Santander Missed Badly…or Did It?

02/01/2012 2:51 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Spain's biggest bank should bounce back nicely later this year by picking up other overstressed banks on the cheap, writes MoneyShow's Jim Jubak, who also writes for Jubak's Picks.

When do you demand that all your competitors report kitchen-sink quarters? When you're convinced that their kitchen sinks are bigger than yours-and when you believe that some at least will go under from the effort of heaving them out the window.

The huge plunge in fourth-quarter earnings at Banco Santander (STD), Spain's biggest bank, drew most of the attention yesterday after the company reported its financial results.

Net income fell for the quarter to ?47 million from ?2.1 billion for the fourth quarter of 2010. The results fell just a bit short of the consensus Wall Street estimate of ?1.78 billion for the quarter. (Banco Santander is a member of my Dividend Income portfolio.)

The quarter wasn't nearly the complete shipwreck that those numbers suggest-if you just look at the results from Santander's current operations. Net interest income rose to ?7.97 billion in the fourth quarter, from ?7.33 billion a year ago. Lending across the group grew by 3.6% year to year. Deposits were up 2.6%.

European banks in general, and certainly Spanish banks, still haven't seen the peak of bad loans, however. Bad loans inched upwards to 3.89% of total loans at the end of the quarter, from 3.86% at the end of the third quarter. And Banco Santander booked provisions for loan losses of ?2.8 billion in the quarter, up from ?2.4 billion in the fourth quarter of 2010.

The results from the bank's operations in Spain, the United Kingdom, and Brazil-all countries where economic growth slowed in the fourth quarter-were particularly negative. Profit for the quarter from Spain drove off a cliff, falling to ?29 million from ?320 million in the fourth quarter of 2010. Earnings from Brazil dipped to ?637 million in the fourth quarter from ?751 million a year earlier. Earnings from the United Kingdom fell to ?388 million from ?436 million.

And that wasn't the end of the bad news. Banco Santander took a huge ?3.18 billion writedown that included charges for its holdings of Spanish real estate (?1.8 billion of the total), goodwill at the bank's Portuguese unit (?600 million), writedowns of other portfolio holdings, and charges for amortizing pensions and other intangibles.

The real-estate writedowns were enough to increase provisions to now cover 50% of the ?8.55 billion in real-estate holdings on the bank's books. That's an increase in provisions from 31% before this quarter.

That was all compelling-if very negative-reading. But what interested me is that rather than complaining about pressure from the recently elected Spanish government of Mariano Rajoy on banks to recognize losses in their real-estate portfolios, Santander chairman Emilio Botin just about yelled: "Bring it on!"

The Spanish administration's plan to make banks acknowledge higher losses on real-estate assets "goes in the right direction" and "these provisions must be fully made this year," Botin told reporters in Madrid. Any lender that can't show it's viable "should be sold," he said.

Which is exactly what Botin and Santander are counting on. In the midst of slowing economies and huge real-estate writedowns, Santander has actually increased its core capital under the current Basel II rules to 10.2% in December, from 9.42% at the end of the third quarter.

On January 9, the bank said it had met the 9% core capital requirement under European Banking Authority rules six months ahead of the authority's June deadline.

Santander knows that it and Spain's second largest bank, Banco Bilbao Vizcaya (BBVA), will be able to meet new capital rules and write down real estate portfolios at the same time. But many of Spain's other banks won't. So they're counting on a big chunk of Spain's banking industry either going under or selling out (to them if the price is right) in the not too distant future.

After spending much of the last decade expanding outside their Spanish base-a diversification that is turning out to be critical to surviving this crisis-the two big Spanish banks see a big opportunity to grab a bigger share of their home market. (Banco Bilbao Vizcaya is a member of my Jubak's Picks portfolio.)

For Banco Santander and Banco Bilbao, this crisis is too good to waste.

The other critical piece of news in Banco Santander's quarterly report was management's pledge to keep its dividend at 60 euro cents a share in 2012. With the stock closing in Madrid today at just below ?6 a share, that's a dividend yield of 10%.

This quarter isn't the last bad news out of Banco Santander. The bank says that it will complete the cleanup of its real-estate portfolio in 2012-which certainly promises another kitchen-sink quarter or two. (I'd expect the bank to write down another ?2 billon in its real-estate portfolio.) And I'm sure that Banco Bilbao will add its own bad news to the stew when it reports on February 2.

But I'm glad to see a kitchen sink or two from Banco Santander on the trash heap. I don't think you need to rush in to build a position now (although anytime the stock trades below ?6 in Madrid, I think it's worth while adding to positions in either those shares or the New York ADR.)

In the short term-that is by mid-2012-I think this is an $8.50 per unit ADR. (Up from $7.88 at the close today.but don't forget the 10% dividend yield.) Longer-term-say December 2012, when the bank has finished write-offs and ended its need to raise capital-my target is still $12 per ADR.

And there is that 10% yield.

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, may or may not now own positions in any stock mentioned in this post. The fund did own shares of Polypore International 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 here.

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