“Cheap” Bank Still Dangerous

bank stockBank stocks have been a hit in the market sell-off over the past few years. Many bank stocks are still selling at a discount to book value, even after this recent six-month increase in stock prices. Although many bank stocks have risen lately, one has not and continues in its own market sell-off: Banco Santander, S.A. (NYSE/STD). Banco Santander remains near its 52-week low and near the lows of the market sell-off in late 2008 early 2009.

While Banco Santander may appear cheap to some people, I would urge caution before putting money into this troubled firm. As the largest bank in Spain, Banco Santander faces a huge amount of headwinds. Current earnings showed a decline to €1.6 billion from €2.1 billion in the previous year for the first quarter. Part of the loss was €3.0 billion set aside to cover bad loans in Spain and other periphery countries. At the end of March, Banco Santander had nonperforming loans valued at €33.0 billion, or four percent of the total loan portfolio.

While four percent might seem large for bank stocks, it might not be enough, considering that Banco Santander has a huge amount of business in the Spanish real estate market, where Spain’s average net nonperforming loan ratio for other bank stocks is close to 10%.

There are some portions of Banco Santander that are doing very well, mainly its Latin American divisions. Unfortunately for investors in Banco Santander, the firm has already started selling the best portions off to try to raise more capital. The last thing you want in bank stocks during a market sell-off is for them to get rid of their best assets. You are left holding an empty shell with poor properties and a bleak future.

Billions more need to be raised and the Spanish real estate market sell-off continues. I worry about how Banco Santander is going to raise the funds. Several European bank stocks have done share issues, which cost shareholders dearly—some by issuing shares at such a drastic price that the bank stocks shares declined over 40%.

Why should American investors care? As we’ve learned with the downfall of Lehman Brothers, large bank stocks are intertwined worldwide. Banco Santander, with 15,000 branches, is the 19th largest bank worldwide when measured by assets. The ripple effects of one of these bank stocks going under would be truly damaging to the worldwide financial system. One thing that does worry me is a similarity that Banco Santander has with Lehman Brothers, in that a large part of its banking relies on wholesale debt and external funding to raise money for daily operations, as opposed to deposits. Meaning, if the wholesale funding market freezes like it did in 2008, this bank could be in serious trouble, causing an even bigger market sell-off.

I also don’t think the dividend yield will be maintained, so investors who buy now may be in for a shock if the dividends end up being cut. And, with the real estate bubble in Spain continuing to deflate in a market sell-off, considering Banco Santander is one of the largest lenders to construction firms and real estate development in Spain, the losses might be massive.

Banco Santander also has a total exposure to sovereign debt of approximately $77.0 billion, with approximately $3.0 billion in Portuguese debt and over $63.0 billion in Spanish sovereign debt. With such a large exposure to Spanish debt, any default or revision to the debt by the Spanish government could shut the entire firm down and wipe out shareholders’ equity completely in a massive market sell-off.

This, of course, means that Banco Santander is one of the bank stocks that “can’t fail,” with the Spanish government and the European Central Bank most likely willing to step in to support one of the biggest bank stocks in Europe. That’s a big bet that I’m not willing to make. If the firm does issue shares in its Latin American divisions like Chile or Mexico, I might be interested in those separate areas, as long as they have no connection to the European division.