Spanish Banks Stay Strong amid Downturn

Despite Spain's weak economy, Santander and BBVA defy the banking gloom, thanks to scant subprime exposure and strong Latin America ties

Emilio Botin, Chairman of Spanish banking group Santander Central Hispano PIERRE-PHILIPPE MARCOU/AFP/Getty Images

by Mark Scott

Compared with its U.S. and European rivals, Spain's Santander—the largest bank in the euro zone by market value—and its smaller rival, Banco Bilbao Vizcaya Argentaria (BBVA), have a lot to smile about. Lacking exposure to U.S. subprime assets, the Spanish financial giants have successfully navigated the choppy economic waters, while other banks, such as Merrill Lynch (MER) and Citigroup (C), have been forced to call for life preservers.

Key to the banks' success has been geographic diversification. Like the conquistadors before them, these Spanish financial buccaneers have flourished by expanding into the New World. That has helped shield them from an economic downturn that's threatening their home market. Both Santander (STD) and BBVA (BBV) now generate roughly one-third of their net profits from Latin America—a region relatively unscathed by the credit crunch.

The benefit from overseas expansion was evident on July 29, when Santander posted an annual 6.1% increase in first-half net profit, to $7.4 billion, on the back of a 13.8% jump in revenues, to $21 billion. A day earlier, BBVA—Spain's second-largest bank by market cap—announced an 11.6% increase in first-half net (excluding one-off charges), to $4.5 billion, on revenues of $15.1 billion, up 15.2%. That's markedly better than some other banks' multibillion-dollar losses (BusinessWeek, 7/16/08).

Spain's Slowdown

"Both banks have been performing well against their peer group," says Antonio Ramirez, a banking analyst at stockbroker Keefe, Bruyette, & Woods (KBW) in London. "Diversifying into other markets should help protect them against the economic slowdown in Spain."

This theory will soon be tested, as the Spanish economy is expected to grow a mere 1.6% in 2008, compared with 3.8% last year. The country's unemployment rate now tops 10.4%. And after a 10-year housing boom, the domestic real estate market has imploded, leaving banks holding millions of dollars of bad loans (BusinessWeek.com, 7/21/08). Raj Badiani, an economist at researcher Global Insight, reckons there's a 60% chance the Spanish economy will fall into recession.

How will this domestic downturn affect Spain's financial highfliers? Analysts at brokerage Dresdner Kleinwort (AZ) expect BBVA to continue outperforming rivals, due to its large capital reserves and strong presence in emerging markets. The bank saw a 7.6% increase in first-half net profit from its Mexico unit, to $1.5 billion, and a 7.5% rise in South America, to $548 million. It has roughly $78 billion in reserves to underpin its operations—a larger cushion than at most other banks.

Latin America Payoff

For Santander, Latin America also will grow in importance once the bank finalizes its takeover of Brazil's Banco Real. Santander paid $17.2 billion for the Brazilian business as part of the breakup of Dutch financial giant ABN Amro (BusinessWeek.com, 10/5/07). According to Santander Chief Executive Alfredo Sáenz, the bank's increased presence in Brazil will eventually produce a 30% overall net profit, compared with 9.5% currently. First-half profit from Latin America rose 1.6%, to $1.1 billion.

Not that the Spanish banks are completely immune from the problems affecting other financial players. As in the U.S., declining real estate sales in Spain—still the main market for BBVA and Santander—are hitting their balance sheets. Defaults as a proportion of Santander's total loans topped 1.3% in the first half of 2008, compared with 0.8% over the same period last year. For BBVA, the figure rose to 1.2% this year, vs. 0.8% in 2007. "There's no doubt both banks will suffer somewhat from the indigestion caused by the Spanish housing market," says Keefe, Bruyette, & Woods' Ramirez.

Yet despite domestic economic turbulence, both Spanish banks are better prepared than others to take advantage of current financial instability. Santander agreed on July 14 to buy troubled British mortgage lender Alliance & Leicester (ALLL.L) for $2.6 billion. Rumors abound that other deals will follow as the banks look to snap up distressed assets across Europe.

That spells good news for Spain's leading financial players. With limited exposure to U.S. subprime assets and buoyed by strong lending portfolios in the Americas, BBVA and Santander are standing tall.

Scott is a reporter in BusinessWeek's London bureau .