Update Banco Santander (STD)

01/04/2012 3:30 pm EST


Jim Jubak

Founder and Editor, JubakPicks.com

Shares of Banco Santander (SAN.SM) are down 3.9% in Madrid today and the U.S. ADRs (American Depositary Receipts) are down 3% (STD) in New York as of 1 p.m. Eastern Time on a big increase in shares outstanding as a result of the conversion of non-listed preferred shares into ordinary shares that count as core capital. The new shares started trading today and represent an increase in shares outstanding of about 3.8%. The conversion is part of Banco Santander’s efforts to raise capital to meet the regulatory requirements set down by the most recent stress test conducted by the European Banking Authority. The conversion increases the bank’s core capital to 10% under the old Basel II global banking rules, 8.9% under the new Basel III rules, and 8.7% under the European Banking Authority rules.

In its December 8 announcement of the results of its latest round of stress tests the European Banking Authority calculated that Banco Santander had a risk-adjusted core capital ratio of 6.77%. Since then Banco Santander has sold off parts of its Brazilian and Chilean operations, sold its entire Colombian subsidiary, and conducted a conversion of preferred to ordinary shares that have brought the bank to within striking distance of the European Bank Authority’s 9% core capital requirement.

To me, the numbers look like Banco Santander will be able to meet the rest of its capital needs—for the moment and pending write downs in its portfolio—from retained earnings.

The ADRs are a member of my Dividend Income Portfolio http://jubakpicks.com/ and pay a trailing dividend yield of 11.5%. That yield is attractive, of course, only as long as the bank actually pays out the dividend. That’s not guaranteed but I think it’s more likely than not, especially since about 70% of investors have been willing in recent quarters to take their dividend in shares rather than in cash. The ADRs currently trade at $7.52. I think the ADRs will trade at $9 or better—at $9 that would be roughly a 20% gain from today’s price--once the bank has finished raising capital and has demonstrated that the dividend is secure in the next quarter or two. A longer-term target price would be $12 a share by December 2012.

I think the current ADR price seriously under-estimates the strengths of Banco Santander—and especially the ability of what is still the world’s 11th largest bank by market capitalization to raise capital.

The worry about European banks right now is that they can’t raise capital in the financial markets—it’s just too expensive when your shares are trading at 50% or 67% of book value--that they can’t reduce their asset base by selling off loans—nobody wants to buy loans to Greek companies or mortgages on Spanish real estate—and that they don’t have much in the way of non-core businesses to sell off—at least not at a decent price.

Over the last two quarters Banco Santander has very clearly demonstrated that this bank doesn’t fit that profile of worries.

First, this is a global bank with plenty of attractive assets outside of the struggling Spanish and EuroZone markets. In the third quarter the bank sold a piece of its Latin American insurance business and part of its U.S. consumer loan business for a total of $3.5 billion. In the fourth quarter Banco Santander sold pieces of its Chilean subsidiary and all of its Colombian unit for $2.75 billion.

Second, Banco Santander is actually finding buyers for some of the most troubled assets in its portfolio. For example, as of December 9 it sold $8.81 billion in troubled loans at its Brazilian subsidiary, Santander Brasil. The discount was huge—loans originally valued at 16 billion Brazilian reais went for just 300 million Brazilian reais—but these loans were delinquent by a year or more and represented the most troubled part (a 9% part) of Santander Brasil’s portfolio. Getting them off the bank’s books even at a very low price takes a big whack at the risk-adjusted capital requirements of bank regulators.

Third, Banco Santander is actually raising capital in the financial markets—although the bank has had to use some unusual methods for doing that. For example, the bank gives holders of its ADRs the option of taking new shares, without paying withholding tax, instead of cash for their dividends. In the third quarter 73% of ADR holders took the share offer—that added cash to retained earnings and $82 million in new capital.

Add in the bank’s almost $8 billion in free cash flow in the last 12 months and I think Banco Santander won’t have any trouble presenting a plan for meeting the European Banking Authority’s capital requirements by the January 20, 2012 deadline—without dipping into dividends. (The bank will then have until June 30 to execute that plan.)

Some of the assets that Banco Santander is selling are in the bank’s fastest growing markets and that will definitely cut into growth in the future. But you own these shares now not for that future growth but on the likelihood that this bank has seen the bottom of its fortunes during the euro debt crisis.

Unless, that is, Spain goes the way of Greece and the country has to write down its sovereign debt. Banco Santander holds $4.4 billion less of Spanish government debt in December 2011 than it held in July 2011. But it still holds almost $50 billion in Spanish government debt.

If you think Spain will have to write off part of that debt, then Banco Santander sure isn’t the pick for you. If you think Spain is in better shape than Italy…or Greece, I think that in Banco Santander you’re looking at one of the best performers in 2012.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund did own shares in Banco Santander as of the end of September. For a full list of the stocks in the fund as of the end of September see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/

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