2 options for Spanish bank stocks

Banco Santander stands out because of the attractiveness of its non-Spanish operations.

By Jim J. Jubak Sep 14, 2012 2:28PM
So now where for Spain's biggest and healthiest banks, Banco Bilbao Vizcaya (BBVA) and Banco Santander (SAN)?

Let me concentrate on Banco Bilbao in this post. Banco Bilbao is a member of my Jubak’s Picks portfolio

When I last visited this stock on May 30, it sat at $5.25 and I suggested that a reasonable one-year range for the stock’s price was $8 to $10.25. That gave me a potential 42% gain to the bottom of that range at $8.

Friday afternoon, the shares traded at $8.66.

A climb to a $10 top of the range over the next year, for example, offers only a 14% gain from here. That’s not enough, in my estimation, to justify holding onto to these shares given the likelihood that we’ve still got another patch of bad news ahead from Spain. (The stock also pays a 5.63% dividend so the total potential return is about 20%.)

A move to $12 a share -- my target price earlier in 2012 -- would produce a potential gain of 38% plus that 5.63% dividend. How likely is that? And how many bumps lie in the road to $12?

I think there are some useful clues in the second-quarter earnings report released at the end of June. It comes down to how bad debt balances out against easier capital.

Banco Bilbao missed Wall Street consensus on profits in the quarter by about 25% because the bank had to take higher provisions than expected against bad loans. Impairment losses climbed to 2.182 billion euros in the quarter, roughly double the 1.085 billion euros of the previous quarter. Non-performing loans rose to 4.03% from 4.02% in the first quarter. Non-performing loan ratios were stable in the bank’s South America unit and improved in Asia. Mexico was a concern with non-performing loans climbed to 4.0% from 3.8%. But the big problem was Spain where the non-performing loan ratio is both high -- at 5% -- and looks to be continuing to climb from 4.9% in the previous quarter.

What really pops out though in looking at Spain is the relatively low coverage levels on this bad debt at the bank even after the latest round of provisions for bad loans. Provisions cover just 50% of non-performing loans on the Spanish portfolio (66% for the bank as a whole.) That’s only a slight improvement from the 49% coverage in the first quarter.

Core capital rose to 10.8% in the quarter and while it looks like Banco Bilbao will have to raise more capital to meet future regulatory requirements, the improvement in financial markets after the latest plan from European Central Bank President Mario Draghi has meant that Banco Bilbao has been able successfully to tap financial markets again. On Sept. 10, Banco Bilbao was able to sell 1.5 billion euros in a three-year senior unsecured note with a 4.375% yield. No guarantee that the bank will be able to repeat that if Spain’s bond market takes a turn for the worse, but the offering does demonstrate that Banco Bilbao is one of Spain’s strongest banks.

Unfortunately, at the same time as access to the financial markets has improved for a strong bank such as Banco Bilbao, the Spanish economy continues to deteriorate. The economy shark by 0.3% in the first quarter and by 0.4% in the second quarter and is now forecast to show a contraction of 1.7% for the year as a whole.

That -- with unemployment of 25% or more -- certainly suggests that more of Banco Bilbao's loans will head toward the non-performing category. (People without jobs and companies without customers tend to have trouble paying on their loans.) The bank had only recognized about 24.4% of the losses in its property book as of the end of the second quarter, well short of the 40% required by new regulations. I think it’s safe to say that the bank could see another quarter or two with higher than currently expected provisions against bad loans.

So here are your options.

1. You can just hang on since this is one of the strongest banks in Spain and Banco Bilbao is likely to pick up market share in Spain from weaker banks. The decision here may hinge on how attractive you think the bank’s Mexican operation, the largest in Mexico, is. I do think the current 5.63% dividend is safe.

2. You can sell, taking the 66% gain from $5.25 on May 30 (offset against losses you have from buying the stock when I first recommended it back in February 2011 at $12.10), and then look to re-enter if the stock falls back to $7.00 to $7.50 or so on the next leg of the Spanish debt crisis. A drop back to $7 would return the potential gain to $10 to 30%. A drop to $7.50 would give a potential gain of 25%. I think this could be a profitable swing trade since the odds of another uptick in the Spanish debt crisis are high and Banco Bilbao is a likely long-term winner among European banks.

If you own shares of the two big Spanish banks as I do with Banco Bilbao in the Jubak’s Picks portfolio and Banco Santander in the dividend income portfolio, and you’d like to reduce your exposure to Spain and the euro crisis, I’d suggest sticking with Banco Santander over Banco Bilbao because of the greater attractiveness of Banco Santander’s non-Spanish operations.

Which then leaves you with just the issue of timing. I think the euro and the euro debt crisis is on a temporary upswing that has longer to run. So you might let Banco Bilbao run for a bit longer -- through the next round of European summits in October/November, for example. A decision by the government of Mariano Rajoy to ask for formal support of Spain’s bonds would be a positive for Spanish stocks.

But do remember that you’re looking for an exit here before the next swing of the pendulum.

At the time of this writing, Jim Jubak didn't own shares of any companies mentioned in this post in personal portfolios. The mutual fund he manages, Jubak Global Equity Fund (JUBAX), may or may not own positions in any stock mentioned. The fund did own shares of Banco Bilbao and Banco Santander as of the end of June. For a full list of the stocks in the fund as of the end of the most recent quarter, see the fund's portfolio here. 
Sep 16, 2012 11:23AM
"economy shark by 0.3"...That's who we're all worried about, Mr. Juback: the economy shark :) Seriously though, I agree SAN is a good bet for the long term with its very high dividend and recent performance. If you believe, like I do, that Germany is unlikely to let the currency union fail, then Spain should be ok after a few more years of spasms mostly related to the budgets of its provinces. SAN's diversification and its aggressive provisions will keep it out of the dumpster and in the meantime, the 10% dividend will keep one out of the water. .
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