one-off charge in the United Kingdom. But contagion from its own sovereign is still the bigger worry, even though Spain is a fraction of global business. Santander needs to do more to clear the danger.

The extra 620 million pound charge in the UK may have been unexpected, but it’s hardly surprising. Other British banks have moved to cover claims on payment protection insurance – cover that pays out on loan obligations in the case of illness or unemployment. Santander’s first-half profits dropped 21 percent thanks to the charge. Strip this out, and the drop would have been 7 percent.

Bad loans in both Spain and Brazil caused more grief. Brazil, which accounts for a quarter of group net profit and is usually a bright spot, saw a worrying 11 percent profit decline from the previous quarter. But it’s Spain that continues to be the largest source of concern. This may seem unfair: the country accounts for just 12 percent of Santander’s profit, and loans to real estate developers are just 3.4 percent of the loan book. But every time Spanish bond yields rise, Santander shares dip.

The best way for Santander to distance itself from its home market, other than buy businesses abroad, is to increase provisions for losses related to property. Santander has set aside 32 percent of the value of foreclosed properties – 40 percent on plots of land. But this is not enough considering the dire state of the market. Increasing the overall coverage to 40 or 50 percent could see its balance sheet free of the deadweight. Similarly, the coverage level for non-performing and substandard real estate loans looks too low at 26 percent.

Even if it does an aggressive cleanup, Santander may not be rewarded by investors right away. And Spain is not only its only problem — poor stock market conditions have stalled a planned listing of its UK arm. But more concerted action at home may eventually improve the flow of credit to the economy. Maybe it’s time Santander took the lead.

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