Santander deal raises doubts over ECB stress test

Executed as a risk trade in under four hours and anchored by large orders from US and UK hedge funds, the deal gives the bank capital to grow its balance sheet at a time when, unlike many peers, it claims to be budgeting to add loans rapidly in many of the 10 countries in which it operates. 

For the bank it was a good deal, which Euromoney reports on in depth this month. For investors, time will tell. Its shares had traded at €6.85 when they were suspended on news of the coming supply. 

The deal was only just covered at the price of €6.18 where bookrunners Goldman Sachs and UBS had underwritten it. The share price sank to  €5.89 in the aftermath and had only recovered to  €5.94 by the end of January.

Buyers of the new shares won’t be the only ones watching nervously. It’s worth asking what this deal tells us about the credibility of the asset quality review and stress test the new regulator for large European banks completed amid great fanfare just three months earlier. Santander passed that test with flying colours. 

In late September, the ECB found that in the adverse scenario of its stress test, Santander would have the lowest capital decrease among its international peers with its transitional common equity tier 1 ratio dropping just 1.4 percentage points, to 9%, meaning that it would still easily exceed the 5.5% minimum and the required capital amount by close to €20 billion. 

Rather overlooked amid the fanfare for the deal and accompanying early release of 2014 numbers, Santander revised down its estimated year-end Basel III fully-loaded CET1 to 8.3% from 8.5-8.6% just eight weeks earlier – the difference coming down to a model approval for Brazil (worth 29bp) – granted by the Brazilian regulator but not yet by the ECB.

Now, here was Europe’s biggest bank bowing to what analysts and investors had long argued, that its capital level was far too low, even though the new regulator had blessed it. 

Santander’s new chief financial officer, José García Cantera, insists to Euromoney that the ECB exerted no pressure on the group to raise more. 

Investors may hear faint echoes in all this of the much-derided 2011 stress tests from the European Banking Authority.

Is all this new capital going to be consumed in chasing loan growth? New executive chairman Ana Botín has unequivocally ruled out acquisitions and can expect a bad market reaction if these now follow. 

Cantera carves out one exception to Euromoney. The bank simply has to be on the shortlist of potential buyers doing due diligence on Novo Banco (the successor to Banco Espírito Santo) when the government of Portugal privatizes it.

But could Santander need some of that new capital for the most traditional use of all: absorbing bad debts? The bank proclaims that it is big in markets now coming well out of the crisis – the US and UK – recovering fastest in the eurozone – Spain and Portugal – or never exposed to any such woes – Mexico, Chile, Poland.

But it has a big position in Brazil, where the macro outlook remains worrying. In Spain, many economists see signs of deflation taking hold. Portugal isn’t growing. Analysts at Berenberg, for example, remain sceptical that Santander’s capital is sufficient, even after the €7.5 billion raise, citing the high level of private debt and need for further deleveraging in Spain and exposures in Brazil.

Berenberg questions if Santander’s scale and structure is fit for a post-too-big-to-fail world made up of total loss-absorbing capacity regulations. It sets a target price of €5.40 for the stock.

Investors have placed much faith in the credibility of the ECB as bank regulator. Its asset quality review brought some needed consistency to previously divergent definitions of non-performing loans across Europe. But the quality of those loan exposures may ultimately depend on underlying collateral values. There is still a leap of faith required for investors in bank equity.