The price action in BBVA and Banco Santander on Wednesday morning:
The reason for the weakness appears to be a Barclays Capital downgrade.
The BarCap banking team, led by the highly rated Tom Rayner, has cut ratings on both stocks to “underweight” arguing that their premium ratings — Santander trades at a 44 per cent premium to book value and BBVA 15 per cent — can’t be justified given increasing stresses in the domestic property market and fears of Spain’s fiscal situation.
Here’s the summary:
We have cut our 2010E and 2011E EPS estimates by 5% and 12% for BBVA and by 4% and 9% for Santander, largely reflecting higher impairment charges as generic reserves run out and specific impairments increase. Our new 12m price targets imply a 2010E P/E of 7.2x and P/tNAV of 1.3x. for BBVA and a 2010E P/E of 10.2x and P/tNAV of 1.7x for Santander.
However, that’s probably the least interesting part of the note. Although it is puzzling that Santander in particular commands such a rating given the difficult backdrop.
Much more interesting is what Rayner has to say about loan loss provisioning, something which has been mentioned on FT Alphaville many times before and is now becoming mainstream, and real estate valuations:
Although the Bank of Spain’s countercyclical approach required both banks to build substantial reserves of generic provisions, we believe that the severity of the current downturn will lead to these reserves being run down to their minimum level in 2010E for BBVA and 2011E for Santander, with Bank of Spain impairment reserving requirements and tighter rules on property valuation likely to exacerbate the situation.
As a result we expect both banks to see a jump in impairment charges in 2011E. Reflecting market concerns for a more severe and prolonged downturn in Spain, we have also modelled a stress test scenario under which both banks provide for impairment of 9-10% of their domestic loan books.
And here are the results of said stress test:
As you can see, under this scenario both banks suffer a sharp drop in earnings, although they remain profitable with adequate capital ratios. (For more on the Bank of Spain’s new provision requirements go here).
Turning to real estate, which Rayner says is the main area of contention from a credit risk perspective, he reckons the exposure of both banks is pretty similar; €17.7bn for BBVA and €14.6bn for Santander, with non performing assets (NPAs) representing 17 per cent and 8 per cent of their respective loan books.
Now, Rayner suspects the lower NPA ratio at Santander reflects the different approaches the two banks have taken to managing their exposure to Spanish property developers. While BBVA focuses on restructuring the loans, Santander is quicker to actually acquire the underlying collateral.
But if you add acquired property to NPAs, things start to look very different, as this table shows.
The figure for Santander rises to almost 29 per cent!
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Readers may also recall that BBVA revealed an unexpectedly large rise in bad debts when it filed annual results in January. Indeed, of the €3bn of NPAs referred to in the table above, about half represented doubtful loans that were reclassified as non performing loans (NPLs) in the fourth quarter.
According to Rayner this included around 50 specific names, where developers were continuing to meet regular interest payments but where the ultimate repayment of principal was deemed unlikely given the economic environment.
Anyway based on those trends, here’s what he ultimately means for the real estate books of both banks:
It can be seen that we expect a further significant increase in NPLs from €3bn to €5bn for BBVA, representing c.30% of the total portfolio, and from €1bn to €3bn for Santander, representing 20% of the loan book.
A notable difference is that Santander has a coverage ratio of 60% against its exposure compared to only 34% for BBVA. Although it is not possible to know how collateral values differ between the two portfolios, we suspect that much of the difference reflects the fact that the new NPLs at BBVA have a lower cover ratio reflecting the Bank of Spain’s requirement to take 25% in the first year.
Our forecasts assume that BBVA’s cover ratio will remain stable in 2010E as the required provsions for this year have already been taken but then start to rise as additional provisions become necessary. This results in a bigger spike in provisions for BBVA versus Santander and an overall provision charge that remains at an elevated level for longer.
The full note can be found in the usual place.
Related links:
BBVA, an exercise in Spanish banking losses – FT Alphaville
Provisioning for losses the Spanish way – FT Alphaville